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SECURITIES AND EXCHANGE COMMISSION

(Mark One)

OR

Commission file number 000-30063

ARTISTDIRECT, INC.

(323) 634-4000
(Registrant’s telephone number, including area code)

5670 Wilshire Boulevard, Suite 200
Los Angeles, CA 90036
(Former name, former address and former fiscal year, if changed since last report)

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 o

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

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

Number of shares of Common Stock, par value $0.01 per share, outstanding as of September 30, 2003: 3,462,117 shares.

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INDEX

     In this Report, the words “ARTISTdirect,” the “Company,” “we,” “us” and “our” collectively refer to ARTISTdirect, Inc.

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PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS OF ARTISTDIRECT, INC.

ARTISTdirect, Inc. and Subsidiaries
Consolidated Balance Sheets
(amounts in thousands, except for share data)

See accompanying notes to condensed consolidated financial statements.

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ARTISTdirect, Inc. and Subsidiaries
Consolidated Statements of Operations

(amounts in thousands, except for share data)

See accompanying notes to condensed consolidated financial statements.

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ARTISTdirect, Inc. and Subsidiaries
Consolidated Statements of Changes in Stockholders’ Equity (Deficit)
(amounts in thousands, except for share data)

See accompanying notes to condensed consolidated financial statements.

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ARTISTdirect, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
(amounts in thousands)

See accompanying notes to condensed consolidated financial statements.

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ARTISTDIRECT, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 1 - THE COMPANY

ARTISTdirect, Inc. (the “Company”) was formed on October 6, 1999 upon its merger with ARTISTdirect, LLC. This merger was only a change in the form of ownership of the Company. ARTISTdirect, LLC was organized as a California limited liability company and commenced operations on August 8, 1996.

NOTE 2 – GOING CONCERN

     The Company has incurred losses and negative cash flows from operations in every fiscal period since inception and has an accumulated deficit of $215.2 million as of September 30, 2003. For the three months and nine months ended September 30, 2003, the Company incurred net losses of $1.7 million and $14.2 million, respectively, and negative operating cash flows of $4.6 million and $9.3 million, respectively. Additionally, the Company has been funding substantially all of the operations of ARTISTdirect Records, LLC, its record label joint venture with Radar Records Holdings, LLC, an entity owned by the Company’s Chairman, Ted Field. The Company’s operations to date and loans to ARTISTdirect Records, LLC have been funded by sales of its capital stock. Management expects the Company’s operating losses and the operating losses of ARTISTdirect Records, LLC to continue for the foreseeable future. The Company does not currently anticipate that available cash reserves will be sufficient to meet anticipated needs for working capital and capital expenditures over the next twelve months without additional capital. The Company is attempting to raise additional funding, but does not have any formal commitments as of the date of these financial statements. If sufficient funding is not available, then the Company may not be able to fund its own operations or its remaining commitment to provide funding to ARTISTdirect Records, LLC. In such event, the Company may seek to divest all or certain of its assets in order to raise the capital necessary to sustain business operations. Should this fail the Company may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss for stockholders. The conditions described above raise substantial doubt about the Company’s ability to continue as a going concern. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.

NOTE 3 – CRITICAL ACCOUNTING POLICIES

Principles of Consolidation

     The accompanying financial statements include the consolidated accounts of the Company and its subsidiaries in which it has controlling interests in the form of voting and operating control. All significant intercompany accounts and transactions have been eliminated for all periods presented.

Liability associated with investments in affiliated companies

     Investments in affiliated companies in which the Company’s voting interest is greater than 20% and does not have a controlling financial interest, or in which the Company is able to exert significant influence in instances where the voting interest is less than 20%, are accounted for under the equity method of accounting. Under this method, the investment, originally recorded at cost, is adjusted to recognize the Company’s share of the net earnings or losses of the affiliates as they occur rather than as dividends or other distributions received. The Company’s share of losses is generally limited to the extent of the Company’s investment in and advances to the investee. However, the Company records losses in excess of its investment when funding commitments exist.

     The Company is accounting for its investment in ARTISTdirect Records, a limited liability company that was founded with Ted Field in July 2001, on the equity method of accounting since the Company does not have voting or operational control of the investee. The Company originally committed to fund 100% of the operations of ARTISTdirect Records, up to $50.0 million, and recorded 100% of the losses attributable to that venture from inception to April 30, 2002. From May 1, 2002, the Company’s funding commitment was reduced to $45.0 million by the sale of 5% of ARTISTdirect Records’ equity to BMG and therefore the Company has recorded only its proportionate share, on the basis of relative funding commitments, of any losses of ARTISTdirect Records since that time. As of September 30, 2003, the Company had funded advances of $33.0 million to ARTISTdirect Records and recorded losses totaling $45.0

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million, equal to the total of its funding commitment. As a result, it is expected that no additional equity losses in ARTISTdirect Records will be recorded by the Company going forward. However, the Company remains obligated to fund $12.0 million in 2004. The Company has recorded a liability related to this investment as of September 30, 2003 and December 31, 2002 as the Company’s share of losses exceeded their advances as of these respective dates.

     The Company records a valuation allowance on loans to ARTISTdirect Records in the period in which it appears that the loan is no longer collectible. The Company has not recorded a valuation allowance on its loans to ARTISTdirect Records as the carrying amount of the loans has been reduced to zero as a result of the Company recording its share of losses of ARTISTdirect Records as of September 30, 2003 and December 31, 2002.

Unaudited Interim Financial Information

     The unaudited interim financial statements of the Company included herein have been prepared in accordance with the instructions for Form 10-Q under the Securities Exchange Act of 1934, as amended, and Article 10 of Regulation S-X under the Securities Act of 1933, as amended. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations relating to interim financial statements.

     In the opinion of management, the accompanying unaudited interim consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the financial position of the Company at September 30, 2003 and results of its operations, stockholders’ equity (deficit) and cash flows for the nine months ended September 30, 2003 and 2002. The results of operations for the three months and nine months ended September 30, 2003 are not necessarily indicative of the expected results for the full year or any future period. These financial statements should be read in conjunction with the consolidated financial statements and footnotes included in the Company’s documents filed with the Securities and Exchange Commission (“SEC”) including its Form 10-K and Registration Statements on Form S-1, and all amendments thereto.

Loss Per Common Share

     The Company computes net loss per share in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 128, “Earnings Per Share,” and Securities and Exchange Commission Staff Accounting Bulletin (“SAB”) No. 98. SFAS No. 128 requires companies with complex capital structures to present basic and diluted earnings per share (“EPS”). Basic EPS is measured as the income or loss available to common shareholders divided by the weighted average outstanding common shares for the period. Diluted EPS is similar to basic EPS but presents the dilutive effect on a per-share basis of potential common shares (e.g., convertible securities, options, warrants, and similar investments) as if they had been converted at the beginning of the periods presented. Potential common shares that have an anti-dilutive effect (i.e., those that increase income per share or decrease loss per share) are excluded from diluted EPS. The number of potentially dilutive common share equivalents outstanding and excluded from diluted EPS because their effect is anti-dilutive as of September 30, 2003 and 2002 was approximately 780,000.

Revenue Recognition

     E-commerce revenue consists primarily of the gross amount of sales revenue paid by the customer for recorded music and merchandise sold via the Internet, including shipping fees, and is recognized when the products are shipped. The Company records e-commerce revenue on a gross basis as the Company enters into the sale transactions with customers, establishes the prices of the products, chooses the suppliers of the products, assumes the risk of inventory loss and collects all amounts from the customers and assumes the credit risk. E-commerce revenue is subject to amounts due to the respective artists based on their contracts, and such expense is recorded as part of direct cost of product sales.

     The Company records amounts charged to customers for shipping and handling in accordance with Emerging Issues Task Force 00-10, “Accounting for Shipping and Handling Fees and Costs.” Pursuant to EITF 00-10, the Company records amounts charged to customers for shipping and handling as revenue, and records the related costs incurred for shipping and handling to direct cost of product sales in the consolidated statements of operations. For the three and nine months ended September 30, 2003 and 2002, the Company recorded $165,000 and $567,000, and

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223,000 and $717,000, respectively, as revenue for shipping and handling fees charged to customers. For the three and nine months ended September 30, 2003 and 2002, the Company recorded $145,000 and $485,000, and 195,000 and $662,000, respectively, of shipping and handling costs as direct cost of product sales in the consolidated statements of operations.

     Media revenue consists primarily of the sale of advertisements and sponsorships, both online and offline, under short-term contracts. To date, the duration of the Company’s advertising and sponsorship commitments has generally averaged from one to three months with certain programs lasting up to nine months. The Company’s online obligations typically include the guarantee of a minimum number of “impressions” or times that an advertisement appears in pages viewed by the users of the Company’s online properties. Online advertising revenue is generally recognized as the impressions are served during the period in which the advertisement is displayed, provided that no significant obligations of the Company remain and collection of the resulting receivable is reasonably assured.

     The Company recognizes revenue for sponsorship arrangements, both online and offline, over the period during which the advertising is provided, generally on a straight-line basis. If the sponsorship arrangement is for the sponsorship of a specific event, the Company recognizes revenue when event occurs. The Company recognizes revenue separately for each element of integrated entertainment marketing packages that offer advertisers a combination of off-line concert and tour sponsorships that are supported by on-line banner advertising, web page sponsorships, emails to the Company’s customers and custom content. The Company determines the fair value of each deliverable based on the fair value of the different deliverables when sold on a stand-alone basis. The Company recognizes revenue for each deliverable as the services are provided. The Company recognizes revenue for the banner impression deliverable as the banner impressions are delivered. The Company recognizes revenue for the customer emails when the emails are sent. The Company recognizes revenue for web page sponsorships on a straight-line basis over the term of the sponsorship. The Company recognizes revenue for custom content when the content is provided to the customer. The Company recognizes revenue for event sponsorships when the event has occurred.

     iMusic record label revenue consists primarily of the sale of compact discs by artists signed to iMusic, the brand name used by the Company for the record label operated by its wholly owned subsidiary ARTISTdirect Digital, Inc. The Company recognizes revenues upon the shipment of compact discs from its distributors to retailers and independent wholesalers and records appropriate reserves for product returns. At the time of the shipment of the product, the following criterion under Statement of Financial Accounting Standards (SFAS) No. 48, “Revenue Recognition When Right of Return Exists,” have been met: the seller’s price to the buyer is substantially fixed or determinable at the date of sale; the buyer has paid the seller, or the buyer is obligated to pay the seller and the obligation is not contingent on resale of the product; the buyer’s obligation to the seller would not be changed in the event of theft or physical destruction or damage of the product; the buyer acquiring the product for resale has economic substance apart from that provided by the seller; the seller does not have significant obligations for future performance to directly bring about resale of the product by the buyer; the amount of future returns can be reasonably estimated.

     The Company estimates the provision for returns on a quarterly basis by album based on the amount of time since the initial album release, the actual returns to date, the trend of sales activity (sales by the retailers and wholesalers) and the number of unsold units at retailers and wholesalers. Returns to the Company’s distributors are deemed to be returns to the Company. iMusic record label revenues recorded for the three months and nine months ended September 30, 2003 are net of a provision for returns of $136,000 and $600,000, respectively.

Stock-Based Compensation

     The Company accounts for stock-based employee compensation in accordance with the provisions of Accounting Principles Board (“APB”) Opinion No. 25 and FASB Interpretation No. 44 (FIN 44), “Accounting for Certain Transactions Involving Stock Compensation,” and complies with the disclosure requirements of SFAS No. 123, “Accounting for Stock-Based Compensation.” Under APB No. 25, compensation expense is recorded based on the difference, if any, between the fair value of the Company’s stock and the exercise price on the measurement date. The Company accounts for stock issued to non-employees in accordance with SFAS No. 123, which requires entities to recognize as expense over the service period the fair value of all stock-based awards on the date of grant and EITF 96-18, “Accounting for Equity Investments that are Issued to Other Than Employees for Acquiring, or in

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Conjunction with Selling, Goods or Services”, which addresses the measurement date and recognition approach for such transactions.

     Stock-based compensation included in cost of revenue represents the amortization of non-cash compensation expense related to vendor warrants and stock options granted to artists and their advisors in connection with entering into contractual commitments to operate their online commerce activities. The Company records the fair value of options and warrants granted to non-employees as compensation expense over the period of service. The Company determines the fair value of these options and warrants based on the Black-Scholes option pricing model.

     Stock-based compensation included in operating expenses represents the amortization of non-cash compensation expense related to equity instruments granted to employees, directors, professional firms, artists and artist advisors. Compensation for equity grants to non-employees is recorded in the same manner as described above. The Company records stock compensation for employee option grants equal to the excess of the fair value of its common stock over the exercise price on the grant date. The Company records the compensation over the vesting period.

     Pro forma information regarding net loss per share is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of such statement. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model. The assumptions used in the model and the weighted average fair value of each option granted for 2002 are as follows: risk free interest rate of 4%, volatility of 120%, dividend yield of 0% and a weighted average expected life of 5 years. There have been no option grants in 2003.

     For purpose of pro forma disclosures, the estimated fair value of the options is amortized into expense over the options’ vesting period. The Company’s pro forma information follows (in thousands, except per share amount):

Impairment of Long-Lived Assets

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     Impairment of long-lived assets is monitored on a continuing basis, and is assessed based on the undiscounted cash flows generated by the underlying assets. In the event the carrying amount of long-lived assets exceed the undiscounted future cash flows, then the carrying amount of such assets is adjusted to their fair value. There was no impairment of long-lived assets as of December 31, 2002. In the second quarter of 2003, the Company determined that its fixed assets were impaired due to continuing losses, going concern issues, the delisting of its stock from the NASDAQ Stock Market and the likelihood that the majority of these assets will be abandoned in the near future. The Company believed that these factors were indicators of impairment and the carrying amount of the fixed assets was reduced to the estimated fair value. Accordingly, the Company recorded a write-off of $2.25 million in the second quarter of 2003.

Estimates

     In preparing financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reporting period. Some of the more significant estimates are the allowances for sales returns and inventory obsolescence, reserves on artist advances, allowances for bad debt, impairment of long-lived assets and goodwill, stock based compensation and the valuation allowance on deferred tax assets. Actual results could differ from those estimates.

Recently Issued Accounting Pronouncements

     In November 2002, the FASB’s Emerging Issues Task Force (EITF) issued EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” EITF 00-21 addresses certain aspects of the accounting by a vendor for arrangements under which it will perform multiple revenue-generating activities. Specifically, EITF 00-21 addresses how to determine whether an arrangement involving multiple deliverables contains more than one unit of accounting. In applying EITF 00-21, separate contracts with the same entity or related parties that are entered into at or near the same time are presumed to have been negotiated as a package and should, therefore, be evaluated as a single arrangement in considering whether there are one or more units of accounting. That presumption may be overcome if there is sufficient evidence to the contrary. EITF 00-21 also addresses how arrangement consideration should be measured and allocated to the separate units of accounting in the arrangement. The guidance in this Issue is effective for revenue arrangements entered into in fiscal periods beginning after June 15, 2003. The Company adopted this accounting pronouncement during the quarter ended September 30, 2003 but it has not had any significant impact on the Company’s financial statements.

     In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an amendment of SFAS No. 123”. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. This statement also amends the disclosure requirements of SFAS No. 123 and APB Opinion No. 28, “Interim Financial Reporting,” to require prominent disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method used on reported results. Certain of the disclosure modifications are required for fiscal years ending after December 15, 2002 and are included in the Notes to these Consolidated Financial Statements. The Company implemented SFAS No. 148 effective January 1, 2003 regarding disclosure requirements for condensed financial statements for interim periods. The Company’s management has determined that they will continue to account for stock-based employee compensation in accordance with APB No. 25.

     In February 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities (“FIN 46”), which addresses the consolidation by business enterprises of variable interest entities, which have one or both of the following characteristics: (1) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional financial support from other parties, or (2) the equity investors lack one or more of the following essential characteristics of a controlling financial interest: (a) the direct or indirect ability to make decisions about the entity’s activities through voting or similar rights, (b) the obligation to absorb the expected losses of the entity if they occur, or (c) the right to receive the expected residual returns of the entity if they occur. FIN 46 will have a significant effect on existing practice because it requires existing variable interest entities to be consolidated if those entities do not effectively disburse risks among parties involved. In addition, FIN 46 contains detailed disclosure requirements. FIN 46 applies immediately to variable interest entities created after January 31, 2003, and to variable

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interest entities in which an enterprise obtains an interest after that date. It applies in the first fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003. This Interpretation may be applied prospectively with a cumulative-effect adjustment as of the date on which it is first applied or by restating previously issued financial statements for one or more years with a cumulative-effect adjustment as of the beginning of the first year restated. The adoption of this pronouncement may have a significant impact on the Company’s consolidated financial statements as the operations of ARTISTdirect Records, which the Company is currently accounting for under the equity method, may have to be consolidated effective December 31,2003.

NOTE 4 – INVESTMENT IN ARTISTDIRECT RECORDS, LLC

     In May 2001, the Company entered into an agreement with veteran entertainment executive Frederick W. “Ted” Field to become Chairman and Chief Executive Officer of ARTISTdirect and form a new record label, ARTISTdirect Records, LLC, in partnership with ARTISTdirect. On June 29, 2001, ARTISTdirect stockholders approved the employment of Mr. Field and the formation of the record label. ARTISTdirect Records was formed as a 50/50 co-venture between ARTISTdirect and Mr. Field, with the Company providing a significant financial commitment.

     In November 2001, ARTISTdirect Records agreed in principle to enter into a preliminary North American distribution agreement and worldwide license agreement with BMG, the global music division of Bertelsmann AG. Under the terms of the agreement, BMG Distribution will distribute ARTISTdirect Records’ releases in North America, and BMG will license ARTISTdirect Records’ repertoire in territories throughout the world. In April 2002, the agreements with BMG were finalized including BMG’s purchase of 5% of the equity of ARTISTdirect Records from the Company. As part of this transaction, BMG agreed to assume $5.0 million of the Company’s funding commitment to ARTISTdirect Records. In December 2002, BMG exercised its option to extend the term of the distribution and license agreement until September 2004.

     The Company initially committed to the venture a total of $50 million over five years with the Company committing to fund up to $15.0 million per year, subject to a limit of $33 million in any three year period. Any funding in excess of these amounts would require the approval of the Company’s Board of Directors. As a result of the BMG equity purchase, the Company’s funding commitment was reduced to $45 million of which it has advanced $33.0 million as of September 30, 2003.

     In August 2002, the Company’s Board of Directors approved an agreement (the “Bridge Loan Agreement”) to accelerate up to $10 million of its funding commitment to ARTISTdirect Records. This funding was in addition to the $15 million that the Company was obligated to advance to ARTISTdirect Records in 2002 as part of the initial $50 million funding commitment. During 2002, the Company funded its $15 million commitment plus the additional $10 million bridge loan for total advances to the record label of $25.0 million in 2002 and $30.25 million from the inception of the record label through December 31, 2002. The $10 million of accelerated funding was credited toward the satisfaction of the Company’s overall funding commitment and funding obligation for 2003 resulting in a remaining funding commitment of $2.75 million for 2003 and $12.0 million for 2004. The Company’s commitment to fund ARTISTdirect Records is subject to a guaranty for the benefit of BMG. Should the Company fail to meet its commitment, BMG may choose to enforce the guaranty or provide substitute financing that could result in dilution of the Company’s interest in ARTISTdirect Records.

     As consideration for entering into the Bridge Loan Agreement and funding the additional $10 million, the Company received an additional 20% interest in ARTISTdirect Records from Radar Records Holdings, L.L.C. (“FieldCo,” the entity through which Mr. Field owns his interest in ARTISTdirect Records) which resulted in an increase in the Company’s ownership share of ARTISTdirect Records to 65% from 45% and a decrease in Mr. Field’s ownership share to 30% from 50% (the “Ownership Transfer”). The Bridge Loan Agreement also provides that any dilution from the issuance of equity interests in ARTISTdirect Records that would have been borne solely by the Company will be borne both by FieldCo and the Company pro rata with their then respective ownership interests. Furthermore, the Bridge Loan Agreement contains a provision designed to provide the Company with a minimum compound annual rate of return of 25% based upon the realized value of the Bridge Loan Agreement and the Ownership Transfer, however, there can be no assurance that such rate of return will be realized. Consequently, the Company has not recorded any amounts related to the 25% minimum annual compounded return.

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     During the third quarter of 2003, ARTISTdirect Records raised $100,000 of additional capital from two outside investors and $250,000 from Ted Field, Chairman of the Company and CEO of ARTISTdirect Records. This funding was in addition to the $900,000 of funding received in the second quarter from outside investors and $250,000 from Ted Field. The total funding of $1.5 million during the second and third quarters was obtained through the issuance of Convertible Promissory Notes (the “Bridge Notes”). The Bridge Notes accrue interest at an annual rate of 8% and shall be converted into new equity in ARTISTdirect Records when an aggregate amount of at least $2.0 million, including the $1.5 million of Bridge Notes already issued, of new financing is raised. The Bridge Notes are due in June 2005. In addition, the holders of the Bridge Notes received warrants with a term of five years to purchase additional equity of ARTISTdirect Records at $.01 per unit equivalent to the number of units of new equity that their Bridge Notes are converted into. The relative fair value of the warrants issued as of September 30, 2003 was $750,000, which was recorded as additional paid in capital, resulting in a discount on the carrying amount of the Bridge Notes. The Bridge Notes are convertible into equity based on their face amount, which results in a beneficial conversion feature with a relative fair value of $750,000. The fair value of the warrants is being expensed as interest expense over the term of the Bridge Notes. Since the commitment date for the beneficial conversion feature is contingent upon the completion of the financing round, the fair value of the beneficial conversion feature will be expensed upon the completion of a financing round of an aggregate amount of at least $2.0 million. The resulting carrying amount of the Bridge Notes as of September 30, 2003 is $750,000.

     During the third quarter of 2003, ARTISTdirect Records significantly reduced its operating activities and laid off the majority of its staff while it continues to seek additional capital. ARTISTdirect Records did not release any new records during the period.

     ARTISTdirect Records requires additional capital in order to continue operations, and therefore the Company is continuing to pursue alternatives to raise additional capital for both itself and for ARTISTdirect Records. However, there can be no assurance that additional capital can be obtained by either the Company or by ARTISTdirect Records on reasonable terms or at all. If additional funds were raised through the issuance of equity securities of either the Company or ARTISTdirect Records, the percentage ownership of the Company’s current stockholders in the Company and/or the Company’s ownership of ARTISTdirect Records would be reduced. Failure to raise additional capital could seriously harm the business of ARTISTdirect Records and impair the value of the Company’s investment in ARTISTdirect Records. In such event, ARTISTdirect Records may seek to divest all or certain of its assets or the Company may seek to divest all or a part of its ownership of ARTISTdirect Records, in order to raise the capital necessary to sustain business operations of the Company and/or ARTISTdirect Records. Should this fail, ARTISTdirect Records may be forced to cease operations and seek bankruptcy protection or undertake liquidation, potentially resulting in a total loss of the Company’s investment in ARTISTdirect Records.

     Because the Company does not have voting or operating control of ARTISTdirect Records, even with its majority ownership position, it does not consolidate the results of ARTISTdirect Records and it records its share of losses based on the equity method of accounting as loss from equity investments in its consolidated statements of operations. However, the Company may be required to begin consolidating ARTISTdirect Records as of December 31, 2003 as a result of FASB’s FIN No. 46 (see Recently Issued Accounting Pronouncements above for further details). Prior to the completion of BMG’s purchase of a 5% interest in ARTISTdirect Records in April 2002 and BMG’s assumption of 10% of the Company’s total funding commitment, the Company had committed to fund 100% of the operations of ARTISTdirect Records and has recorded 100% of the losses attributable to that venture from the inception of ARTISTdirect Records to April 30, 2002. Since May 1, 2002, the Company has recorded only its proportionate share, on the basis of remaining relative funding commitments, of any losses of ARTISTdirect Records. During the second quarter of 2003, the Company’s cumulative losses recognized since inception of ARTISTdirect Records reached $45.0 million, the amount of its reduced funding commitment plus its initial capital contribution. As a result, the Company ceased recording any additional equity losses beyond that amount and does not anticipate recording any additional equity losses in the future. Therefore, the Company did not recognize any equity losses related to ARTISTdirect Records during the three months ended September 30, 2003 compared with equity losses of $5.6 million for the three months ended September 30, 2002. For the nine months ended September 30, 2003 and 2002, the Company recognized equity losses of $7.1 million and $23.6 million, respectively.

However, the Company may be required to begin consolidating ARTISTdirect Records as of January 1, 2004 as a result of FASB’s FIN No. 46 (see Recently Issued Accounting Pronouncements above for further details). The Company charged ARTISTdirect Records $0 and $562,500 for the three months and nine months ended September 30, 2003, respectively, and $337,500 and $1,012,500, for the three months and nine months ended September 30, 2002, for the reimbursement of overhead costs including rent and other occupancy costs and shared personnel.

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These amounts are reflected as a reduction in general and administrative expense in the Company’s consolidated statements of operations.

     The carrying amount of the Company’s investment in ARTISTdirect Records represents the difference between the Company’s investment and advances and the Company’s share of losses from ARTISTdirect Records. The Company records its loan advances to ARTISTdirect Records as additional equity investments. As of September 30, 2003 and December 31, 2002, the Company’s share of losses exceeded the amount of the Company’s investment and advances to those dates, resulting in a credit balance of approximately $12.0 million and $7.7 million, respectively. Therefore, the carrying amounts have been classified as a liability on the Company’s balance sheet.

     The Company has no recorded investment in the loans to ARTISTdirect Records, as the carrying amount of the loans have been reduced to zero as a result of the Company recording its share of losses of ARTISTdirect Records as of September 30, 2003 and December 31, 2002. The Company does not record interest income on the loans to ARTISTdirect Records.

     A roll forward of the Company’s net investment balance for the periods indicated is as follows:

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     The statements of operations for ARTISTdirect Records, LLC for the three months and nine months ended September 30, 2003 and 2002 are as follows (amounts in thousands):

ARTISTdirect Records, LLC
Statements of Operations
(amounts in thousands)

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     The balance sheets for ARTISTdirect Records, LLC as of September 30, 2003 and December 31, 2002 are as follows (amounts in thousands):

ARTISTdirect Records, LLC
Balance Sheets
(amounts in thousands)

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NOTE 5 – BUILDING LEASE

     In June 2003, the Company initiated discussions with its landlord regarding the potential termination or restructuring of its office lease that had a term through April 2010. On June 24, 2003, the landlord filed suit against the Company for unlawful detainer of its premises and in July 2003 the landlord drew down the entire remaining $1.35 million letter of credit that the Company had put forth as a security deposit in conjunction with the execution of the original lease. In September 2003, the Company reached an agreement to terminate our lease with the landlord. In conjunction with the termination, the Company issued to the landlord 200,000 warrants that enable the purchase of an equivalent number of the Company’s shares at $.50 per share. In October 2003, the legal proceeding against us was dismissed with prejudice. As a result, the Company recorded an expense of $429,000, comprised of $1.35 million under the letter of credit which was funded by the Company, plus $100,000 of expense related to the issuance of warrants to the landlord, offset by a deferred rent obligation which was recorded to reflect rent under the lease on a straight-line basis.

NOTE 6– SEGMENT INFORMATION

     As of September 30, 2003, the Company operates primarily through three reportable segments: E-commerce operations (“E-commerce”), Media operations (“Media”) and Record Label operations through its iMusic record label and its 65% equity interest in ARTISTdirect Records LLC, its co-venture with Ted Field. However, because the Company does not exert voting and operating control over ARTISTdirect Records, its results are not consolidated.

     Prior to December 2001, the Company also considered its talent agency business to be a segment, but the Company decided in December 2001 to exit this business and as a result it has been shown as a discontinued operation in the consolidated statements of operations. The segment data below has been restated for all periods to reflect the current segment structure.

     E-commerce revenue is generated from the sale of recorded music and music-related merchandise. Media revenue is generated from the sale of advertising and sponsorships, both online and offline. Record label revenue is generated from the sale of recorded music performed by artists signed to the Company’s wholly owned iMusic record label.

     The factors for determining reportable segments were based on service and products. Each segment is responsible for executing a unique marketing and business strategy. The accounting policies of the segments are the same as those described in the summary of significant accounting policies. The Company evaluates performance based on EBITDA (earnings or loss before interest, taxes, depreciation and amortization, including stock based compensation, and loss from impairment of goodwill). Included in EBITDA loss are direct operating expenses for the segment. The following table summarizes the revenue and EBITDA loss by segment for the three months and nine months ended September 30, 2003 and 2002. Corporate expenses consist of general operating expenses that are not directly related to the operations of the segments.