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

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

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Publication and Distribution.    We offer services to encode content as secure digital music files and have the ability to encode approximately 20,000 individual music samples per day. Our system hosts digital music files and distributes them through a network of music websites and a digital music subscription service.

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Syndication.    Our distribution system syndicates music content to a network of leading retail, music and original equipment manufacturer (“OEM”) websites.

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Promotion and Sale.    We offer services to manage the secure promotion, transfer and sale of digital music, including reporting on digital music sales. Our Liquid Player software, a desktop software application, allows the consumer to preview, purchase and download digital recorded music. Our Liquid Player includes the capability of purchasing digital Christian music from EMI CMG through its digital music subscription service, burnitfirst.com. We also enable the output of digital music to recordable compact discs and digital audio devices. To enable online sales, we provide a set of e-commerce services, including credit card processing, the remittance of royalty payments and detailed transaction reports. In addition, we provide promotional services that help build market awareness for content available through our network.

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Potential for Increased Revenues and Lower Costs for Content Partners.    Our services are designed to enable record companies and artists to generate increased revenues by offering their entire catalog of existing music, as well as singles and periodic releases, for sale online. Our products and services provide a cost-effective way to digitally offer entire music catalogs to consumers, thus reducing the costs associated with physical manufacturing, warehousing and shipping.

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Superior Consumer Experience.    Our solution enables consumers to preview, purchase, download and export a wide variety of near compact disc quality music online. We make it simple to search for, sample and buy selected digital recorded music from a growing inventory. Our Liquid Player enables customers to purchase digital Christian music from EMI CMG through our digital music subscription service, burnitfirst.com. Our Liquid Player also enables digital music to be transferred to a compact disc by means of a recordable compact disc device and output to digital audio devices. We further simplify the user experience by supporting multiple music download formats, including Liquid Audio, Microsoft Windows Media and MP3.

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Security and Compliance.    Our digital rights management (“DRM”) system protects copyright owners against piracy by authenticating, limiting and tracking the number of copies made of a digitally delivered sound recording. Our platform also includes patented territory restriction capabilities that enable the sale over the Internet of digital recorded music in compliance with geographic distribution limitations.

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Multiple Formats and Digital Rights Management Systems.    Our multi-format distribution solution is based on an open architecture and can publish, syndicate and sell content using leading download formats and DRMs, including Liquid Audio, Microsoft Windows Media, MP3 and Sony OpenMG.

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Global Reach.    Our platform allows the Internet to be used as a global distribution channel for artists, record companies and retailers. This could be particularly significant to independent record labels that have limited access to traditional retail distribution channels. Our patented territory restriction technology identifies the approximate geographic location of consumers to enforce content rules worldwide.

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EMI Recorded Music.    Under an agreement with Virgin Holdings, Inc., an affiliate of EMI Recorded Music, in July 2000 we started to sell EMI songs and albums through designated music destination and retail sites, including CDNOW. We also sell music from EMI CMG or we encode, through its digital music subscription service, burnitfirst.com.

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Sony Music.    We are encoding, hosting and delivering promotional downloads from Sony Music on Amazon.com’s website, through our agreement with Amazon.com.

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Universal Music Group.    We are encoding, hosting and delivering promotional downloads from Universal Music Group on Amazon.com’s website, through our agreement with Amazon.com.

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Warner Music Group.    Under an agreement with Warner Music Group, in November 2000 we started to sell Warner songs and albums through our Liquid Music Network.

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Zomba Records Group.    Zomba has made songs and albums from some of the most popular artists available for sale through the Liquid Music Network. These artists include Britney Spears and ‘N SYNC.

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Independent Labels.    Many independent record labels have chosen to make their catalogs available online using our solution. These labels include Artemis Records, Avex, Beggars Banquet, Del-Fi Records, edel music, Rounder Records, Strictly Rhythm, Sub Pop Records, Twin/Tone Records and Vanguard Records. As of December 31, 2001, record labels have chosen to promote and sell more than 180,000 digital music recordings through our Liquid Music Network. This compares to approximately 140,000 digital music recordings at the beginning of 2001.

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Amazon.com.    Under our agreement with Amazon.com, we are encoding, hosting and delivering promotional music downloads for the free downloads section of Amazon.com’s music website, which is designed to increase compact disc sales.

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Best Buy.    Leading retailer Best Buy uses the Liquid Store commerce solution and offers a custom branded version of Liquid Player software to sell music from our catalog of content on our bestbuy.com website.

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CDNOW.    CDNOW uses RIFFS to promote and sell digital music to consumers through our online retail website, cdnow.com. The website began offering music from our catalog of content for sale in February 2000.

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Musicland.    Musicland is using RIFFS for its destination sites, SamGoody.com, Suncoast.com, OnCue.com and MediaPlay.com, and started selling music from our catalog of content in August 2000.

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Digital Rights Management (“DRM”).    Our DRM solution protects content delivered online through a digital identification and rights reporting system. Consumers can use our FastTrack Security technology to enjoy secure music on one computer or use its Liquid Passport to move their music to multiple machines while still providing anti-piracy protections.

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Consumer Electronics Technology.    Our Secure Portable Player Platform (“SP3”) provides content management and protection technology for consumer electronic devices. We have developed specific technologies to enable music to be securely copied to portable digital audio devices. The SP3 system also provides a technology interface that facilitates compatibility with other digital rights management systems.

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Multi-Format Distribution Container.    We have developed a master media container that facilitates the delivery of media through our system. This container structure is designed to permit extension to other media types, such as third-party formats or video. The container is optimized for music distribution and includes multiple images that can be used to preview and purchase media content in multiple formats including Liquid Audio, MP3, Microsoft Windows Media and Sony ATRAC3, and at multiple resolutions. The multi-format nature of the container also facilitates compatibility across systems. This container also facilitates the real-time insertion of information such advertising and promotions.

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Watermarking.    Watermarking embeds indelible and inaudible digital information into the audio waveform. We have developed our own patented watermarking technology that is specifically designed to operate in conjunction with compression technologies. The embedded information is useful for identifying and tracking audio usage and cannot be removed without destroying the recorded music.

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Audio Compression.    Audio compression reduces the bandwidth required to stream and download music over network connections. Our format-neutral music distribution system supports the delivery of music using several leading compression technologies: AAC, Sony ATRAC3, MS-Audio and MP3. We have added extensions to the AAC audio compression technology that further improve audio quality. In addition, we have developed an exclusive, proprietary lossless compression algorithm that is useful for professional audio applications.

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Liquid Server.    Our Liquid Server software is the heart of our platform and manages and delivers encoded music files for streaming or downloading. We have built transaction, security and copyright management functionality into the Liquid Server. We have integrated this software with a variety of e-commerce and database software applications so that a large volume of digital music and associated information can be securely sold or distributed through the Internet.

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Territory Restrictions.    We have been awarded a patent by the U.S. Patent Office for the territory restrictions capabilities in our platform. This technology identifies the approximate geographic location of consumers. We use this technology to enforce rules for content access related to territory. This enforcement is necessary since complex worldwide music licensing arrangements often preclude the sale of some content in specific territories.

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Open Interfaces.    We have developed interfaces to third-party systems for commerce, databases and general purpose media delivery. Our commerce interfaces allow our platform to take advantage of many payment methods from credit cards to micro-payment solutions. The database interfaces allow our system to dynamically update time sensitive information, such as pricing, without requiring expensive re-encoding of content. Our third-party system interfaces permit us to connect and provide compatibility with general purpose media delivery systems such as those provided by RealNetworks and Microsoft Corporation.

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Secure Protocols.    We have created secure protocols for communication between all parts of the system. Secure communications are necessary to prevent theft of content as it moves through the system. Secure links exist between the Liquid Server and content creation tools for publishing, the server and Liquid Player for consumer downloading, and the server and clearinghouse for transaction reporting.

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Device Interfaces.    We have developed SP3, which provides a set of security interfaces and techniques for secure digital audio devices. SP3 is an open specification for use by many device manufacturers. SP3 is consistent with the goals of the Secure Digital Music Initiative (“SDMI”) and is in use by several leading device manufactures. SDMI is sponsored by the Recording Industry Association of America (“RIAA”) to develop an open standard for the secure digital delivery and use of recorded music.

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Content Distribution Technology.    We have developed systems and technology to manage the distribution of content to online merchants such as retailers and service providers. This distribution technology automates and controls the terms for which content is made available to consumers via online retailers and service providers. This system also provides distribution tracking that facilitates customer support for online merchants.

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Automated Encoding, Publication and Content Management.    We have created technologies that improve the efficiency of online music distribution and reduce operating costs. Our content encoding system allows us to format large amounts of quality audio content for online use in a timely and cost effective manner. We also have developed a content management system that automates the services that are necessary for content creators to publish and manage their content. We have also developed database technology that permits us to manage the large volume of content in our distribution system.

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Open Technical Architecture.    An open system design is important because standard formats are not yet available for online music distribution. Our technology has been designed to provide an open and flexible solution that can adapt to many competing compression technologies and formats, including

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Robust and Scalable System Architecture.    A comprehensive and robust system architecture is important to meet the demands that may result from large scale consumer adoption. We have developed a broad range of technologies that enables efficient music distribution services. We have developed specific technologies that permit our system to scale across multiple systems and locations. This technology provides unique advantages for efficiently delivering music and other media to a global audience.

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Superior Audio Quality.    Although the growth and pervasiveness of free music sharing has materially adversely impacted our efforts to create a successful business plan, we continue to believe consumers will pay for quality music, and believe that we have consistently provided superior audio quality for digital music. We employ specific techniques and optimize industry algorithms to improve sound quality. We believe that our use of standardized compression algorithms such as AAC, MP3 and Microsoft Windows Media, provide greater compatibility than proprietary audio compression solutions.

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quantity and variety of digital recorded music content;

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copyright licenses associated with digital recorded music;

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the number and quality of music-related and retail websites;

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ease of consumer experience;

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number of music players distributed;

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price and cost of products and services;

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ability to ensure secure digital delivery of recorded music;

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ability to adapt to changes in component technologies and consumer preferences;

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brand awareness; and

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fidelity and quality of sound of digital recorded music.

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the availability of sufficient bandwidth on the Internet to enable consumers to download digital recorded music rapidly and easily;

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the willingness of consumers to invest in computer technology that facilitates the downloading of digital music;

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the cost of time-based Internet access;

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the number, quality and variety of digital recordings available for purchase through our system relative to those available through other online digital delivery companies, digital music websites, music swapping or sharing websites or through traditional physical delivery of recordings;

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the availability of portable devices to which digital recorded music can be transferred;

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the fidelity and quality of the sound of the digital recorded music; and

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the level of consumer comfort with the process of downloading and paying for digital music over the Internet, including ease of use and lack of concern about transaction security.

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larger audiences;

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larger technical, production and editorial staffs;

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greater brand recognition;

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access to more recorded music content;

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a more established Internet presence;

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a larger advertiser base; and

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substantially greater financial, marketing, technical and other resources.

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use leading technologies effectively;

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continue to develop our strategic and technical expertise;

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enhance our current products and services;

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develop new products and services that meet changing customer needs;

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advertise and market our products and services; and

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influence and respond to emerging industry standards and other technological changes.

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the timing of individual software licenses to customers;

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competition for consumers from traditional retailers as well as providers of online music services;

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the announcement and introduction of new products and services by us and our competitors;

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distribution of the player through OEM and retail partners;

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the upgrade percentage of our promotional player to the paid Player Plus version;

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our ability to increase the number of websites that will use our platform for digital music delivery;

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the timing of our partners’ introduction of new products and services for digital music sales; and

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variability and length of the sales cycle associated with our product and service offerings.

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market adoption and growth of sales of digitally downloaded recorded music over the Internet;

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legal developments with respect to copyright law and downloadable music;

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our ability to attract significant numbers of music recordings to be syndicated in our format;

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our ability to provide reliable and scalable service, including our ability to avoid potential system failures;

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market acceptance of new and enhanced versions of our products and services; and

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the price and mix of products and services we offer.

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take advantage of opportunities, including acquisitions of complementary businesses or technologies;

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develop new products or services; or

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respond to competitive pressures.

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unexpected changes in regulatory requirements;

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export restrictions;

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export controls relating to encryption technology;

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longer payment cycles;

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problems in collecting accounts receivable;

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political and economic instability; and

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potentially adverse tax consequences.

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difficulties in staffing and managing international operations;

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differences in music rights reporting structures; and

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seasonal reductions in business activity.

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actual or perceived lack of security of information, such as credit card numbers;

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lack of access and ease of use;

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inconsistent quality of service and lack of availability of cost-effective, high speed service;

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possible outages due to damage to the Internet;

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excessive governmental regulation; and

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uncertainty regarding intellectual property rights.

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RESULTS

OF OPERATIONS

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revenue recognition;

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estimating valuation allowances, specifically the allowance for doubtful accounts and sales returns reserve; and

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accounting for income taxes.

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(1)

Amounts represent matching contributions to our 401(k) savings plan, and for Robert G. Flynn, also include reimbursement of relocation costs.

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(1)

Options were granted under our 1996 Equity Incentive Plan and generally vest over four years from the date of grant.

(2)

Based on an aggregate of 1,650,750 options granted by us in the year ended December 31, 2001 to our employees, directors and consultants, including the Named Executive Officers.

(3)

Options were granted at an exercise price equal to the fair market value per share of common stock on the grant date, as determined by our board of directors according to the provisions of the 1996 Equity Incentive Plan.

(4)

The potential realizable value is calculated based on the term of the option at its time of grant, or 10 years. In accordance with the rules of the Securities and Exchange Commission, the following table also sets forth the potential realizable value over the term of the options, the period from the grant date to the expiration date, based on assumed rates of stock appreciation of 5% and 10% compounded annually. These amounts do not represent our estimate of future stock price performance. Actual realizable values, if any, of stock options will depend on the future performance of the common stock.

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(1)

The value of unexercised in-the-money options at fiscal year-end is based on a price per share of $2.35 less the exercise price.

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*

$100 invested on July 9, 1999 in stock or index, including reinvestment of dividends. Fiscal year ending December 31.

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each person known by us who beneficially owns more than 5% of the common stock;

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each of our executive officers;

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each of our directors and nominees for director; and

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all executive officers and directors as a group.

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(1)

Includes 74,478 shares of common stock issuable upon the exercise of options exercisable within 60 days of March 13, 2002.

(2)

Includes 57,290 shares of common stock issuable upon the exercise of options exercisable within 60 days of March 13, 2002.

(3)

Includes 125,916 shares of common stock issuable upon the exercise of stock options exercisable within 60 days of March 13, 2002.

(4)

Includes 103,504 shares of common stock issuable upon the exercise of stock options exercisable within 60 days of March 13, 2002.

(5)

Includes 60,414 shares of common stock issuable upon the exercise of options exercisable within 60 days of March 13, 2002.

(6)

Includes 80,943 shares of common stock owned by Hummer Winblad Venture Partners II, L.P., 488 shares of common stock owned by Hummer Winblad Technology Fund II, L.P. (collectively, the “Hummer Winblad Funds”) and 20,000 shares of common stock issuable upon the exercise of stock options exercisable within 60 days of March 13, 2002. Ann Winblad is a general partner of Hummer Winblad Equity Partners II, L.P. (“HWII”), the general partner of each of the Hummer Winblad Funds. Consequently, Ms. Winblad may be deemed to beneficially own all of the shares held by the Hummer Winblad Funds. Ms. Winblad disclaims beneficial ownership of such shares, except to the extent of her respective pecuniary interest therein.

(7)

Includes 30,000 shares of common stock issuable upon the exercise of stock options exercisable within 60 days of March 13, 2002.

(8)

Includes 501,602 shares of common stock issuable upon the exercise of stock options exercisable within 60 days of March 13, 2002.

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Does not exceed 1%.

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(1)

Ann Winblad is a member of our board of directors. Ms. Winblad is a general partner of Hummer Winblad Venture Partners.

(2)

Hummer Winblad Venture Partners II, L.P. purchased 1,756,098 shares of Series A preferred stock, 757,370 shares of Series B preferred stock and 80,943 shares of Series C preferred stock. Hummer Winblad Technology Fund II, L.P. purchased 62,198 shares of Series A preferred stock and 26,825 shares of Series B preferred stock. Hummer Winblad Technology Fund II, L.P. purchased 10,976 shares of Series A preferred stock, 4,733 shares of Series B preferred stock and 488 shares of Series C preferred stock.

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confidential treatment received as to certain portions

(1)

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

(2)

incorporated by reference to the Registration Statement on Form S-1 and all amendments thereto, Registration No. 333-91541, filed with the Securities and Exchange Commission on November 23, 1999 and declared effective December 14, 1999

(3)

incorporated by reference to the Form 10-Q filed with the Securities and Exchange Commission on May 15, 2000

(4)

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

(5)

incorporated by reference to the Form 10-Q filed with the Securities and Exchange Commission on November 13, 2000

(6)

incorporated by reference to Exhibits of the Form 8-A filed with the Securities and Exchange Commission on August 15, 2001

(7)

this exhibit has been omitted because the information is shown in the financial statements or notes thereto

(8)

incorporated by reference to the Form 10-K filed with the Securities and Exchange Commission on March 29, 2002

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