Napster (NAPS) 10-Q 2005 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 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 September 30, 2005

OR

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-32373

Napster, Inc.

(Exact name of Registrant as specified in its charter)

Delaware	77-0551214
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

9044 Melrose Avenue

Los Angeles, California 90069

(Address of principal executive offices, including zip code)

Registrant’s telephone number, including area code: (310) 281-5000

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

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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of October 28, 2005, there were43,887,284 shares of the Registrant’s Common Stock outstanding, par value $0.001.

NAPSTER, INC.

TABLE OF CONTENTS

		Page Number
PART I. Financial Information
Item 1	Financial Statements (unaudited)
	Condensed Consolidated Balance Sheets as of September 30, 2005 and March 31, 2005	4
	Condensed Consolidated Statements of Operations for the three and six months ended September 30, 2005 and 2004	5
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the six months ended September 30, 2005	6
	Condensed Consolidated Statements of Cash Flows for the six months ended September 30, 2005 and 2004	7
	Notes to Condensed Consolidated Financial Statements	9
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3	Quantitative and Qualitative Disclosures about Market Risk	47
Item 4	Controls and Procedures	48
PART II. Other Information
Item 1	Legal Proceedings	49
Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	50
Item 3	Defaults Upon Senior Securities	50
Item 4	Submission of Matters to a Vote of Security Holders	50
Item 5	Other Information	50
Item 6	Exhibits	50
Signatures		51
Index to Exhibits		52
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1

2

Cautionary Note regarding Forward-Looking Statements

In addition to historical information, this Quarterly Report on Form 10-Q (this “Quarterly Report”) contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are those that predict or describe future events or trends and that do not relate solely to historical matters. You can generally identify forward-looking statements as statements containing the words “believe,” “expect,” “will,” “anticipate,” “intend,” “estimate,” “project,” “assume” or other similar expressions, although not all forward-looking statements contain these identifying words. All statements in this Quarterly Report regarding our future strategy, future operations, projected financial position, estimated future revenues, projected costs, future prospects, and results that might be obtained by pursuing management’s current plans and objectives are forward-looking statements. You should not place undue reliance on our forward-looking statements because the matters they describe are subject to known and unknown risks, uncertainties and other unpredictable factors, many of which are beyond our control. Our forward-looking statements are based on the information currently available to us and speak only as of the date on which this Quarterly Report was filed with the Securities and Exchange Commission (“SEC”). We expressly disclaim any obligation to issue any updates or revisions to our forward-looking statements, even if subsequent events cause our expectations to change regarding the matters discussed in those statements. Over time, our actual results, performance or achievements will likely differ from the anticipated results, performance or achievements that are expressed or implied by our forward-looking statements, and such difference might be significant and materially adverse to our stockholders. Many important factors that could cause such a difference are described in this Quarterly Report under the caption “Risk Factors” which you should review carefully. Please consider our forward-looking statements in light of those risks as you read this Quarterly Report.

3

PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

NAPSTER, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except per share data)

(unaudited)

	September 30, 2005			March 31, 2005
ASSETS
Current assets:
Cash and cash equivalents	$	68,049		$	135,416
Short-term investments		59,550			32,380
Accounts receivable, net of allowance for doubtful accounts of $11 at September 30, 2005 and $6 at March 31, 2005		1,553			1,545
Prepaid expenses and other current assets		3,672			9,775
Total current assets		132,824			179,116
Property and equipment, net		5,287			5,337
Goodwill		34,658			34,658
Identifiable intangible assets, net		337			1,349
Other assets		445			422
Total assets	$	173,551		$	220,882
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	5,224		$	6,547
Income taxes payable		3,708			4,125
Accrued liabilities		13,492			11,381
Deferred revenues		8,322			8,345
Deferred gain on divestiture		2,123			2,073
Short-term debt		89			15,110
Total current liabilities		32,958			47,581
Long-term liabilities
Deferred income taxes		2,160			1,696
Other long-term liabilities		188			212
Total liabilities		35,306			49,489
Commitments and contingencies (Note 9)
Stockholders’ equity:
Preferred stock, $0.001 par value; Authorized: 10,000,000 shares; Issued and outstanding: none at September 30, 2005 and March 31, 2005		-			-
Common stock, $0.001 par value; Authorized: 100,000,000 shares; Issued and outstanding: 43,887,000 shares at September 30, 2005 and 42,961,000 shares at March 31, 2005		44			43
Additional paid-in capital		260,475			256,586
Deferred stock-based compensation		(3,898	)		(533	)
Accumulated deficit		(119,961	)		(86,423	)
Accumulated other comprehensive income		1,585			1,720
Total stockholders’ equity		138,245			171,393
Total liabilities and stockholders’ equity	$	173,551		$	220,882

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

4

NAPSTER, INC

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)

(unaudited)

	Three Months Ended September 30,						Six Months Ended September 30,
	2005			2004			2005			2004
Net revenues	$	23,379		$	9,315		$	44,380		$	17,182
Cost of revenues (1)		18,287			7,508			32,692			13,955
Gross margin		5,092			1,807			11,688			3,227
Operating expenses:
Research and development (2)		3,216			3,189			6,411			6,076
Sales and marketing (3)		10,391			9,447			26,663			13,742
General and administrative (4)		4,791			5,704			10,987			10,567
Amortization of intangible assets		474			474			948			988
Total operating expenses		18,872			18,814			45,009			31,373
Loss from continuing operations		(13,780	)		(17,007	)		(33,321	)		(28,146	)
Other income, net		451			106			331			75
Loss before income tax benefit (provision)		(13,329	)		(16,901	)		(32,990	)		(28,071	)
Income tax benefit (provision)		(283	)		828			(548	)		4,415
Loss from continuing operations, after income taxes		(13,612	)		(16,073	)		(33,538	)		(23,656	)
Income from discontinued operations, net of tax effect (5)		-			760			-			5,703
Net loss	$	(13,612	)	$	(15,313	)	$	(33,538	)	$	(17,953	)
Other comprehensive loss net of tax:
Foreign currency translation adjustment	$	(123	)	$	247		$	(275	)	$	(27	)
Unrealized gain (loss) on short-term investments		111			(49	)		140			(124	)
Comprehensive loss	$	(13,624	)	$	(15,115	)	$	(33,673	)	$	(18,104	)
Earnings per share:
Net loss per share from continuing operations, after income taxes
Basic and diluted	$	(0.32	)	$	(0.46	)	$	(0.78	)	$	(0.69	)
Net income per share from discontinued operations
Basis and diluted	$	-		$	0.02		$	-		$	0.17
Net loss per share
Basic and diluted	$	(0.32	)	$	(0.44	)	$	(0.78	)	$	(0.52	)
Weighted average shares used in computing net income (loss) per share
Basic and diluted		42,977			34,729			42,969			34,230

(1) Includes stock-based compensation charges of $3 and $4 for the three and six months ended September 30, 2005 and $0 and $0 for the three and six months ended September 30, 2004, respectively

(2) Includes stock-based compensation charges of $72 and $95 for the three and six months ended September 30, 2005 and $2 and $4 for the three and six months ended September 30, 2004, respectively.

(3) Includes stock-based compensation charges of $29 and $38 for the three and six months ended September 30, 2005 and $0 and $0 for the three and six months ended September 30, 2004, respectively.

(4) Includes stock-based compensation charges of $190 and $286 for the three and six months ended September 30, 2005 and $202 and $446 for the three and six months ended September 30, 2004, respectively.

(5) Includes stock-based compensation charges of $0 and $0 for the three and six months ended September 30, 2005 and $95 and $231 for the three and six months ended September 30, 2004, respectively.

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

5

NAPSTER, INC

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN

STOCKHOLDERS’ EQUITY

(in thousands)

(unaudited)

	Common Stock				Additional Paid-in Capital			Deferred Stock- Based Compensation			Accumulated Deficit			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
	Shares		Amount
Balance at March 31, 2005	42,961		$	43	$	256,586		$	(533	)	$	(86,423	)	$	1,720		$	171,393
Net loss												(33,538	)					(33,538	)
Foreign currency translation adjustment															(275	)		(275	)
Unrealized gain on short-term investments															140			140
Issuance of common stock under employee stock plans	933			1		3,914			(3,807	)								108
Cancellation of common stock and reversal of deferred stock-based compensation upon employee termination	(7	)		-		(29	)		29									-
Stock-based compensation related to option issued to non-employee						10												10
Amortization of deferred stock-based compensation									413									413
Adjustment to stock issue costs in connection with issuance of common stock						(6	)											(6	)
Balance at September 30, 2005	43,887		$	44	$	260,475		$	(3,898	)	$	(119,961	)	$	1,585		$	138,245

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

6

NAPSTER, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Six Months Ended September 30,
	2005			2004
Cash flows from operating activities:
Net loss	$	(33,538	)	$	(17,953	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		2,634			5,109
Amortization of prepaid marketing expenses		1,727			4,998
Stock-based compensation charges		423			680
Impairment of assets		-			282
Change in fair market value of hedge		684			-
Non-cash purchase of LT investment - IseeMedia		-			(200	)
Non-cash loss from remeasurement of cash balance		510			-
Deferred tax expense		464			-
Gain on sale of GoBack assets		-			(1,682	)
Change in operating assets and liabilities:
Accounts receivable		(16	)		4,408
Prepaid expenses and other assets		(496	)		(3,071	)
Accounts payable		(1,324	)		449
Income taxes payable (receivable)		(454	)		102
Accrued liabilities		2,153			(2,571	)
Deferred revenues		(22	)		2,117
Other long-term liabilities		(3	)		(285	)
Net cash used in operating activities		(27,258	)		(7,617	)
Cash flows from investing activities:
Purchases of property and equipment		(444	)		(213	)
Capitalization of software development costs		(1,128	)		-
Proceeds from sale of GoBack assets		-			2,760
Purchases of short-term investments		(62,749	)		(61,005	)
Proceeds from sale of short-term investments		-			13,316
Maturities of short-term investments		39,934			35,455
Transfer to restricted cash account		-			1,000
Net cash used in investing activities		(24,387	)		(8,687	)
Cash flows from financing activities:
Principal payment of capital lease obligation		(51	)		(427	)
Repayment of line of credit		(15,000	)		-
Issuance of common stock under employee stock plan		108			461
Issuance of common stock		-			1
Net cash (used in) provided by financing activities		(14,943	)		35
Effect of exchange rates on cash		(779	)		(62	)
Change in cash and cash equivalents		(67,367	)		(16,331	)
Cash and cash equivalents at beginning of period		135,416			36,911
Cash and cash equivalents at end of period	$	68,049		$	20,580

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

7

NAPSTER, INC

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS—(Continued)

(in thousands)

(unaudited)

	Six Months Ended September 30,
	2005		2004
Supplemental cash flow information:
Cash paid for interest	$	155	$	302
Cash paid for income taxes	$	410	$	115
Non-cash disclosure of investing and financing activities:
Unrealized gains (losses) on short-term investments	$	140	$	(124	)
Issuance of common stock in connection with startegic marketing agreement and purchase acquisition	$	-	$	4,999
Issuance of common stock in connection with restricted stock awards to employees, net of terminations	$	3,885	$	-
Asset purchased under capital lease	$	22	$	-
Goodwill resulting from the acquisition of Napster, LLC	$	-	$	51
Reversal of accrual for offering expenses related to private equity financing	$	6	$	186

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

8

NAPSTER, INC

Notes to Condensed Consolidated Financial Statements

NOTE 1—BASIS OF PRESENTATION

Basis of presentation

The unaudited condensed consolidated financial statements have been prepared by Napster, Inc., a Delaware corporation (“Napster” or the “Company”), pursuant to the rules and regulations of the SEC. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, Napster believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes included in Napster’s Annual Report on Form 10-K for the year ended March 31, 2005.

Until December 17, 2004, Napster was known as “Roxio, Inc.” and operated its business in two divisions, the consumer software division (“CSD”) and the online music distribution division, also known as the Napster division. On December 17, 2004, Napster completed the sale of substantially all of the assets and liabilities of CSD to Sonic Solutions, a California corporation (“Sonic”). Sonic paid a total of $72.3 million in cash, subject to certain future adjustments, and 653,837 shares of Sonic common stock, valued at approximately $13.6 million as of the closing date. The divestiture of CSD was accounted for as a discontinued operation in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” (“SFAS No. 144”) and, accordingly, the results of operations of the CSD are no longer presented within continuing operations.

Since the sale of CSD in December 2004, Napster has focused exclusively on the digital music distribution business under the Napster brand and, since January 3, 2005, has been traded on the Nasdaq Stock Market under the symbol “NAPS.”

The condensed consolidated financial statements reflect all adjustments, which include only normal, recurring adjustments, that are, in the opinion of management, necessary to state fairly the results for the periods presented. The results for such periods are not necessarily indicative of the results to be expected for the full year.

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

Reclassification

Certain reclassifications have been made to prior year balances in order to conform to the current period presentation, such as, stock-based compensation expenses have been reclassified to their respective operating expense classification. This reclassification does not have an effect on Napster’s consolidated financial condition, results of operations, or cash flows.

9

NAPSTER, INC

Advertising Costs

Advertising costs, with the exception of production costs related to television advertising, are expensed as incurred through direct spending. Advertising costs (excluding television production costs) were approximately $7.3 million and $20.0 million for the three and six months ended September 30, 2005, respectively, and $6.0 million and $8.8 million for the three and six months ended September 30, 2004, respectively.

Foreign Currency Derivatives

Napster currently has a foreign exchange forward contract related to $7.6 million held in Danish Kroner in connection with the liquidation of a foreign subsidiary. The amount of the forward contract is $7.0 million, leaving $600,000 of Danish Kroner subject to currency fluctuations. This forward contract expires December 2, 2005. Napster does not enter into foreign exchange forward contracts for trading purposes, but has done so to minimize the short-term impact of foreign currency fluctuations of these foreign currency assets.

Gains and losses on this foreign exchange forward contract are included in Other income, net, in the Condensed Consolidated Statements of Operations and offset foreign exchange gains or losses from the revaluation of the associated cash balance. For the three months ended September 30, 2005, Napster recognized a loss of $63,000 from the associated foreign currency. At September 30, 2005, $15,000 was recorded as a payable for this forward contract.

Stock-based compensation

The following table illustrates the effect on net loss and earnings per share if Napster had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation (in thousands, except per share amounts):

	Three Months Ended September 30,						Six Months Ended September 30,
	2005			2004			2005			2004
Net loss, as reported	$	(13,612	)	$	(15,313	)	$	(33,538	)	$	(17,953	)
Add:
Unearned stock-based compensation expense included in reported net loss, net of related tax effects		284			299			413			681
Deduct:
Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(1,193	)		(2,203	)		(2,430	)		(4,504	)
Pro forma net loss	$	(14,521	)	$	(17,217	)	$	(35,555	)	$	(21,776	)
Net loss per share:
Basic and diluted - as reported	$	(0.32	)	$	(0.44	)	$	(0.78	)	$	(0.52	)
Basic and diluted - pro forma	$	(0.34	)	$	(0.50	)	$	(0.83	)	$	(0.64	)

Napster uses the straight-line method to amortize its SFAS No. 123 pro forma stock–based compensation expense over the vesting period, which is generally four years, for stock options and restricted stock awards, and over the applicable purchase period, which ranges from six months to two years, for ESPP purchase rights.

Pro forma information regarding net loss and net loss per share is required by SFAS No. 123. This information is required to be determined as if Napster had accounted for its restricted stock awards, employee stock options, and ESPP under the fair value method of SFAS No. 123, as amended by SFAS No. 148.

10

NAPSTER, INC

The fair value of stock options and ESPP stock purchase rights was estimated on the date of grant using the Black-Scholes model. The following table sets forth the weighted-average assumptions used to calculate the fair value of the stock options and ESPP stock purchase rights granted during the periods. There were no stock options granted in the three months ended September 30, 2005.

	Three Months Ended September 30,		Six Months Ended September 30,
	2005	2004	2005	2004
Stock options:
Expected volatility	-	98%	93%	98%
Risk-free interest rate	-	3.21%	3.91%	3.20%
Expected life	-	4 years	4 years	4 years
Expected dividend yield	-	zero	zero	zero
ESPP stock purchase rights:
Expected volatility	97%	98%	97%	98%
Risk-free interest rate	2.65%	2.27%	2.65%	2.27%
Expected life	1.5 years	1.2 years	1.5 years	1.2 years
Expected dividend yield	zero	zero	zero	zero

The Black-Scholes option pricing model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option pricing models require the input of highly subjective assumptions including expected stock price volatility. Napster uses projected volatility rates, which are based upon historical volatility rates, trended into future years. Because Napster’s employee stock options and ESPP stock purchase rights have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing option-pricing models do not necessarily provide a reliable single measure of the fair value of our options and purchase rights.

Under the Black-Scholes option pricing model, the weighted average fair value of stock options at date of grant was $4.26 per share for options granted during the six months ended September 30, 2005 and $2.86 per share for options granted during the three and six months ended September 30, 2004, respectively. No options were granted in the three months ended September 30, 2005. The weighted-average fair value of purchase rights under the ESPP was $2.62 per share for purchase rights granted during the three and six months ended September 30, 2005 and $1.96 per share for purchase rights granted during the three and six months ended September 30, 2004, respectively.

The fair value of restricted stock awards is identical whether accounted for in accordance with APB 25 or SFAS No. 123.

NOTE 2—DISCONTINUED OPERATIONS

As described in Note 1, on December 17, 2004 Napster sold substantially all of the assets and liabilities constituting CSD, including all of the capital stock of certain international subsidiaries historically included in CSD, to Sonic. The remaining international subsidiaries historically included in CSD have been substantially liquidated. The disposition is accounted for by Napster as a discontinued operation in accordance with SFAS No. 144. Therefore, CSD’s results of operations for the three and six months ended September 30, 2004 and cash flows for the six months ended September 30, 2004 have been classified as results of operations from discontinued operations. There were no discontinued operations for the three and six month periods ended September 30, 2005.

11

NAPSTER, INC

Operating Results of Discontinued Operations

Summarized selected condensed consolidated statement of operations for the discontinued operations for the three and six month periods ended September 30, 2004 are as follows (in thousands):

	Three Months Ended September 30, 2004		Six Months Ended September 30, 2004
Net revenues	$	18,115	$	40,163
Gross margin		12,958		29,716
Operating expenses		11,093		21,068
Gain on divestiture		-		1,682
Income from discontinued operations before provision for income taxes		1,743		10,458
Tax provision		983		4,755
Income from discontinued operations	$	760	$	5,703

NOTE 3—CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS

Cash and cash equivalents

	September 30, 2005 Fair Value		March 31, 2005 Fair Value
	(in thousands)
Cash	$	47,065	$	19,493
Cash equivalents:
Commercial paper		4,262		3,541
Government securities		-		1,963
Money market securities		16,722		110,419
Total cash equivalents		20,984		115,923
Total cash and cash equivalents	$	68,049	$	135,416

Short-term investments

	September 30, 2005 Fair Value		March 31, 2005 Fair Value
	(in thousands)
Commercial paper	$	18,772	$	4,561
Corporate securities		10,229		10,657
Municipal securities		9,523		1,059
U.S. agencies securities		5,967		6,263
Certificates of deposit		1,002		-
Sonic Solutions common stock		14,057		9,840
Total short-term investments	$	59,550	$	32,380

Napster’s investments in marketable securities and short-term investments are all considered available for sale. The fair values of these investments approximate carrying value. Realized gains on short-term investments totaled $245,000 and $62,000 in the three months ended September 30, 2005 and 2004, respectively, offset by realized losses on short term investments of $141,000 and $59,000, respectively. Realized gains on short-term investments totaled $345,000 and $122,000 in the six months ended September 30, 2005 and 2004, respectively, offset by realized losses on short term investments of $172,000 and $132,000, respectively. There was a $1.2 million unrealized gain on the Sonic Solutions common stock as of September 30, 2005 and March 31, 2005. We hold a fair value hedge on the Sonic Solutions common stock. Although the value of the common stock increased $4.3 million in the six months ended September 30, 2005, the associated fair value hedge receivable, which is presented as an other current asset, declined a comparable amount. Additionally, there were $128,000 and $33,000 of unrealized gains on other short term investments as of September 30, 2005 and March 31, 2005, respectively, and $551,000 and $596,000 of unrealized losses as of September 30, 2005 and March 31, 2005, respectively.

12

NAPSTER, INC

Approximately $45.5 million and $20.6 million of the short-term investments mature in less than one year as of September 30, 2005 and March 31, 2005, respectively. The remaining short-term investments generally have effective maturity dates between one and two years. As the short-term investments represent the investment of cash available to fund current operations, the entire balance has been classified as short-term in the balance sheet.

NOTE 4—BALANCE SHEET DETAIL

Prepaid expenses and other current assets

	September 30, 2005		March 31, 2005
	(in thousands)
Prepaid insurance	$	798	$	180
Other accounts receivable		628		—
Finished goods inventories		336		149
Prepaid content advances		272		452
Prepaid marketing expense		204		3,081
Fair value hedge receivable		—		4,619
Other prepaid fees		1,434		1,294
	$	3,672	$	9,775

Total content advances at September 30, 2005 and March 31, 2005 were $554,000 and $748,000, respectively. A total of $282,000 and $296,000 of those amounts, respectively, are included in other assets.

Property and equipment

	Life	September 30, 2005			March 31, 2005
		(in thousands)
Property and equipment, net:
Computer equipment and software	3 - 5 years	$	8,677		$	8,327
Furniture and fixtures	3 - 8 years		326			293
Leasehold improvements	Life of lease		666			640
Capitalized software development costs	3 - 5 years		1,690			562
			11,359			9,822
Less: Accumulated depreciation and amortization			(6,072	)		(4,485	)
		$	5,287		$	5,337

Depreciation and amortization expense in continuing operations totaled $818,000 and $1.6 million for the three and six months ended September 30, 2005, respectively, and $665,000 and $1.3 million for the three and six months ended September 30, 2004, respectively. Depreciation and amortization expense in discontinued operations totaled $652,000 and $1.3 million for the three and six months ended September 30, 2004, respectively. The amortization of capitalized software development costs, included in depreciation and amortization expense in continuing operations, totaled $47,000 and $94,000 for the three and six months ended September 30, 2005, respectively, and $40,000 and $79,000 for the three and six months ended September 30, 2004, respectively. Capitalized software development costs include $1.1 million of costs related to projects that are not completed and for which amortization has not commenced.

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Accrued liabilities

	September 30, 2005		March 31, 2005
	(in thousands)
Accrued affiliate and content liabilities	$	6,704	$	5,327
Accrued publishing fees		2,334		784
Accrued compensation and related expenses		1,373		1,745
Other accrued liabilities		3,081		3,525
	$	13,492	$	11,381

Deferred revenue

	September 30, 2005		March 31, 2005
	(in thousands)
Unearned content revenues	$	7,302	$	6,849
Unearned hardware and license revenues		1,020		1,017
Deferred marketing expense benefit		-		479
	$	8,322	$	8,345

NOTE 5—IDENTIFIABLE INTANGIBLE ASSETS AND GOODWILL

Identifiable intangible assets

Identifiable intangible assets as of September 30, 2005 consist principally of trademarks with a net book value totaling $337,000, which will be fully amortized during the quarter ending December 31, 2005. Amortization of identifiable intangible assets for continuing operations was $506,000 and $1.0 million for the three and six months ended September 30, 2005, respectively, and $506,000 and $1.1 million for the three and six months ended September 30, 2004, respectively. Amortization of identifiable intangible assets within discontinued operations was $735,000 and $1.5 million for the three and six months ended September 30, 2004, respectively.

Goodwill

Changes in the carrying amount of goodwill are as follows:

	Six Months Ended September 30, 2005		Year Ended March 31, 2005
	(in thousands)
Balance at beginning of fiscal year	$	34,658	$	89,516
Goodwill resulting from the acquisition of Napster, LLC		-		(51	)
Divestiture of CSD		-		(55,597	)
Effect of foreign currency exchange		-		790
Balance at end of period	$	34,658	$	34,658

In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” Napster annually evaluates the carrying value of goodwill and adjusts the carrying value if the asset’s value has been impaired. In addition, Napster periodically evaluates if there are any events or circumstances that would require an impairment assessment of the carrying value of the goodwill between each annual impairment assessment. Napster completed its most recent annual goodwill impairment review as of March 31, 2005 and concluded that goodwill was not impaired. No impairments have been identified or recorded in any period presented.

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NOTE 6—SHORT-TERM DEBT

At September 30, 2005, Napster had available a $17.0 million revolving line of credit with Silicon Valley Bank and was in compliance with all covenants relating to this line of credit.

NOTE 7—STOCKHOLDERS’ EQUITY

Restricted Stock Awards

During the six months ended September 30, 2005, Napster granted to employees restricted stock awards for 900,878 shares of common stock with a weighted-average fair value of $4.23 per share. Restricted stock awards are shares of common stock which are forfeited if the employee leaves the company prior to vesting. The restricted stock awards vest ratably over a four-year period in annual cliffs. Stock-based compensation during the three and six months ended September 30, 2005 includes $228,000 and $302,000, respectively, of compensation expense associated with these restricted stock awards. We will recognize stock-based compensation expenses related to the grants of these restricted awards as the shares vest through 2009. A total of 893,561 shares of stock were outstanding under restricted stock award grants at September 30, 2005.

Deferred stock-based compensation at September 30, 2005 includes $3.5 million in deferred compensation expense associated with these restricted stock awards. No compensation expense will be recognized for restricted stock awards that do not vest.

NOTE 8—GEOGRAPHIC INFORMATION

Net revenue by countries

The following table presents net revenues from continuing operations by geography based on the location of customers:

	Three Months Ended September 30,				Six Months Ended September 30,
	2005		2004		2005		2004
	(in thousands)
United States	$	20,615	$	8,365	$	39,090	$	15,895
United Kingdom		2,764		950		5,290		1,287
	$	23,379	$	9,315	$	44,380	$	17,182

Cash and investments

The following table presents cash and investments by country:

	September 30, 2005		March 31, 2005
	(in thousands)
United States	$	117,117	$	156,259
United Kingdom		2,832		3,242
Denmark		7,635		7,659
Other countries		15		636
	$	127,599	$	167,796

Napster does not anticipate that it will incur any material U.S. income or foreign withholding taxes when cash is repatriated to the United States.

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Long-lived assets

The following table presents long-lived assets, excluding goodwill and identifiable intangible assets, by geography based on the location of the assets:

	September 30, 2005		March 31, 2005
	(in thousands)
United States	$	5,652	$	5,726
Europe		80		33
	$	5,732	$	5,759

NOTE 9—COMMITMENTS AND CONTINGENCIES

Litigation

Napster and Pressplay have been notified by a number of companies that the Pressplay and Napster online music distribution services may infringe patents owned by those companies. Napster is investigating the nature of these claims and the extent to which royalties may be owed by Napster and Pressplay to these entities. The ultimate resolution of these claims cannot be determined at this time.

On October 8, 2004, SightSound Technologies, Inc. filed a lawsuit against Napster and Napster, LLC in U.S. District Court for the Western District of Pennsylvania, Case No. 04-1549, alleging infringement of certain of its patents by the Napster service. SightSound is demanding monetary damages and injunctive relief. Napster was served with the complaint in the lawsuit on November 5, 2004. Napster has answered the complaint and filed an application with the United States Patent and Trademark Office for reexamination of the patents. In January 2005, SightSound moved for a preliminary injunction of the Napster service and Napster moved for a stay of the proceedings pending the outcome of Napster’s reexamination application. On February 28, 2005, the court granted Napster’s motion to stay and denied SightSound’s motion for preliminary injunction without prejudice. On March 3, 2005, SightSound filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit, appealing the district court’s order. On March 22, 2005, SightSound filed a Petition to Cancel certain trademark registrations owned by Napster before the Trademark Trial and Appeals Board, claiming that Napster did not acquire the rights to these trademarks when it purchased them through the bankruptcy estate. Napster believes that this petition is entirely without merit, and it has been stayed by TTAB pending resolution of the litigation in Pennsylvania. On May 19, 2005, Napster filed a motion with the U.S. Bankruptcy Court for the District of Delaware to reopen the Napster bankruptcy case and enforce the order assigning all of the assets of the former Napster, Inc. (including trademarks and goodwill) to us. On August 23, 2005, an order confirming the sale to Napster of the Napster trademarks, including goodwill, was granted by the Bankruptcy Court. On or about October 31, 2005, the United States Patent and Trademark Office issued second office actions rejecting all of the claims of the SightSound patents. SightSound will likely respond to these office actions within two months. Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of these matters will have on Napster’s results of operations, financial position or cash flows.

On August 5, 2005, Ho Keung Tse filed suit against Apple Computer, Inc., Napster, Inc., MusicMatch, Inc., Sony Connect, Inc., Yahoo, Inc. and RealNetworks, Inc. in U.S. District Court for the District of Maryland alleging infringement of U.S. Patent No. 6665797 by the defendants’ respective music distribution services. Mr. Tse is demanding monetary damages and injunctive relief. The defendants have formed a joint defense group and intend to defend themselves vigorously. Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of these matters will have on Napster’s results of operations, financial position or cash flows.

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Napster is a party to other litigation matters and claims from time to time in the ordinary course of its operations, including copyright infringement litigation for which it is entitled to indemnification by content providers, and is a party to certain litigation matters relating to CSD that have been assumed by Sonic in connection with its purchase of CSD. While the results of such litigation and claims cannot be predicted with certainty, Napster believes that the final outcome of such matters will not have a material adverse impact on its business, financial position, cash flows or results of operations.

Indemnification

Napster has agreed pursuant to the CSD divestiture agreement to indemnify Sonic for breaches of representations and warranties (other than those breaches related to tax matters) and covenants contained in the agreement, for undisclosed liabilities, and for defects with respect to the financial statements provided to Sonic relating to CSD. The agreement limits the maximum amount of potential future payments and the time period during which a claim may be made.

In addition, Napster has agreed to indemnify Sonic for unpaid tax liabilities with respect to any tax year ended on or before December 17, 2004 (or for any other tax year to the extent allocable to the portion of such period beginning before and ending on December 17, 2004), to the extent such tax liabilities neither are reflected in the closing working capital calculation pursuant to the agreement nor create a realized reduction in Sonic’s tax liabilities. Napster will also indemnify Sonic for damages that relate to certain other tax-related matters, as described in the agreement. No limitation is set forth on the period of time by which a claim must be made pursuant to the foregoing indemnities nor is there a specified limitation on the maximum amount of potential future payments.

Contingent Liabilities

Napster may also be required to make additional post-closing payments to Sonic if reserves for sales returns and allowances, working capital, or channel inventory as of December 17, 2004 differ from the levels specified by the agreement.

Under copyright law Napster is required to pay licensing fees for compositions embodied in digital sound recordings and for the sound recordings themselves that are delivered in the Napster service. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or by arbitration if unsuccessful. There are certain geographies and agencies for which we have not yet completed negotiations with regard to the royalty rate to be applied to the current or historic sales of our digital music offerings. Napster accrues for the cost of these fees in accordance with SFAS No. 5, “Accounting for Contingencies,” based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. As of September 30, 2005 and March 31, 2005 a total of $2.3 million and $784,000, respectively, was accrued for contingent publishing fees. If the final agreed rate differs significantly from management’s estimates, the actual amount paid and expensed could differ materially from the recorded amounts.

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NOTE 10—RECENT ACCOUNTING PRONOUNCEMENTS

Share-Based Payments

On December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which revises the previously effective SFAS No. 123 and supersedes APB No. 25, and on March 29, 2005 the SEC issued SAB 107, “Share-Based Payment.” These pronouncements address the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25 and generally requires that such transactions be accounted for using a fair value-based method and recognized as expenses in our consolidated statements of operations. The effective date of the proposed standard for public companies is for the first annual reporting period beginning after June 15, 2005. We are evaluating the requirements under SFAS No. 123(R) and expect the adoption on April 1, 2006 to have a significant adverse impact on our consolidated statements of operations and net income (loss) per share.

Exchanges of Nonmonetary Assets

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” (“SFAS No. 153”) an amendment of APB No. 29, which requires nonmonetary exchanges to be recorded at the fair value of the assets exchanged, with certain exceptions. This standard requires most exchanges of productive assets to be accounted for at fair value, rather than at carryover basis. The provisions of SFAS No. 153 are effective for fiscal years beginning after June 15, 2005 and we will adopt this standard in fiscal 2006. Adoption of this statement will have no material impact on our consolidated financial position or results of operations.

Foreign Earnings Repatriation

In December 2004, the FASB issued FASB Staff Position (“FSP”) 109-2 regarding “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (the “AJCA”) (“FSP 109-2”). The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. We have no material earnings to repatriate, so we do not expect this new position statement to have a material impact on our consolidated financial position or results of operations.

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NOTE 11—SUBSEQUENT EVENTS

On October 14, 2005, Napster, LLC, a subsidiary of Napster, entered into a Joint Venture Operating Agreement with Tower Records Japan, Inc. (“Tower Japan”), relating to the formation and operation of a Japan-based joint venture company (the “Joint Venture”) for the purpose of operating the Napster online music service across digital distribution channels in Japan. Under the terms of this agreement, Napster LLC will license intellectual property rights to the Joint Venture, including platform technology and trademarks in exchange for certain guaranteed royalties, and Tower Japan will support the Joint Venture’s marketing and advertising activities. The Joint Venture will have exclusive rights to operate the Napster service in Japan.

On October 14, 2005, Napster, LLC contributed 151,200,000 Japanese Yen ($1.3 million at September 30, 2005 exchange rates) to the Joint Venture and in February 2006 Napster LLC will contribute an additional 157,500,000 Japanese Yen ($1.4 million at September 30, 2005 exchange rates) to the Joint Venture, in exchange for a 31.5% ownership interest. Tower Japan will contribute a total of 671,300,000 Japanese Yen for a 68.5% ownership interest. The parties will each have customary shareholder rights in the Joint Venture, including veto rights, rights to appoint directors and officers and rights of first refusal. Tower Japan will also be obligated to arrange or provide debt or equity funding including through an unsecured revolving loan facility. Napster, LLC will account for its investment in the Joint Venture under the equity method of accounting.

On October 21, 2005, Katherine Chamberlin, purportedly on behalf of a class of California consumers, filed a lawsuit against Napster, Inc. and Napster, LLC alleging a violation of California state statutes relating to expiration dates on gift certificates. We have not been served in this matter but do not believe that the lawsuit, if served, will have a material impact on our business or on our consolidated financial position or results of operations.

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

The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere in this quarterly report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, in “Risk Factors” and elsewhere in this quarterly report.

Management’s Discussion and Analysis of Financial Condition and Results of Operations is organized as follows:

• Executive Summary—a high level discussion of the business including a discussion of our strategy, opportunities, challenges and risks.

• Critical Accounting Policies and Estimates—a discussion of accounting policies that require critical judgments and estimates.

• Results of Operations—an analysis of our consolidated results of operations for the periods presented in our financial statements.

• Liquidity and Capital Resources—an analysis of cash flows, sources and uses of cash, and contractual obligations.

• Recent Accounting Pronouncements—information on recent accounting pronouncements.

Executive Summary

Napster, among the most recognized brands in digital music, is a leading provider of online music for the consumer market. Our subscription services and our “a la carte” single track download service enable fans to sample one of the world’s largest and most diverse digital music catalogues and to experience the most feature rich service utilizing a secure and legal platform. Napster users have access to songs from all major labels and hundreds of independent labels and have many ways to discover, share and acquire new music and old favorites. Napster subscribers also enjoy community features, such as the ability to email songs to friends and to browse other members’ collections. For consumers who want to purchase songs and albums a la carte, rather than through a subscription, we also offer Napster Light, a “lighter” version of our Napster service that does not include the ability to stream or download unlimited tracks or enjoy other premium community features. Napster is currently available in the United States, Canada and the United Kingdom and is headquartered in Los Angeles with offices in Frankfurt, London, New York, San Diego and San Jose.

Until December 17, 2004, Napster was known as “Roxio, Inc.” and we operated our business in two divisions, the consumer software division (“CSD”) and the digital music distribution division, also known as the Napster division.

On December 17, 2004, we completed the sale of substantially all of the assets and liabilities of CSD to Sonic Solutions, a California corporation (“Sonic”), including all of the capital stock of certain international subsidiaries. Sonic paid a total of $72.3 million in cash, subject to certain future adjustments, and 653,837 shares of Sonic common stock, valued at approximately $13.6 million as of the closing date. We intend to retain the proceeds and use them for general working capital purposes and to operate and expand our Napster business.

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Since the sale of our consumer software division, we have focused exclusively on our digital music distribution business under the Napster brand and, since January 3, 2005, have been traded on the Nasdaq Stock Market under the symbol “NAPS.”

Napster derives its primary revenues from digital music subscriptions and permanent music downloads. The Napster service offers subscribers on-demand access to a wide variety of music that can be streamed or downloaded as well as the ability to purchase individual tracks or albums on an a la carte basis. Subscription and permanent download fees are paid by end user customers in advance either via credit card, online payment systems or redemption of pre-paid cards, gift certificates or promotional codes. Napster also periodically licenses merchandising rights and resells hardware that our end users may utilize to store and replay their digital music content.

The digital music business was launched under the Napster brand in the United States in October 2003. Prior to this launch we had digital music revenue from the acquisition of a business, Napster, LLC, formerly known as Pressplay. During May 2004, we expanded the service to be available in both the United Kingdom and Canada. We expect to launch our service in Germany this fiscal year and in Japan through our Joint Venture in fiscal 2007.

Our digital music subscription services, Napster and Napster To Go, provide consumers with unlimited access to over 1,500,000 songs for monthly fees of $9.95 and $14.95, respectively in the United States. Fees in other geographies vary based on the local currency and market factors. With all of our products, consumers can discover, access and acquire their favorite songs by searching or browsing our catalogue, or accessing preprogrammed content through radio stations or custom compilations. Napster subscribers also have access to community features, such as sharing songs with other members and searching their collections. With a Napster subscription, for as long as consumers maintain their subscription, they can enjoy unlimited on-demand streaming and unlimited tethered downloading of songs to the hard drives of three PCs. With a Napster To Go subscription users can enjoy all the benefits of a Napster subscription, as well as unlimited transfers of tethered downloads to a compatible MP3 player without paying an additional fee per song. In other words, a Napster To Go subscriber enjoys unlimited music on up to three PCs and “on the go” with up to two compatible MP3 players. In addition to our Napster and Napster To Go offerings, we provide a download music store, called Napster Light, where customers who are not subscribers can purchase individual tracks for $0.99 each or albums starting at $6.95. These tracks can be downloaded or “burned” to a CD, or transferred to an MP3 player. Napster’s catalogue of available music exceeds one and a half million tracks and all content is licensed from major music companies, including EMI Recorded Music, Sony BMG, Universal Music Group and Warner Music Group, as well as numerous independent labels, on a non-exclusive basis.

Consumers have a choice of MP3 players, portable media players and mobile phones with which to enjoy Napster To Go. Currently, over forty devices by numerous manufacturers are compatible with Napster To Go. Current manufacturers of compatible devices include but are not limited to: Dell, Creative, SanDisk, Samsung, Gateway, iRiver, Palm, Toshiba, Motorola, Audiovox and Siemens. If the public availability of compatible devices is delayed, or there are not enough compatible devices, our planned revenue growth could be adversely impacted.

We sell our digital music services directly to end users through our Napster.com website, but also use retail distribution partners to promote and bundle the Napster services with other products they sell. If we lost access to our retail distribution partners, our revenues could be adversely impacted.

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The market for digital music is rapidly growing and we expect our digital music business to continue to grow as the industry expands. This market is highly competitive and we expect competition to continue to increase in the future as the market expands. We believe that our unique technology and feature set positions us ahead of many of our competitors. Our strategy is to drive increased demand, and stay ahead of our competition by continuing to expand the features of our Napster service and provide our customers the best user experience. Additionally, our strategic priorities include continuing to build our customer brand, pursuing strategic partnerships and pursuing strategic acquisitions and complementary technologies.

Since the acquisition of Pressplay in May 2003, the Napster division has operated at a loss and net negative cash flow. We expect to continue to operate at a loss and net negative cash flow due to our significant investments to enhance service capabilities, market Napster To Go and grow worldwide.

Critical Accounting Policies & Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an ongoing basis, we evaluate significant estimates used in preparing our financial statements, including those related to revenue recognition, sales returns and allowances, bad debt allowances, valuation and amortization of long-lived assets, restructuring provisions, other contingencies and deferred income taxes. Actual results could differ from these estimates. Certain of our critical accounting policies are impacted significantly by judgments, assumptions and estimates used in the preparation of the financial statements.

These critical accounting policies and the effect that changes in management’s estimates could have on our consolidated financial statements are further described below.

Revenue Recognition

We recognize revenues in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition in Financial Statements”, Emerging Issues Task Force (“EITF”) 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”) and EITF 99-19 “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”). In general, we recognize revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, the product or services have been delivered and collectibility of the resulting receivable is reasonably assured.

Music subscriptions are paid in advance, typically for monthly or annual periods. Music subscription revenues are recognized on a daily basis over the subscription period. Revenues from sales of individual songs or albums by download are recognized at the time the music is delivered, digitally, to the end user. Revenues from pre-paid cards are deferred and then recognized as tracks are downloaded by the end users or, if redeemed for a subscription, over the subscription period. Revenues from licenses of Napster merchandising rights are recognized upon receipt of royalty reports from the licensee.

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We have arrangements whereby customers pay one price for multiple products and services. In some cases, these arrangements involve a combination of hardware and services. In other cases, the customer pays a single price for multiple music downloads and months of music subscriptions. For arrangements with multiple deliverables, revenue is recognized upon the delivery of the separate units in accordance with EITF 00-21. Consideration from multiple element arrangements is allocated among the separate elements based on their relative fair values. In the event that there is no objective and reliable evidence of fair value, the revenue recognized upon delivery is the total arrangement consideration less the fair value of the undelivered items. The maximum revenue recognized on a delivered element is limited to the amount that is not contingent upon the delivery of additional items. Management applies significant judgment in establishing the fair value of multiple elements within revenue arrangements. Estimates of fair value represent our best estimates, but changes in circumstances relating to the products and services sold in these arrangements may result in one-time revenue charges as future elements of the arrangements are delivered.

We have arrangements with certain customers whereby the customer provides goods or services to Napster. Our revenue and the charges for the goods or services provided by a customer are accounted for in accordance with EITF No. 01-09, “Accounting for Consideration Given by a Vendor to a Customer,” including subsequent interpretations. The costs of separately identifiable goods or services received from a customer are valued at the cost we would incur to procure the same goods or services from a non-customer third party. If the goods or services cannot be separated, the total consideration is recorded as a reduction of revenues. Consideration paid to customers under these arrangements that exceeds the separately identifiable value of the goods or services provided would be reflected as a reduction of the customer’s revenue. Management exercises significant judgment in determining the fair value of separately identified goods or services. Estimates of fair value represent our best estimates, but changes in circumstances relating to the products and services sold in these arrangements may result in one-time expense or revenue charges.

We recognize revenue gross or net in accordance with EITF 99-19. In most arrangements, we contract directly with our end user customers, are the primary obligor and carry all collectibility risk. Revenue in these arrangements is recorded on a gross basis. In some cases, we utilize third party distributors to sell products or services directly to end user customers and carry no collectibility risk. In those instances, in accordance with EITF 99-19, we report the revenue net of the amount paid to the distributor.

Music Publishing Rights and Music Royalty Accruals

Under copyright law we are required to pay licensing fees for compositions embodied in digital sound recordings and for the sound recordings themselves that we deliver in our Napster service. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration. There are certain geographies and agencies for which we have not yet completed negotiations with regard to the royalty rate to be applied to the current or historic sales of our digital music offerings. We accrue for the cost of these fees in accordance with SFAS No. 5 based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. While Napster bases its estimates on historical experience and on various other assumptions that management believes to be reasonable under the circumstances, actual results may differ significantly from these estimates under different assumptions or conditions and as a result could have a material impact on our financial position, results of operations, and cash flows.

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Prepaid Content Advances and Marketing Fees

We recognize up front advance payments for digital content and marketing fees in Prepaid and Other Current Assets. Prepaid Content Advances are expensed as content fees and become due in accordance with the terms of the related agreements, generally based on usage. Prepaid Marketing Fees are expensed as we receive separately identifiable marketing services from our strategic marketing partners. Advances that are not recovered by the end of their contractual terms may be non-refundable. The recoverability of these balances is subject to regular review by management considering expected future content fees and marketing services. The estimates of expected future benefits include judgments about growth in demand for our products, performance by our strategic partners and fair values for related services. Changes in these estimates could require us to write down the carrying value of these advances and could materially impact our financial position and results of operations.

Capitalized software development costs

Internal use software.    We comply with AICPA SOP No. 98-1 “Accounting for Cost of Computer Software Developed or Obtained for Internal Use” (“SOP 98-1”) and EITF Issue 00-2, “Accounting for Website Development Costs.” In accordance with SOP 98-1, software development costs incurred as part of an approved project plan that result in additional functionality to internal use software are capitalized and amortized on a straight-line basis over the estimated useful life of the software, generally three years.

Software held for sale.    In accordance with SFAS No. 86, “Computer Software to be Sold, Leased, or Otherwise Marketed,” development costs of computer software to be sold, leased or otherwise marketed are subject to capitalization beginning when a product’s technological feasibility has been established and ending when a product is available for general release to customers. We have not capitalized any software development costs as technological feasibility is generally not established until a working model is completed, at which time substantially all development is complete.

Management applies significant judgment when determining whether products under development are technologically feasible or whether it is probable that they will result in additional functionality. These judgments include assessments of our development progress and expected performance. Additionally, the future realizability of capitalized software costs is subject to regular review by management, who consider expected future benefits. The estimates of expected future benefits include judgments about growth in demand for our products, performance by our strategic partners and fair values for related services. Changes in these estimates could require us to write down the carrying value of these capitalized amounts and could materially impact our financial position and results of operations.

Goodwill and other intangible assets

We account for goodwill and other intangible assets in accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” which we adopted effective April 1, 2001. We ceased to amortize goodwill effective April 1, 2001 and evaluate the carrying value of goodwill on an annual basis. We will adjust the carrying value if the asset’s value has been impaired. We amortize other intangible assets on the straight-line method over their estimated useful lives, generally three years. During the fourth quarters of each of fiscal 2005, 2004 and 2003, we completed our annual impairment tests. In addition, Napster periodically evaluates whether there are any events or circumstances that would require an impairment assessment of the carrying value of the goodwill and other intangible assets between each annual impairment assessment. Screening for and assessing whether impairment indicators exist or if events or changes in circumstances, including changes in market conditions, operating fundamentals, competition and general economic conditions, have occurred requires significant judgment. Additionally, changes in the high-technology industry occur frequently and quickly. Therefore, there can be no assurance that a charge to operations will not occur as a result of future goodwill and purchased intangible impairment tests.

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Income Taxes

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes.” As part of the process of preparing our consolidated financial statements we are required to determine our income taxes in each of the jurisdictions in which we operate. This process involves determining our current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We must assess the likelihood that our deferred tax assets will be recovered from various means, including future taxable income, and, to the extent we believe that recovery is not more likely than not, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations. The above process is computed separately for each of continuing operations, the discontinued operation and elements of other comprehensive income.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against our net deferred tax assets. We have recorded a full valuation allowance against our deferred tax assets, net of reversing deferred tax liabilities, as of March 31, 2005 due to uncertainties related to our ability to utilize our deferred tax assets, primarily consisting of net operating losses and accrued liabilities and other provisions not currently deductible for tax purposes. The timing of the reversal of the remaining deferred tax liability related to the election to step up the tax basis of the Pressplay goodwill is indefinite. The valuation allowance is based on our estimates of taxable income by jurisdiction in which we operate and the period over which our deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, we may need to establish an additional valuation allowance, which could materially impact our financial position and results of operations.

Contingencies

Napster accounts for contingent liabilities in accordance with SFAS No. 5, “Accounting for Contingencies,” pursuant to which contingent liabilities are recorded when it is probable that a liability has been incurred and the amount of the liability can be reasonably estimated.

Management applies significant judgment when estimating probable amounts of contingent liabilities. Future negotiations regarding the contingent obligations could cause the ultimate obligation to be smaller or larger than the amount estimated. Changes in these estimates could require us to take additional charges or benefits in future periods and could materially impact our financial position and results of operations.

Equity Instruments

Napster accounts for stock-based compensation in accordance with APB No. 25, “Accounting for Stock Issued to Employees,” (“APB No. 25”) and complies with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”) as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure, Amendment of SFAS No. 123.” Under APB No. 25, compensation expense is recognized based on the difference, if any, on the measurement date between the fair value of Napster’s common stock and the amount an employee must pay to acquire the common stock. The compensation expense is recognized over the periods the employee performs the related services, generally the vesting period of four years.

Napster accounts for equity instruments issued to non-employees in accordance with the provisions of SFAS No. 123 and EITF No. 96-18, “Accounting for Equity Instruments that are Issued to Other than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” which requires that such equity instruments are recorded at their fair value on the measurement date.

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Management generally estimates the fair value of non-traded equity instruments using the Black-Scholes model. The Black-Scholes model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. This model requires the input of highly subjective assumptions including the expected stock price volatility. Changes in the subjective input assumptions can materially affect the fair value estimate, which could materially impact our financial position and results of operations.

Results of Operations

Our fiscal year ends on March 31. Unless otherwise stated, all years and dates refer to our fiscal year.

The financial information presented in this quarterly report is not necessarily indicative of our financial position, results of operations or cash flows in the future.

Net Revenues

The following table sets forth, for the periods indicated, the summary of our revenues from continuing operations:

	Three Months Ended September 30,				As a Percentage of Net Revenues Three Months Ended September 30,				Six Months Ended September 30,				As a Percentage of Net Revenues Six Months Ended September 30,
	2005		2004		2005		2004		2005		2004		2005		2004
	(in thousands)								(in thousands)
Online music revenues:
Content	$	21,036	$	8,912	90	%	96	%	$	41,787	$	15,620	94	%	91	%
Hardware & license		2,343		403	10	%	4	%		2,593		1,562	6	%	9	%
Total online music revenue	$	23,379	$	9,315	100	%	100	%	$	44,380	$	17,182	100	%	100	%

Content Revenues

Content revenues increased approximately 136% to $21.0 million from $8.9 million in the second quarter of fiscal 2006 as compared to the corresponding quarter of fiscal 2005. Content revenues increased approximately 168% to $41.8 million from $15.6 million in the first half of fiscal 2006 as compared to the corresponding period of fiscal 2005. These increases are due primarily to subscriber growth, increased downloads and international expansion, as well as $646,000 of one time promotional revenue in the first quarter of fiscal 2006.

The Napster service was launched in the United States during October 2003 and in the United Kingdom and Canada during May 2004. Since these launches, excluding the cyclical impact of university subscribers, our subscriber base has increased steadily. Total paid subscribers were 448,000 as of September 30, 2005 compared to 412,000 at March 31, 2005 and 182,000 as of September 30, 2004.

In the long term, we anticipate that content revenues will continue to increase as a result of marketing activities and initiatives designed to continue subscriber growth, expand internationally and decrease customer churn.

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Hardware & License Revenues

Hardware and license revenues increased 481% to $2.3 million in the second quarter of fiscal 2006 as compared to $403,000 in the corresponding quarter of fiscal 2005. Hardware and license revenues increased 66% to $2.6 million in the first half of fiscal 2006 as compared to $1.6 million in the corresponding period of fiscal 2005. These increases are primarily the result of one time hardware promotions. We had $2.1 million of hardware revenue from a promotion in the second quarter of fiscal 2006, and $1.1 million of hardware revenue from a promotion in the first quarter of fiscal 2005.

We anticipate that hardware and license revenues will fluctuate depending on the hardware promotions and trademark licenses that we enter into each period.

Geographic Revenues

The following table sets forth, for the periods indicated, the summary of our revenues from continuing operations per geographic region:

	Three Months Ended September 30,				As a Percentage of Net Revenues Three Months Ended September 30,				Six Months Ended September 30,				As a Percentage of Net Revenues Six Months Ended September 30,
	2005		2004		2005		2004		2005		2004		2005		2004
	(in thousands)								(in thousands)
Online music revenues:
North America	$	20,615	$	8,365	88	%	90	%	$	39,090	$	15,895	88	%	93	%
United Kingdom		2,764		950	12	%	10	%		5,290		1,287	12	%	7	%
Total online music revenues	$	23,379	$	9,315	100	%	100	%	$	44,380	$	17,182	100	%	100	%

The increase in revenues in both geographies in all periods is related to the steady growth of the online music service in the United States and the launches of the service in the United Kingdom and Canada in May 2004. We anticipate that the mix of revenue outside of the United States will fluctuate as a result of continued marketing activities and initiatives focused on world-wide customer growth and international expansion.

Gross Margin

The following table sets forth, for the periods indicated, our gross margins from continuing operations:

	Three Months Ended September 30,						As a Percentage of Related Revenues Three Months Ended September 30,				Six Months Ended September 30,					As a Percentage of Related Revenues Six Months Ended September 30,
	2005			2004			2005		2004		2005			2004		2005		2004
	(in thousands)										(in thousands)
Online music gross margin:
Content	$	5,696		$	1,825		27	%	20	%	$	12,160		$	3,186	29	%	20	%
Hardware & license		(604	)		(18	)	(26	%)	(4	%)		(472	)		41	(18	%)	3	%
Total online music gross margin	$	5,092		$	1,807		22	%	19	%	$	11,688		$	3,227	26	%	19	%

Content gross margin is the profit from revenues after deducting the cost of royalties to content providers and publishers, technical support, bandwidth and hosting costs, depreciation and amortization of infrastructure assets related to the delivery of our online services, and any other direct costs of providing the services or products.

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Gross margin on content revenue increased seven percentage points to 27% from 20% in the second quarter of fiscal 2006 as compared to the corresponding quarter of fiscal 2005 (or approximately 212% to $5.7 million from $1.8 million). Approximately nine percentage points are due to the change in revenue mix from download revenues to subscription revenues, which have a higher margin, offset by a two percentage point decrease due to a free trial promotion that increased costs during the three months ended September 30, 2005.

Gross margin on content revenues increased nine percentage points to 29% from 20% in the six months ended September 30, 2005 as compared to the corresponding period of fiscal 2005. Approximately six percentage points of this improvement are due to the change in revenue mix from download revenues to subscription revenues, which have a higher margin. Approximately two percentage points of this increase are due to the relatively fixed cost base that was put in place in October 2003 as part of the Napster service, two percentage points are due to approximately $646,000 of non-recurring promotional revenue in the first quarter of fiscal 2006 that had no incremental cost, and an offsetting one percentage point decrease is due to a free trial promotion that increased costs with no corresponding revenue in the three months ended September 30, 2005.

Online service headcount dedicated to maintaining content and providing customer care was 9 and 6 at September 30, 2005 and 2004, respectively.

We expect online music gross margins as a percentage of revenue to continue to be adversely impacted to the extent that we fund low margin promotions in the second half of fiscal 2006 or spend to improve our online service infrastructure. Excluding one time items and low margin hardware promotions, we expect margins to be impacted negatively near term as label fees associated with portable music subscriptions increase.

Operating Expenses

We classify operating expenses as research and development, sales and marketing and general and administrative. Each category includes related expenses for salaries, employee benefits, incentive compensation, stock-based compensation, travel, telephone, communications, rent and allocated facilities and professional fees. Our sales and marketing expenses include additional expenditures specific to the marketing group, such as public relations, advertising, trade shows, marketing collateral materials and subscriber acquisition costs, as well as expenditures specific to the sales group, such as commissions and referral fees paid to marketing partners. In addition, we include restructuring charges and certain amortization of identifiable intangible assets as operating expenses.

The following table sets forth, for the periods indicated, our operating expenses from continuing operations:

	Three Months Ended September 30,				As a Percentage of Net Revenues Three Months Ended September 30,				Six Months Ended September 30,				As a Percentage of Net Revenues Six Months Ended September 30,
	2005		2004		2005		2004		2005		2004		2005		2004
	(in thousands)								(in thousands)
Research and development	$	3,216	$	3,189	14	%	34	%	$	6,411	$	6,076	14	%	35	%
Sales and marketing		10,391		9,447	44	%	102	%		26,663		13,742	60	%	80	%
General and administrative		4,791		5,704	21	%	61	%		10,987		10,567	25	%	62	%
Amortization of intangible assets		474		474	2	%	5	%		948		988	2	%	6	%
	$	18,872	$	18,814	81	%	202	%	$	45,009	$	31,373	101	%	183	%

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Research and Development

Research and development expenses consist primarily of salary, benefits and contractors’ fees for our development and other costs associated with the minor enhancements of existing products and development of new features for the online service.

Research and development expenses increased $27,000 or 1%, remaining constant at $3.2 million in the second quarter of fiscal 2006 as compared to the corresponding quarter of fiscal 2005. Bonuses paid in the first quarter did not recur in the second quarter, but the decrease in bonus expense was offset by a higher headcount.

Research and development expenses increased 6% to $6.4 million from $6.1 million in the first half of fiscal 2006 as compared to the corresponding period of fiscal 2005 due primarily to additional headcount.

Research and development headcount for the continuing operations was 74 and 67 as of September 30, 2005 and 2004, respectively.

We anticipate that research and development expenses will increase in the near term as headcount continues to increase slightly.

Sales and Marketing

Sales and marketing expenses consist primarily of salary and benefits for sales and marketing personnel, referral fees paid to marketing partners, other subscriber acquisition costs, as well as costs associated with advertising and promotions.

Sales and marketing expenses increased $944,000 or 10% to $10.4 million in the second quarter of fiscal 2006 as compared to $9.4 million in the corresponding quarter of fiscal 2005. These increases were primarily due to $630,000 of additional personnel-related charges associated with headcount added during fiscal 2005 and $314,000 of increased marketing program expenses. The increase in program expenses is related to new television and other planned marketing programs during the first half of fiscal 2006, offset by a $4.6 million reduction due to strategic marketing expense in fiscal 2005 that did not recur in fiscal 2006.

Sales and marketing expenses increased $12.9 million or 94% to $26.7 million from $13.7 million in the first half of fiscal 2006 as compared to the corresponding period of fiscal 2005. These increases were primarily due to $11.4 million of increased marketing program expenses during the first half of fiscal 2006 and $1.5 million of additional personnel-related charges associated with raises, bonuses and headcount added during fiscal 2005. The increase in marketing program expenses is related to television and other planned marketing programs in fiscal 2006, offset by a $5.7 million reduction due to strategic marketing expense in fiscal 2005 that did not recur in fiscal 2006.

Overall sales and marketing headcount for the continuing operation increased to 35 at September 30, 2005 from 18 at September 30, 2004.

We expect sales and marketing expenses to increase in the third fiscal quarter as we decreased advertising expenses during the summer months of the second fiscal quarter.

General and Administrative

General and administrative expenses consist primarily of salary and benefit costs for executive and administrative personnel, professional services, administrative outsources and other general corporate activities. General and administrative charges for the continuing operations in fiscal 2005 include all corporate overhead charges that are not directly attributable to CSD.

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General and administrative expenses decreased $913,000, or 16%, to $4.8 million in the second quarter of fiscal 2006 as compared to $5.7 million in the corresponding quarter of fiscal 2005 due primarily to decreased corporate overhead costs following the divestiture of CSD. Specifically, personnel related costs were reduced by $668,000, corporate depreciation by $200,000, and professional and other fees by $45,000.

General and administrative expenses increased $420,000, or 4%, to $11.0 million in the first half of fiscal 2006 as compared to $10.6 million in the corresponding period of fiscal 2005 due primarily to $724,000 of additional professional service and outsourced administrative services. Professional fees increased due to the number of legal matters, including the SightSound litigation, and additional fees associated with year-end compliance with Sarbanes-Oxley requirements. Personnel costs increased $91,000 reflecting the accrued bonuses in the quarter ending June 30, 2005, offset by reduced costs on lower head count due to the reduction in G&A headcount following the CSD divestiture, and reduced corporate depreciation of $395,000.

General and administrative headcount, including all corporate general and administrative employees, was 42 at September 30, 2005 compared to 60 at September 30, 2004.

We expect general and administrative expenses to increase slightly in the near term as we expand our European headquarters and in the event that we are required to spend more on legal matters such as the SightSound, Tse and Chamberlin litigations.

Amortization of Identifiable Intangible Assets

Amortization of identifiable intangible assets remained constant at $474,000 in the second quarter of fiscal 2006 and in the corresponding quarter of fiscal 2005 because the identifiable intangible assets are amortized straight line and there were no changes in the gross asset values. Amortization of identifiable intangible assets decreased $40,000, or 4%, to $948,000 in the first half of fiscal 2006 as compared to $1.0 million in the corresponding period of fiscal 2005 because certain identifiable intangible assets became fully amortized during the first quarter of fiscal 2005. The $337,000 remaining net book value of identifiable intangible assets at September 30, 2005 will be amortized in fiscal 2006.

Other Income (Expense), Net

Other income (expense), net, consists primarily of interest income on our cash equivalents and short-term investments, realized gains (losses) on short-term investments, interest expense, change in the fair value of the hedge and other miscellaneous income. Other income (expense), net increased $345,000 to $451,000 in the second quarter of fiscal 2006 as compared to $106,000 in the corresponding quarter of fiscal 2005. The change is due to a $183,000 increase in investment income, a $275,000 increase in interest income due to higher cash and investment balances, a $236,000 decrease in interest expense, a $217,000 increase in foreign currency gains, offset by a decrease of $366,000 for the discount on the fair market value hedge and $200,000 on the sale of source code in the first quarter of fiscal 2005.

Other income (expense), net increased $256,000 to $331,000 in the first half of fiscal 2006 as compared to $75,000 in the corresponding period of fiscal 2005 due primarily to a $419,000 increase in investment income, a $665,000 increase in investment income due to higher cash and investment balances, a $659,000 decrease in interest expense due to the repayment of the line of credit, an increase of $563,000 in foreign currency losses, a decrease of $724,000 for the discount on the fair market value hedge and $200,000 on the sale of source code in the first quarter of fiscal 2005.

We expect other income (expense), net to decrease in the future as we utilize investments to fund operations, and to fluctuate depending on foreign currency fluctuations.

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Income Tax Benefit (Provision)

We have recorded a valuation allowance to reduce deferred tax assets to the amount we believe is more likely than not to be realized. In the event that deferred tax assets would be realizable in the future in excess of the net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made.

During January 2005, following the divestiture of CSD, which utilized all of our outstanding tax net operating losses, Napster decided to make a tax election to step up the basis in Pressplay goodwill for tax purposes. As a result, the Pressplay goodwill is deductible for tax purposes, which creates a tax timing difference that is presented as a tax liability and deferred tax expense.

The tax provision was $283,000 for the second quarter of fiscal 2006 as compared to an $828,000 benefit in the corresponding quarter of fiscal 2005. The tax provision was $548,000 for the first half of fiscal 2006 as compared to a $4.4 million benefit in the corresponding period of fiscal 2005 due to the prior year benefit reflecting the utilization of losses from continuing operations to offset income from the discontinued operations. The current year expense represents primarily foreign taxes and the timing difference related to the Pressplay goodwill. In the near term we expect to continue to incur operating losses from the continuing operations and no longer have income from discontinued operations against which we can offset the losses.

We have a mix of tax rates across the various jurisdictions in which we do business, and this estimate does not take into account any future benefit from loss carryforwards, which may be realized if we again achieve profitability and begin generating taxable income.

Income from Discontinued Operations

Income from discontinued operations, after benefit (provision) for income taxes decreased $760,000 to zero in the second quarter of fiscal 2006 as compared to $760,000 in the corresponding quarter of fiscal 2005. Income from discontinued operations, after benefit (provision) for income taxes decreased $5.7 million to zero in the first half of fiscal 2006 as compared to $5.7 million in the corresponding period of fiscal 2005 because we sold CSD in December 2004 and we therefore had no discontinued operations in fiscal 2006.

Liquidity and Capital Resources

Napster ended the second quarter of fiscal 2006 with $127.6 million in cash, cash equivalents and short-term investments, including the $14.1 million fair value of the Sonic shares. These amounts consist principally of commercial paper, corporate securities, U.S. government securities, municipal securities, certificates of deposit and money market securities. This balance represents a $40.2 million decrease as compared to March 31, 2005. Our primary ongoing source of cash is receipts from revenues. The primary uses of cash are payroll (salaries and related benefits), general operating expenses (marketing, travel and office rent), payments to content providers, payments for products held for resale, and purchases of property and equipment. Our working capital was $99.9 million at September 30, 2005 compared to $131.5 million at March 31, 2005.

Line of Credit

In March 2004, Napster entered into an agreement with Silicon Valley Bank to provide a $15.0 million revolving line of credit, collateralized by substantially all of our assets. In June 2004, we amended the line of credit agreement to increase the available borrowings to $17.0 million, and in December 2004, we amended the line to release the lender’s security in assets sold to Sonic and to extend the maturity date to December 2006. During May 2005, we repaid the $15.0 million line of credit balance, plus $73,000 of accrued interest.

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As of September 30, 2005, $17.0 million is available for borrowing under the line. The line of credit bears interest at a variable rate of prime plus 0.5% per annum. The line of credit contains a material adverse conditions clause and certain covenants that require us to maintain certain financial ratios. The covenants require at the end of each month and throughout the term of the agreement (i) a minimum tangible net worth of $45.0 million, and (ii) a ratio of unrestricted cash, cash equivalents and short-term investments, plus 10% of net accounts receivable, to total borrowings under the line of credit of not less than 2.00 to 1.00. At September 30, 2005, Napster was in compliance with all covenants under the line of credit.

Financial Position

We believe that the liquidity provided by existing cash, cash equivalents, and short-term investments will provide sufficient capital to meet our requirements for at least the next 12 months. Napster operates and will continue to operate in the near term at a loss and incur net negative cash flow due to significant investments to expand our service capabilities and expand internationally.

On December 29, 2004, Napster entered into a forward contract to hedge against changes in the fair market value of the 653,837 unregistered shares of Sonic stock. This forward contract, carried at fair value, has a maturity between six and twelve months. As a result of the hedge agreement, Napster has eliminated its exposure to changes in the fair value of the shares until the forward contract expires in December 2005.

On September 29, 2005, Napster entered into a forward contract to hedge against changes in the foreign currency exchange value on approximately $7.0 million of Danish Kroner. Napster is required to keep over $7.6 million of Danish Kroner on hand in a liquidating subsidiary until the subsidiary has received tax clearance. As a result of this forward contract, Napster has eliminated most of its exposure to changes in the foreign currency values. This forward contract is carried at fair value and has a maturity of approximately 60 days.

Cash Flows

Cash flows from Operating Activities

Net cash used in operating activities increased $19.7 million to $27.3 million in the first half of fiscal 2006 as compared to $7.6 million in the corresponding period of fiscal 2005 due primarily to increased operating losses partially offset by non-cash amortization and depreciation, as well as positive changes in working capital. Napster expects to continue to use cash for operations as we continue to invest in other new digital music features and geographic expansion.

Cash flows from Investing Activities

Net cash used in investing activities increased $15.7 million to $24.4 million in the first half of fiscal 2006 as compared to $8.7 million in the corresponding period of fiscal 2005 due primarily to the use of investments to provide operating cash and fund capitalized software development. The use of cash also increased in fiscal 2006 due to $2.8 million in proceeds from the sale of Goback assets and $1.0 million transferred to restricted cash in the first half of fiscal 2005.

We expect investment activities to continue to use funds as we draw down short-term investments to fund operating cash flows described above.

Cash flows from Financing Activities

Net cash used in financing activities increased $15.0 million to $15.0 million in the first half of fiscal 2006 as compared to $35,000 in the corresponding period of fiscal 2005. This change is primarily due to the repayment of the $15.0 million line of credit in May 2005.

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Recent Accounting Pronouncements

Share-Based Payments

On December 16, 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment,” which revises the previously effective SFAS No. 123 and supersedes APB No. 25, and on March 29, 2005 the SEC issued SAB 107, “Share-Based Payment”. These pronouncements address the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25 and generally requires that such transactions be accounted for using a fair value-based method and recognized as expenses in our consolidated statements of operations. The effective date of the proposed standard for public companies is for the first annual reporting period beginning after June 15, 2005. We are evaluating the requirements under SFAS No. 123(R) and expect our adoption on April 1, 2006 to have a significant adverse impact on our consolidated statements of operations and net income (loss) per share.

Exchanges of Nonmonetary Assets

In December 2004, the FASB issued SFAS No. 153, “Exchanges of Nonmonetary Assets,” an amendment of APB No. 29, which requires nonmonetary exchanges to be recorded at the fair value of the assets exchanged, with certain exceptions. This standard requires most exchanges of productive assets to be accounted for at fair value, rather than at carryover basis. The provisions of SFAS No. 153 are effective for fiscal years beginning after June 15, 2005 and we will adopt this standard in fiscal 2006. Adoption of this statement will have no material impact on our consolidated financial position or results of operations.

Foreign Earnings Repatriation

In December 2004, the FASB issued a FASB Staff Position (“FSP”) 109-2 regarding “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“AJCA”) (“FSP 109-2”). The AJCA introduces a limited time 85% dividends received deduction on the repatriation of certain foreign earnings to a U.S. taxpayer (repatriation provision), provided certain criteria are met. FSP 109-2 provides accounting and disclosure guidance for the repatriation provision. We have no material earnings to repatriate, so do not expect this new position statement to have a material impact on our consolidated financial position or results of operations.

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RISK FACTORS

The following discussion should be read in conjunction with the financial statements and notes thereto included elsewhere in this quarterly report. The following discussion contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from the results contemplated by these forward-looking statements due to certain factors, including those discussed below, in “Risk Factors” and elsewhere in this quarterly report.

Risks Relating to Our Business in General

Our digital music services initiatives have a limited operating history and a history of losses and may not be successful.

On May 19, 2003, we acquired substantially all of the ownership interests of Napster, LLC (f/k/a Pressplay). We used the Pressplay-branded service as a technology platform to roll-out our online music services division in October 2003. The business models, technologies and market for digital music services are new and unproven. Prior to our acquisition of Napster, LLC, consumer adoption and usage of the Pressplay-branded service had not been significant. On December 17, 2004, we completed the sale of our consumer software division to Sonic Solutions and have subsequently focused our business exclusively on our digital music distribution business, under the Napster brand. You should consider the digital music distribution business and prospects in light of the risks, expenses and difficulties encountered by companies in their early stage of development.

Our Napster business has experienced significant net losses since its inception and, given the significant operating and capital expenditures associated with our business plan, we expect to incur net losses for at least the next twelve months and likely continue to experience net losses thereafter. No assurance can be made that our Napster business will ever contribute net income to our statement of operations. During the period beginning April 1, 2003, just prior to our acquisition of Pressplay in May 2003, through September 30, 2005, we incurred approximately $131.3 million of after tax losses from continuing operations.

The success of our Napster service depends upon our ability to add new subscribers and reduce churn.

We cannot assure you that we will be able to attract new subscribers to the Napster service or that existing subscribers will continue to subscribe. Existing subscribers may cancel their subscriptions to the Napster service for many reasons, including a perception that they do not use the services enough to justify the expense or that the service does not provide enough value or availability of content relative to our competition. The early stages of subscription services such as ours are characterized by higher than normal churn rates and customer acquisition cost. If we are unable to reduce these two factors we may be unable to achieve a profitable business model. In addition, there is significant seasonality in our subscriber numbers due to our university program and to seasonal softness in customer acquisition during the summer months. Students who subscribe to the Napster service generally only do so during the school year when the school is paying for their subscriptions and most of the students do not maintain such subscriptions during the summer in between school terms. If we do not continue to increase the total number of subscribers each quarter, our operating results will be adversely impacted.

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Our digital music distribution business has lower margins than our former consumer software products business.

Costs of our digital music distribution business as a percentage of the revenue generated by that business are higher than those of our former consumer software products business. The cost of third party content, in particular, is a substantial portion of revenues we receive from subscribers and end users and is unlikely to decrease significantly over time as a percentage of revenue. We expect this trend will continue to negatively impact our overall gross margins as our digital music distribution business is our primary source of revenue, and this may affect our ability to attain profitability in our digital music distribution business.

We rely on the value of the Napster brand, and our revenues could suffer if we are not able to maintain its high level of recognition in the digital music sector.

We believe that maintaining and expanding the Napster brand is an important aspect of our efforts to attract and expand our user and advertiser base. We have embarked on a broad branding program to ensure that our position in the digital music sector continues to be strongly associated with the Napster name. Promotion and enhancement of the Napster brand will depend in part on our ability to provide consistently high-quality products and services. If we are not able to successfully maintain or enhance consumer awareness of the Napster brand or, even if we are successful in our branding efforts, if we are unable to maintain or enhance customer awareness of the Napster brand in a cost effective manner, our business, operating results and financial condition would be harmed.

We face significant competition from traditional retail music distributors, from emerging paid online music services delivered electronically such as ours, and from “free” peer-to-peer services.

Our Napster service faces significant competition from traditional retail music distributors such as Tower Records, as well as online retailers such as Amazon.com. These retailers may include regional and national mall-based music chains, international chains, deep-discount retailers, mass merchandisers, consumer electronics outlets, mail order, record clubs, independent operators and online physical retail music distributors, some of which have greater financial and other resources than we do. To the extent that consumers choose to purchase media in non-electronic formats, it may reduce our sales, reduce our gross margins, increase our operating expenses and decrease our profit margins in specific markets.

Our digital music services competitors currently include Apple Computer’s iTunes Music Store, Yahoo! Unlimited, RealNetworks, Inc., the provider of the Rhapsody service, Sony Connect, Walmart.com, FYE, Microsoft’s MSN Music service and online music services powered by MusicNet such as AOL Music and Virgin. Other potential competitors such as MTV and Amazon.com have announced their intention to provide competing music distribution services. Internationally we currently compete with OD2 and Puretracks as well as with a number of the other competitors described above.

Our online music services also face significant competition from “free” peer-to-peer services, such as KaZaA, Morpheus, Grokster and a variety of similar services that allow computer users to connect with each other and to copy many types of program files, including music and other media, from one another’s hard drives, all without securing licenses from content providers. While the US Supreme Court has recently found that Grokster may violate copyright laws, the court did not establish that such services are necessarily liable for copyright infringement, opting instead for a fact-based analysis of the services’ efforts to promote copyright infringement. Additionally, enforcement efforts against those in violation have not effectively shut down these services, and there can be no assurance that these services will ever be shut down. The ongoing presence of these “free” services substantially impairs the marketability of legitimate services, regardless of the ultimate resolution of their legal status.

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Many of our competitors have significantly more resources than we do, and some of our competitors may be able to leverage their experience in providing online music distribution services or similar services to their customers in other businesses. We or our competitors may be able to secure limited exclusive rights to content from time to time. If our competitors secure significant exclusive content, it could harm the ability of our online music services to compete effectively in the marketplace.

In particular, some of these competitors offer other goods and services and may be willing and able to offer music services at a lower price than we can in order to promote the sale of these goods and services. Yahoo!, for example, recently announced that it will offer a competing service at a significant discount to our current prices. If we lower our prices, our gross margins and operating results will be adversely affected. If we do not lower our prices, we may be unable to compete with discount services. This could harm the ability of our online music services to compete effectively in the marketplace.

Digital music distribution services in general are new and rapidly evolving and may not prove to be a profitable or even viable business model.

Digital music distribution services are a relatively new business model for delivering digital media over the Internet. It is too early to predict whether consumers will accept, in significant numbers, digital music services and accordingly whether the services will be financially viable. If digital music distribution services do not prove to be popular with consumers, or if these services cannot sustain any such popularity, our business and prospects would be harmed.

We rely on content provided by third parties, which may not be available to us on commercially reasonable terms or at all.

We rely on third-party content providers, including music publishers and music labels, to offer online music content that can be delivered to users of our service. Rights to provide this content to our customers, particularly publishing rights, are difficult to obtain and require significant time and expense. In order to provide a compelling service, we must be able to continue to license a wide variety of music content to our customers with attractive usage rights such as CD recording, output to MP3 players, portable subscription rights and other rights. In addition, if we do not have sufficient breadth and depth of the titles necessary to satisfy increased demand arising from growth in our subscriber base, our subscriber satisfaction will be affected adversely.

Under copyright law we are required to pay licensing fees for compositions embodied in digital sound recordings and for the sound recordings themselves that we deliver in our Napster service. Copyright law generally does not specify the rate and terms of the licenses, which are determined by voluntary negotiations among the parties or, for certain compulsory licenses where voluntary negotiations are unsuccessful, by arbitration proceedings known as CARP proceedings which are subject to approval by the United States Copyright Office. Past CARP proceedings have resulted in proposed rates for statutory webcasting that were significantly in excess of rates requested by webcasters. We cannot predict the outcome of any negotiations or CARP proceedings and may elect instead to attempt to directly license compositions for our services, either alone or in concert with other affected companies. Such licenses may only apply to music performed in the United States. The availability of licenses for compositions used in international versions of the services is unclear. Therefore, our ability to negotiate appropriate licenses is uncertain.

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Voluntarily negotiated rates for mechanical licenses with respect to streaming and conditional digital downloads with the Harry Fox Agency and National Music Publishers Association have not been agreed to, and we are currently operating under a standstill agreement until such rates are negotiated. No agreement has been reached with performing rights societies such as ASCAP or BMI regarding whether digital downloads constitute public performances of copyrighted works that would trigger payment of public performance royalties. There are other negotiations and EU and Canadian tribunals in process which will set rates for subscription music services and services that deliver digital downloads of music, and the outcome of these negotiations and proceedings will also likely affect our business in ways that we cannot predict. Napster accrues for the cost of these fees, based on contracted or statutory rates, when established, or management’s best estimates based on facts and circumstances regarding the specific music services and agreements in similar geographies or with similar agencies. If the final agreed rate differs significantly from management’s estimate, the actual amount paid and expensed could differ materially from the recorded amounts.

Our success depends on our music service’s interoperability with our customer’s music playback hardware.

In order for our Napster service to be successful, we must design our service to interoperate effectively with a variety of hardware products, including home stereos, car stereos, portable MP3 players, and PCs. We depend on significant cooperation with manufacturers of these products and with software manufacturers that create the operating systems for such hardware devices to achieve our design objectives and to offer a service that is attractive to our customers. Currently, there are a limited number of devices that offer the portable subscription functionality that is required to carry our services. Our software is not compatible with the iPod music player, the current equipment market leader. If we cannot successfully design our service to interoperate with the music playback devices that our customers own, our business will be harmed.

We must provide digital rights management solutions that are acceptable to both content providers and consumers.

We must provide digital rights management solutions and other security mechanisms in our digital music distribution services in order to address concerns of content providers and artists, and we cannot be certain that we can develop, license or acquire such solutions or that content licensors or consumers will accept them. Content providers may be unwilling to continue to support portable subscription services. Consumers may be unwilling to accept the use of digital rights management technologies that limit their use of content, especially with large amounts of free content readily available. Third-party providers of digital rights management software, such as Microsoft, may be unwilling to continue to provide such software to us upon reasonable or any terms. If we are unable to acquire these solutions on reasonable or any terms, or if customers are unwilling to accept these solutions, our business and prospects could be harmed.

Our business could be harmed by a lack of availability of popular content.

Our business is affected by the release of “hit” music titles, which can create cyclical trends in sales distinctive to the music industry. It is not possible to determine the timing of these cycles or the future availability of hit titles. Hit products are important because they generate customer interest. We depend upon the music content providers to continue to produce hit products. To the extent that new hits are not available, or not available at prices attractive to consumers, our sales and margins may be adversely affected.

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We may not successfully develop new products and services.

The success of the Napster service will depend on our ability to develop leading-edge media and digital distribution products and services. Our business and operating results will be harmed if we fail to develop products and services that achieve widespread market acceptance or that fail to generate significant revenues or gross profits to offset our development and operating costs. We may not timely and successfully identify, develop and market new product and service opportunities.

We may not be able to add new content such as video, spoken word or other content as quickly or as efficiently as our competitors or at all. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenues or profitability. Competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies, and we may not have sufficient resources to make these investments.

Because the markets for our products and services are changing rapidly, we must develop new offerings quickly. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements. Our products also may contain undetected errors that could cause increased development costs, loss of revenues, adverse publicity, reduced market acceptance of our products or services or lawsuits by customers.

We must maintain and add to our strategic marketing relationships in order to be successful.

We depend on a number of strategic relationships with third parties to co-market our services. We often enter into co-marketing agreements with infrastructure providers, retailers and other large companies to broaden the distribution of our brand and our services. There is no guarantee that we will be able to renew existing agreements or enter into new agreements on acceptable terms, or at all. If we cannot maintain existing strategic relationships or enter into new relationships, our ability to market our services will be harmed.

In addition, because of the rapidly evolving nature of digital music distribution and our short history of operations, we often enter into strategic agreements that have uncertain financial impact on our business and operations. We cannot guarantee that any of these agreements will result in the desired benefits to our business or result in significant additional revenue.

The growth of our business depends on the increased use of the Internet for communications, electronic commerce and advertising.

The growth of our business depends on the continued growth of the Internet as a medium for media consumption, communications, electronic commerce and advertising. Our business will be harmed if Internet usage does not continue to grow, particularly as a source of media information and entertainment and as a vehicle for commerce in goods and services. Our success also depends on the efforts of third parties to develop the infrastructure and complementary products and services necessary to maintain and expand the Internet as a viable commercial medium. We believe that other Internet-related issues, such as security, privacy, reliability, cost, speed, ease of use and access, quality of service and necessary increases in bandwidth availability, remain largely unresolved and may affect the amount and type of business that is conducted over the Internet, and may impact our ability to sell our products and services and ultimately impact our business results and prospects.

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If broadband technologies do not become widely available or widely adopted, our online music distribution services may not achieve broad market acceptance, and our business may be harmed.

We believe that increased Internet use and especially the increased use of media over the Internet may depend on the availability of greater bandwidth or data transmission speeds (also known as broadband transmission). If broadband technologies do not become widely available or widely adopted, our online music distribution services may not achieve broad market acceptance and our business and prospects could be harmed.

More consumers are utilizing non-PC devices to access digital content, and we may not be successful in developing versions of our products and services that will gain widespread adoption by users of such devices.

In the coming years, the number of individuals who access digital content through devices other than a personal computer, such as personal digital assistants, cellular telephones, television set-top devices, game consoles and Internet appliances, is expected to increase dramatically. Manufacturers of these types of products are increasingly investing in media-related applications, but development of these devices is still in an experimental stage and business models are new and unproven. If we are unable to offer our services on these alternative non-PC devices, we may fail to capture a sufficient share of an increasingly important portion of the market for digital media services or our costs may increase significantly.

Our network is subject to security and stability risks that could harm our business and reputation and expose us to litigation or liability.

Online commerce and communications depend on the ability to transmit confidential information and licensed intellectual property securely over private and public networks. Any compromise of our ability to transmit such information and data securely or reliably, and any costs associated with preventing or eliminating such problems, could harm our business. Online transmissions are subject to a number of security and stability risks, including:

• our own or licensed encryption and authentication technology, and access and security procedures, may be compromised, breached or otherwise be insufficient to ensure the security of customer information or our music content;

• we could experience unauthorized access, computer viruses, system interference or destruction, “denial of service” attacks and other disruptive problems, whether intentional or accidental, that may inhibit or prevent access to our web sites or use of our products and services;

• someone could circumvent our security measures and misappropriate our, our partners’ or our customers’ intellectual property or interrupt operations, or jeopardize our licensing arrangements, which are contingent on our sustaining appropriate security protections;

• our computer systems could fail and lead to service interruptions;

• we may be unable to scale our infrastructure with increases in customer demand; or

• our network of facilities may be affected by a natural disaster, terrorist attack or other catastrophic events.

The occurrence of any of these or similar events could damage our business, hurt our ability to distribute products and services and collect revenue, threaten the proprietary or confidential nature of our technology, harm our reputation and expose us to litigation or liability. We may be required to expend significant capital or other resources to protect against the threat of security breaches, hacker attacks or system malfunctions or to alleviate problems caused by such breaches, attacks or failures.

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We experience fluctuations in our quarterly operating results, which may cause our stock price to decline.

Our quarterly operating results may fluctuate from quarter to quarter. We cannot reliably predict future revenue and margin trends and such trends may cause us to adjust our operations. Other factors that could affect our quarterly operating results include:

• timing of service introductions;

• seasonal fluctuations in sales of our prepaid cards as well as other products and services;

• potential declines in selling prices as a result of competitive pressures;

• changes in the mix of our revenues represented by our various services;

• adverse changes in the level of economic activity in the United States or other major economies in which we do business, or in industries, such as the music industry, on which we are particularly dependent;

• foreign currency exchange rate fluctuations;

• expenses related to, and the financial impact of, possible acquisitions of other businesses; and

• expenses incurred in connection with the development of our digital music distribution services.

We depend on key personnel who may not continue to work for us.

Our success substantially depends on the continued employment of certain executive officers and key employees, particularly Christopher Gorog, our Chief Executive Officer. The loss of the services of these key officers, employees or third parties could harm our business. If any of these individuals were to leave our company, we could face substantial difficulty in hiring qualified successors and could experience a loss in productivity while any such successor obtains the necessary training and experience.

If we fail to manage expansion effectively, we may not be able to successfully manage our business, which could cause us to fail to meet our customer demand or to attract new customers, which would adversely affect our revenue.

Our ability to successfully offer our products and services and implement our business plan in a rapidly evolving market requires an effective planning and management process. We plan to continue to increase the scope of our digital music distribution operations domestically and internationally. In addition, we plan to continue to hire a significant number of employees in fiscal 2006 for the development of new products and services. This anticipated growth in future operations will place a significant strain on our management resources.

In the future, we plan to continue to develop and improve our financial and managerial controls, reporting systems and procedures. In addition, we plan to continue to expand, train and manage our work force worldwide.

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We may need to make additional future acquisitions to remain competitive. The process of identifying, acquiring and integrating future acquisitions may constrain valuable management resources, and our failure to effectively integrate future acquisitions may result in the loss of key employees and the dilution of stockholder value and have an adverse effect on our operating results.

We have completed several acquisitions and may continue to pursue strategic acquisitions in the future. Completing any potential future acquisitions could cause significant diversions of management time and resources. Financing for future acquisitions may not be available on favorable terms, or at all. If we identify an appropriate acquisition candidate for any of our businesses, we may not be able to negotiate the terms of the acquisition successfully, finance the acquisition or integrate the acquired business, products, technologies or employees into our existing business and operations. Future acquisitions may not be well-received by the investment community, which may cause our stock price to fall. We have not entered into any agreements or understanding regarding any future acquisitions and cannot ensure that we will be able to identify or complete any acquisition in the future.

If we acquire businesses, new products or technologies in the future, we may be required to amortize significant amounts of identifiable intangible assets, and we may record significant amounts of goodwill that will be subject to annual testing for impairment. If we consummate one or more significant future acquisitions in which the consideration consists of stock or other securities, our existing stockholders’ ownership could be significantly diluted. If we were to proceed with one or more significant future acquisitions in which the consideration included cash, we could be required to use a substantial portion of our available cash.

Acquisition-related costs can cause significant fluctuation in our net income.

Previous acquisitions have resulted in significant expenses, including amortization of purchased technology, charges for in-process research and development and amortization of acquired identifiable intangible assets, which are reflected in operating expenses. Total amortization of acquired intangible and purchased technology assets in ongoing operations was $2.1 million in the fiscal year ended March 31, 2005, and $506,000 and $1.0 million in the three and six month periods ended September 30, 2005, respectively. Additional acquisitions and any additional impairment of the value of purchased assets could have a significant negative impact on future operating results.

A significant portion of the revenues from our Napster service is derived from international revenues, including international joint ventures. Economic, political, regulatory and other risks associated with international revenues and operations could have an adverse effect on our revenues.

Because we operate worldwide, our business is subject to risks associated with doing business internationally. International net revenues did not account for a significant percentage of our net revenues prior to the sale of our consumer software division; however, we anticipate that revenues from international operations will represent a substantial portion of our total net revenues as we expand our Napster service abroad and enter into joint venture arrangements with international partners such as Tower Records Japan, Inc. Accordingly, our future revenues could decrease based on a variety of factors, including:

• disputes with joint venture partners;

• mismanagement or fraud by joint venture partners;

• changes in foreign currency exchange rates;

• seasonal fluctuations in sales of our prepaid cards as well as other products and services;

• changes in a specific country’s or region’s political or economic condition, particularly in emerging markets;

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• unexpected changes in foreign laws and regulatory requirements;

• difficulty of effective enforcement of contractual provisions in local jurisdictions;

• trade protection measures and import or export licensing requirements;

• potentially adverse tax consequences;

• difficulty in managing widespread sales operations; and

• less effective protection of intellectual property.

To grow our business, we must be able to hire and retain sufficient qualified technical, sales, marketing and administrative personnel.

Our future success depends in part on our ability to attract and retain engineering, sales, marketing, finance and customer support personnel. If we fail to retain and hire a sufficient number of these employees, we will not be able to maintain and expand our business. We cannot assure you that we will be able to hire and retain a sufficient number of qualified personnel to meet our business objectives.

We may be unable to adequately protect our proprietary rights.

Our inability to protect our proprietary rights, and the costs of failing to do so, could harm our business. Our success and ability to compete partly depend on the superiority, uniqueness or value of our technology, including both internally developed technology and technology licensed from third parties. To protect our proprietary rights, we rely on a combination of patent, trademark, copyright and trade secret laws, confidentiality agreements with our employees and third parties, and protective contractual provisions. These efforts to protect our intellectual property rights may not be effective in preventing misappropriation of our technology. These efforts also may not prevent the development and design by others of products or technologies similar to, competitive with or superior to those we develop. Any of these results could reduce the value of our intellectual property. We may be forced to litigate to enforce or defend our intellectual property rights and to protect our trade secrets. Any such litigation could be very costly and could distract our management from focusing on operating our business.

We may be subject to intellectual property infringement claims, such as those claimed by SightSound Technologies, which are costly to defend and could limit our ability to use certain technologies in the future.

Many of our current and potential competitors dedicate substantially greater resources to protection and enforcement of their intellectual property rights, especially patents, than we do. Many parties are actively developing streaming media and digital distribution-related technologies, e-commerce and other Web-related technologies, as well as a variety of online business methods and models. We believe that these parties will continue to take steps to protect these technologies, including, but not limited to, seeking patent protection. As a result, disputes regarding the ownership of these technologies and rights associated with streaming media, digital distribution and online businesses are likely to arise in the future and may be very costly. In addition to existing patents and intellectual property rights, we anticipate that additional third-party patents related to our products and services will be issued in the future. If a blocking patent has been issued or is issued in the future, we would need to either obtain a license or design around the patent. We may not be able to obtain such a license on acceptable terms, if at all, or design around the patent, which could harm our business. For example, on October 8, 2004, SightSound Technologies, Inc. filed a lawsuit against us and Napster, LLC in U.S. District Court for the Western District of Pennsylvania, Case No. 04-1549 alleging infringement of certain of their patents by the Napster service. If they are ultimately able to prevail at trial, we may be unable to provide certain download or subscription features of the Napster service or may be forced to pay significant and costly license royalties, all of which will harm our business.

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Companies in the technology and content-related industries have frequently resorted to litigation regarding intellectual property rights. We may be forced to litigate to determine the validity and scope of other parties’ proprietary rights. Any such litigation could be very costly and could distract our management from focusing on operating our business. In addition, we believe these industries are experiencing an increased level of litigation to determine the applicability of current laws to, and the impact of new technologies on, the use and distribution of content over the Internet and through new devices, especially in the music industry. As we develop products and services that provide or enable the provision of content, in such ways, our litigation risk may increase. The existence and/or outcome of such litigation could harm our business.

From time to time we receive claims and inquiries from third parties alleging that our internally developed technology, or technology we license from third parties, may infringe the other third parties’ proprietary rights, especially patents. Third parties have also asserted and most likely will continue to assert claims against us alleging infringement of copyrights, trademark rights, or other proprietary rights, or alleging unfair competition or violations of privacy rights. We could be required to spend significant amounts of time and money to defend ourselves against such claims. If any of these claims were to prevail, we could be forced to pay damages, comply with injunctions, or stop distributing our products and services while we re-engineer them or seek licenses to necessary technology, which might not be available on reasonable terms, or at all. We could also be subject to claims for indemnification resulting from infringement claims made against our customers and strategic partners, which could increase our defense costs and potential damages. Any of these events could require us to change our business practices and could harm our business.

A decline in current levels of consumer spending could reduce our sales.

Our business is directly affected by the level of consumer spending. One of the primary factors that affect consumer spending is the general state of the local economies in which we operate. Lower levels of consumer spending in regions in which we have significant operations could have a negative impact on our business, financial condition or results of operations.

We may need additional capital, and we cannot be sure that additional financing will be available.

Although we currently anticipate that our available funds and expected cash flows from operations will be sufficient to meet our cash needs for at least the next twelve months, we may require additional financing. Our management could spend or invest the proceeds from the sale of our consumer software division in ways with which our stockholders may not agree. We currently intend to invest the proceeds from the sale of our consumer software division into our digital music distribution business. The investment of these proceeds may not yield a favorable return. Our ability to obtain financing will depend, among other things, on our development efforts, business plans, operating performance and condition of the capital markets at the time we seek financing. We expect to experience operating losses from the Napster service in at least the short term. We cannot assure you that additional financing will be available to us on favorable terms when required, or at all. If we raise additional funds through the issuance of equity, equity-linked or debt securities, those securities may have rights, preferences or privileges senior to the rights of our common stock, and our stockholders may experience dilution.

Changes in stock option accounting rules may adversely impact our reported operating results prepared in accordance with generally accepted accounting principles, our stock price and our competitiveness in the employee marketplace.

Technology companies like ours have a history of using broad-based employee stock option programs to hire, provide incentives to and retain our workforce in a competitive marketplace. We have elected to apply Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) to account for stock options. Accordingly we generally do not recognize any expense with respect to employee stock options as long as such options are granted at exercise prices equal to the fair value of our common stock on the date of grant.

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On December 16, 2004, the Financial Accounting Standards Board (“FASB”) adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment” (“SFAS No. 123(R)”), which revises the previously effective SFAS No. 123, “Accounting for Stock-Based Compensation,”and supersedes APB No. 25. This statement addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for either equity instruments of the enterprise or liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The statement eliminates the ability to account for share-based compensation transactions using APB No. 25, and generally requires that such transactions be accounted for using a fair-value-based method and recognized as expenses in our consolidated statements of operations. The FASB originally stated a preference for a lattice model because it believed that a lattice model more fully captures the unique characteristics of employee stock options in the estimate of fair value, as compared to the Black-Scholes model which we currently use for our footnote disclosure. The FASB decided to remove its explicit preference for a lattice model and not require a particular valuation methodology. The effective date of the standard for public companies is for the first annual reporting periods beginning after June 15, 2005. We are evaluating the requirements under SFAS No. 123(R) and expect our adoption on April 1, 2006 to have a significant adverse impact on our consolidated statements of operations and net income (loss) per share.

We are subject to risks associated with governmental regulation and legal uncertainties.

Few existing laws or regulations specifically apply to the Internet, other than laws and regulations generally applicable to businesses. Certain United States export controls and import controls of other countries, including controls on the use of encryption technologies, may apply to our products. Many laws and regulations, however, are pending and may be adopted in the United States, individual states, and local jurisdictions and other countries with respect to the Internet. These laws may relate to many areas that impact our business, including content issues (such as obscenity, indecency and defamation), copyright and other intellectual property rights, digital rights management, encryption, caching of content by server products, personal privacy, taxation, e-mail, sweepstakes, promotions, network and information security and the convergence of traditional communication services with Internet communications, including the future availability of broadband transmission capability and wireless networks. These types of regulations are likely to differ between countries and other political and geographic divisions. Other countries and political organizations are likely to impose or favor more and/or different regulations than that which has been proposed in the United States, thus furthering the complexity of regulation. In addition, state and local governments may impose regulations in addition to, inconsistent with, or stricter than federal regulations. The adoption of such laws or regulations, and uncertainties associated with their validity, interpretation, applicability and enforcement, may affect the available distribution channels for and costs associated with our products and services and may affect the growth of the Internet. Such laws or regulations may harm our business. Our products and services may also become subject to investigation and regulation of foreign data protection and e-commerce authorities, including those in the European Union. Such activities could result in additional product and distribution costs for us in order to comply with such regulations.

We do not know for certain how existing laws governing issues such as property ownership, copyright and other intellectual property issues, digital rights management, taxation, gambling, security, illegal or obscene content, retransmission of media, personal privacy and data protection apply to the Internet. The vast majority of such laws were adopted before the advent of the Internet and related technologies and do not address the unique issues associated with the Internet and related technologies. Most of the laws that relate to the Internet have not yet been interpreted. In addition to potential legislation from local, state and federal governments, labor guild agreements and other laws and regulations that impose fees, royalties or unanticipated payments regarding the distribution of media over the Internet may directly or indirectly affect our business. While we and our customers may be directly affected by such agreements, we are not a party to such agreements and have little ability to influence the degree such agreements favor or disfavor Internet distribution or our business models. Changes to or the interpretation of these laws and the entry into such industry agreements could:

• limit the growth of the Internet;

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

• increase our cost of doing business;

• expose us to increased litigation risk, substantial defense costs and significant liabilities associated with content available on our web sites or distributed or accessed through our products or services, with our provision of products and services and with the features or performance of our products and web sites;

• lead to increased product development costs or otherwise harm our business; or

• decrease the rate of growth of our user base and limit our ability to effectively communicate with and market to our user base.

The Child Online Protection Act and the Child Online Privacy Protection Act impose civil and criminal penalties on persons distributing material harmful to minors (e.g., obscene material) over the Internet to persons under the age of 17, or collecting personal information from children under the age of 13. We do not knowingly distribute harmful materials to minors or collect personal information from children under the age of 13. The manner in which these Acts may be interpreted and enforced cannot be fully determined, and future legislation similar to these Acts could subject us to potential liability if we were deemed to be non-compliant with such rules and regulations, which in turn could harm our business.

There are a large number of legislative proposals before the United States Congress and various state legislatures regarding intellectual property, digital rights management, copy protection requirements, privacy, email marketing and security issues related to our business. It is not possible to predict whether or when such legislation may be adopted, and certain proposals, if adopted, could materially and adversely affect our business through a decrease in user registration and revenue, and influence how and whether we can communicate with our customers.

We may be subject to market risk and legal liability in connection with the data collection capabilities of our products and services.

Many of our products are interactive Internet applications which by their very nature require communication between a client and server to operate. To provide better consumer experiences and to operate effectively, our products send information to servers. Many of the services we provide also require that a user provide certain information to us. We post an extensive privacy policy concerning the collection, use and disclosure of user data involved in interactions between our client and server products. Any failure by us to comply with our posted privacy policy and existing or new legislation regarding privacy issues could impact the market for our products and services, subject us to litigation and harm our business.

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If, in the future, we conclude that our internal control over financial reporting is not adequate, or if our auditors conclude that our evaluation of internal controls over financial reporting is not adequate, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.

As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on the company’s internal control over financial reporting in their annual reports on Form 10-K. This report is required to contain an assessment by management of the effectiveness of such company’s internal controls over financial reporting. In addition, the independent registered public accounting firm auditing a public company’s financial statements must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting. There is a risk that in the future we may identify internal control deficiencies that suggest that our controls are no longer effective. This could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our financial statements, which could cause the market price of our common stock to decline and make it more difficult for us to finance its operations.

The effectiveness of our disclosure and internal controls may be limited.

Our disclosure controls and procedures and internal control over financial reporting may not prevent all errors and misrepresentations. In the event that there are errors or misrepresentations in our historical financial statements or the SEC disagrees with our accounting, we may need to restate our financial statements. For example, in November 2004 we restated our financial statements in order to correct the valuation of a previously issued warrant and to adjust the purchase accounting of our former subsidiary, MGI Software, and in May 2005 we restated our financial statements to reallocate the tax benefit of certain operating losses from our discontinued operation to our continuing operations. Any system of internal controls can only provide reasonable assurance that all control objectives are met. Some of the potential risks involved could include but are not limited to management judgments, simple errors or mistakes, willful misconduct regarding controls or misinterpretation. There is no guarantee that existing controls will prevent or detect all material issues or be effective in future conditions, which could materially and adversely impact our financial results in the future.

We hold cash in foreign subsidiaries, which we intend to repatriate to the United States, and which may result in income taxes that could negatively impact our results of operations and financial position.

We are in the process of completing a corporate restructuring to close the overseas operations of certain dormant subsidiaries of our former consumer software division. We plan to repatriate our cash from these foreign subsidiaries to the United States. We are likely to incur additional income taxes from the repatriation, which could negatively affect our results of operations and financial position.

The asset purchase agreement with Sonic Solutions exposes us to contingent liabilities.

Under the asset purchase agreement with Sonic Solutions, we have retained various liabilities relating to the consumer software division and have agreed to indemnify Sonic Solutions under certain circumstances, such as if we breach our representations and warranties contained in the asset purchase agreement and for other matters, including all liabilities retained by us under that agreement. For example, an indemnification claim by Sonic Solutions might result if we breach or default on any of our representations about the assets comprising our consumer software division. Under the terms of the asset purchase agreement, if claims are made by Sonic Solutions, we may be required to expend significant cash resources in defense and settlement of such claims, which may adversely affect our business, results of operations and financial condition.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market value risk

Our short-term investments include 653,837 shares of unregistered common stock of Sonic Solutions (the “Sonic Shares”) that were received as partial consideration for the sale of CSD to Sonic Solutions. We intend to sell these shares as soon as they are registered. On December 29, 2004, Napster entered into a forward contract to hedge these shares against exposures resulting from changes in fair market value. This forward contract, carried at fair value, is exercisable between six and twelve months after it was entered into. The changes in fair value of the forward contract are intended to offset changes in the market value of the Sonic Shares. The Sonic Shares are collateral for the forward contract.

Interest rate risk

The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. We maintain our cash, cash equivalents and short-term investments with high quality financial institutions and, as part of our cash management process, we perform periodic evaluations of the relative credit standing of these financial institutions. Amounts deposited with these institutions may exceed federal depository insurance limits. In addition, the portfolio of investments conforms to our policy regarding concentration of investments, maximum maturity and quality of investment.

Some of the securities in which we have invested may be subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the prevailing interest rate later rises, the principal amount of our investment will probably decline in value. To reduce this risk, we maintain our portfolio of cash equivalents and short-term investments in a variety of securities, including commercial paper, certificates of deposit, corporate bonds, U.S. agencies securities, asset-backed securities and money market funds. In general, money market funds are not subject to interest rate risk because the interest paid on these funds fluctuates with the prevailing interest rate. All of our short-term investments mature in less than two years.

The following table presents the amounts of our short-term investments excluding the Sonic Shares that are subject to market risk by range of expected maturity and weighted-average interest rates as of September 30, 2005. Our cash equivalents are invested in money market funds, commercial paper and municipal securities, which are not included in the table because those funds are not subject to interest rate risk due to their short maturities (in thousands, except interest rates).

	Less than One Year			More than One Year			Total		Estimated Fair Value
Short-term investments	$	45,493		$	-		$	45,493	$	45,493
Weighted-average interest rate		3.31	%		0.00	%

We have available to us a $17 million revolving line of credit. At September 30, 2005 there was no balance outstanding on the revolving line of credit.

Financial instruments that potentially subject us to significant concentrations of credit risk consist principally of trade accounts receivable and short-term investments.

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Exchange rate risk

We market our Napster service in the United States, Canada and the United Kingdom, resulting in sales denominated in U.S. dollars, Canadian dollars and United Kingdom pounds. As such, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets.

For our foreign subsidiaries whose functional currency is the local currency, we translate assets and liabilities to U.S. dollars using period-end exchange rates and translate revenues and expenses using average exchange rates during the period. Exchange gains and losses arising from translation of foreign entity financial statements are included as a component of other comprehensive income and have not been significant for all periods presented.

For foreign subsidiaries whose functional currency is U.S. dollars, certain assets and liabilities are re-measured at the period-end or historical exchange rates as appropriate. Revenues and expenses are re-measured at the average exchange rate during the period. Currency translation gains and losses are recognized in current operations.

Cash and cash equivalents are predominantly denominated in U.S. dollars. As of September 30, 2005 we held $7.6 million of cash and cash equivalents in Danish Kroner, $2.8 million in United Kingdom pounds, $560,000 in Euros, and $189,000 in other foreign currencies.

On September 29, 2005, Napster entered into a forward contract to hedge against changes in the foreign currency exchange value on approximately $7.0 million of Danish Kroner. Napster is required to keep over $7.6 million of Danish Kroner on hand in a liquidating subsidiary until the subsidiary has received tax clearance. As a result of this forward contract, Napster has eliminated most of its exposure to changes in the foreign currency values. This forward contract is carried at fair value and has a maturity of approximately 60 days.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedure

Our management has evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures were effective to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (ii) is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. Our disclosure controls and procedures are designed to provide reasonable assurance that such information is accumulated and communicated to our management. Our disclosure controls and procedures include components of our internal control over financial reporting.

Changes in internal control over financial reporting

During the quarter ended September 30, 2005, there were no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Napster and Pressplay have been notified by a number of companies that the Pressplay and Napster online music distribution services may infringe patents owned by those companies. Napster is investigating the nature of these claims and the extent to which royalties may be owed by Napster and Pressplay to these entities. The ultimate resolution of these claims cannot be determined at this time.

On October 8, 2004, SightSound Technologies, Inc. filed a lawsuit against Napster and Napster, LLC in U.S. District Court for the Western District of Pennsylvania, Case No. 04-1549, alleging infringement of certain of its patents by the Napster service. SightSound is demanding monetary damages and injunctive relief. Napster was served with the complaint in the lawsuit on November 5, 2004. Napster has answered the complaint and filed an application with the United States Patent and Trademark Office for reexamination of the patents. In January 2005, SightSound moved for a preliminary injunction of the Napster service and Napster moved for a stay of the proceedings pending the outcome of Napster’s reexamination application. On February 28, 2005, the court granted Napster’s motion to stay and denied SightSound’s motion for preliminary injunction without prejudice. On March 3, 2005 SightSound filed a notice of appeal with the U.S. Court of Appeals for the Federal Circuit, appealing the district court’s order. On March 22, 2005, SightSound filed a Petition to Cancel certain trademark registrations owned by Napster before the Trademark Trial and Appeals Board, claiming that Napster did not acquire the rights to these trademarks when it purchased them through the bankruptcy estate. Napster believes that this petition is entirely without merit and it has been stayed by TTAB pending resolution of the litigation in Pennsylvania. On May 19, 2005, Napster filed a motion with the U.S. Bankruptcy Court for the District of Delaware to reopen the Napster bankruptcy case and enforce the order assigning all of the assets of the former Napster, Inc. (including trademarks and goodwill) to us. On August 23, 2005, an order confirming the sale to Napster of the Napster trademarks, including goodwill, was granted by the Bankruptcy Court. On or about October 31, 2005, the United States Patent and Trademark Office issued second office actions rejecting all of the claims of the SightSound patents. SightSound will likely respond to these office actions within two months. Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of these matters will have on Napster’s results of operations, financial position or cash flows.

On August 5, 2005, Ho Keung Tse filed suit against Apple Computer, Inc., Napster, Inc., MusicMatch, Inc., Sony Connect, Inc., Yahoo, Inc. and RealNetworks, Inc. in U.S. District Court for the District of Maryland alleging infringement of U.S. Patent No. 6665797 by the defendants’ respective music distribution services. Mr. Tse is demanding monetary damages and injunctive relief. The defendants have formed a joint defense group and intend to defend themselves vigorously. Management believes that it is not currently possible to estimate the impact, if any, that the ultimate resolution of these matters will have on Napster’s results of operations, financial position or cash flows.

On October 21, 2005, Katherine Chamberlin, purportedly on behalf of a class of California consumers, filed a lawsuit against Napster, Inc. and Napster, LLC alleging a violation of California state statutes relating to expiration dates on gift certificates. We have not been served in this matter but do not believe that the lawsuit, if served, will have a material impact on our business or on our consolidated financial position or results of operations.

Napster is a party to other litigation matters and claims from time to time in the ordinary course of its operations, including copyright infringement litigation for which it is entitled to indemnification by content providers, and is a party to certain litigation matters relating to CSD that have been assumed by Sonic in connection with its purchase of CSD, and, while the results of such litigation and claims cannot be predicted with certainty, Napster believes that the final outcome of such matters will not have a material adverse impact on its business, financial position, cash flows or results of operations.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

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

There were no matters submitted to a vote of security holders during the quarter ended September 30, 2005.

ITEM 5. OTHER INFORMATION

None.

ITEM 6. EXHIBITS

Exhibits

The exhibits listed on the Exhibit Index (following the Signatures section of this report) are included, or incorporated by reference, in this quarterly report.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Quarterly Report on Form 10-Q to be signed on its behalf by the undersigned thereunto duly authorized.

		NAPSTER, INC. (Registrant)
Date:	November 2, 2005	By:	/s/ WM. CHRISTOPHER GOROG
			Wm. Christopher Gorog Chief Executive Officer (Principal Executive Officer)
		By:	/s/ NAND GANGWANI
			Nand Gangwani Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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INDEX TO EXHIBITS

Exhibit Number	Description of Exhibit
2.1	Asset Purchase Agreement between the Registrant and Napster, Inc., Napster Music Company, Inc., and Napster Mobile Company, Inc., dated November 15, 2002. (1)
2.2	Purchase Agreement among the Registrant, UMG Duet Holdings, Inc., a Delaware corporation, and SMEI Duet Holdings, Inc., a Delaware corporation, dated May 19, 2003. (2)
2.3	Amended and Restated Asset Purchase Agreement between the Company and Sonic Solutions, dated December 17, 2004. (3)
3.1	Amended and Restated Certificate of Incorporation of the Registrant (4)
3.2	Amended and Restated Bylaws of the Registrant (5)
3.3	Certificate of Designation of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Napster, Inc. (6)
4.1	Form of Common Stock certificate of the Registrant (3)
4.2	Registration Rights Agreement dated May 17, 2001 between the Registrant and Virgin Holdings, Inc. (7)
4.3	Preferred Stock Rights Agreement, dated as of May 18, 2001, between Registrant and Mellon Investor Services, LLC, including the Certificate of Designation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively (6)
4.4	Form of Purchase Agreement dated as of June 18, 2003 by and between the Registrant and certain Purchasers set forth on the signature page thereto (8)
4.5	Amended and Restated LLC Operating Agreement of Napster, LLC dated May 19, 2003 by and between Registrant, UMG Duet Holdings, Inc. and SMEI Duet Holdings, Inc. (5)
4.6	Form of Purchase Agreement dated as of January 13, 2004 by and between Napster and certain Purchasers set forth on the signature page thereto (9)
4.7	Registration Rights Agreement dated June 17, 2004 between the Registrant and Best Buy Enterprise Services Inc. (10)
4.8	Common Stock Purchase Agreement between Registrant and Best Buy Enterprise Services Inc. dated June 17, 2004 (10)
4.9	Form of Purchase Agreement dated as of January 20, 2005 by and between Registrant and certain Investors (11)
31.1	Certification of Chief Executive Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer required pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on December 12, 2002.

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(2) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on May 19, 2003.

(3) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on December 23, 2004.

(4) Incorporated by reference to the Registrant’s Form 10 Registration Statement (No. 000-32373) as filed with the Securities and Exchange Commission on May 15, 2001.

(5) Incorporated by reference to the Registrant’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on June 30, 2003.

(6) Incorporated by reference to the Registrant’s Registration Statement on Form 8-A as filed with the Securities and Exchange Commission on June 5, 2001.

(7) Incorporated by reference to the Registrant’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission on June 29, 2001.

(8) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on June 20, 2003.

(9) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on January 13, 2004.

(10) Incorporated by reference to the Registrant’s Registration Statement on Form S-3 (No. 333-117520) as filed with the Securities and Exchange Commission on July 20, 2004.

(11) Incorporated by reference to the Registrant’s Current Report on Form 8-K as filed with the Securities and Exchange Commission on January 21, 2005.

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