10-K

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

x	ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
	For the fiscal year ended December 31, 2008
o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number:  000-30063

ARTISTdirect, Inc.
(Name of Small Business Issuer in Its Charter)

Delaware	95-4760230
(State or Other Jurisdiction	(I.R.S. Employer
of Incorporation or Organization)	Identification Number)

1601 Cloverfield Boulevard, Suite 400 South, Santa Monica, California 90404-4082
(Address of Principal Executive Offices, including Zip Code)

Issuer’s Telephone Number, Including Area Code:  (310) 956-3300

Securities registered pursuant to Section 12(b) of the Act:  None

Securities registered pursuant to Section 12(g) of the Act:  Common stock, $0.01 par value

Check whether the issuer is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.   Yes o No x

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes o No x

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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

Check if disclosure of delinquent filers pursuant to Item 405 of Regulation S-B is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x

Indicate by check mark whether registrant is a “large accelerated filer, “accelerated filer,” non-accelerated filer” or “smaller reporting company reporting company” as such terms are defined  in Rule 12b-2 of the Exchange Act (check one):  Large Accelerated Filer o  Accelerated Filer o  Non-Accelerated Filer o  Smaller Reporting Company  x

Check whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

As of June 30, 2008, the aggregate market value of the voting common stock held by non-affiliates of the registrant was approximately $1,509,851, based on the closing price per share of $0.27 for the registrant’s common stock as reported on the Over-the-Counter Bulletin Board on such date.

As of April 10, 2009, there were 56,077,158 shares of the registrant’s common stock, par value $0.01 per share, issued and outstanding.

Documents incorporated by reference:  None.

ARTISTDIRECT INC.
ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

		Page
PART I
ITEM 1.	BUSINESS	2
ITEM 1A	RISK FACTORS	15
ITEM 1B	UNRESOLVED STAFF COMMENTS	20
ITEM 2.	PROPERTIES	21
ITEM 3.	LEGAL PROCEEDINGS	21
ITEM 4.	SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS	21
PART II
ITEM 5.	MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES	22
ITEM 6	SELECTED CONSOLIDATED FINANCIAL DATA	22
ITEM 7.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23
ITEM 7A	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	41
ITEM 8.	FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA	42
ITEM 9.	CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE	42
ITEM 9A(T).	CONTROLS AND PROCEDURES	42
ITEM 9B.	OTHER INFORMATION	42
PART III
ITEM 10.	DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE	43
ITEM 11.	EXECUTIVE COMPENSATION	46
ITEM 12.	SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS	52
ITEM 13.	CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE	58
ITEM 14.	PRINCIPAL ACCOUNTANT FEES AND SERVICES	60
ITEM 15.	EXHIBITS AND FINANCIAL STATEMENT SCHEDULES	60
SIGNATURES		61

1

NOTE CONCERNING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Annual Report on Form 10-K (“Annual Report”) for ARTISTdirect, Inc. (“ARTISTdirect,” the “Company,” “we,” “our”  or “us”) contains “forward-looking” statements within the meaning of the United States Private Securities Litigation Reform Act of 1995, including statements that include the words “may,” “will,” “believes,” “expects,” “anticipates,” or similar expressions. These forward looking statements may include, among others, statements concerning our expectations regarding our business, growth prospects, revenue trends, operating costs, accounting, working capital requirements, competition, results of operations and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The forward-looking statements in this Annual Report involve known and unknown risks, uncertainties and other factors that could cause our actual results, performance or achievements to differ materially from those expressed or implied by the forward-looking statements contained herein.

Each forward-looking statement should be read in context with, and with an understanding of, the various disclosures concerning our business made elsewhere in this Annual Report, as well as other public reports filed by us with the United States Securities and Exchange Commission. Investors should not place undue reliance on any forward-looking statement as a prediction of actual results of developments. Except as required by applicable law or regulation, we undertake no obligation to update or revise any forward-looking statement contained in this Annual Report.

PART I

ITEM 1.BUSINESS

General

Incorporated under the laws of the State of Delaware in July 1999, we were exclusively an Internet based digital media company that was home to an on-line music website and an affiliate network of lyric websites. Through our acquisition of MediaDefender, Inc., a Delaware corporation (“MediaDefender”), in July 2005, we also became a provider of anti-piracy solutions in the Internet piracy protection industry.  Below is an overview of our business segments:

·Internet Piracy Prevention. Our Internet piracy prevention (“IPP”) segment is currently operated by MediaDefender, as a wholly-owned subsidiary of ARTISTdirect. MediaDefender’s proprietary suite of IPP solutions offers significant levels of protection on major peer-to-peer (“P2P”) file-sharing networks. Our IPP segment accounted for approximately 64% and 61% of our revenue during the fiscal years ended December 31, 2008 and 2007, respectively.  Refer to “MediaDefender Overview - Internet Anti-Piracy Segment below for more information.

·Media. Our media operations include our content-oriented websites, a network of third party music sites, our advertising and other marketing initiatives. Revenue from media operations is generated from the sale of online advertising and integrated marketing solutions. We market and sell advertising on a cost-per-impression basis to advertising agencies and directly to various companies as part of their marketing programs. Customers may purchase advertising space for our flagship website www.artistdirect.com or the entire ARTISTdirect network, and they may tailor advertising based on music genre (e.g., jazz, country or rock music) or based on functionality (e.g., directing advertising to customers using music download features or broadband-only features of the ARTISTdirect network). Our media segment accounted for approximately 36% and approximately 33% of our revenue during the fiscal years ended December 31, 2008 and 2007, respectively.

·E-Commerce. E-commerce operations consist of the sale of recorded music and artist-related merchandise on our websites.  Most of our sales come from our ARTISTdirect shopping area, which offers a comprehensive selection of music CDs and a range of artist and lifestyle merchandise. Effective August 31, 2007, the Company restructured the relationship with its merchandising partner to eliminate merchandise sales and focus on sales of music CDs. Our e-commerce segment accounted for approximately 3% and approximately 6% of our revenue during the fiscal years ended December 31, 2008 and 2007, respectively.

Refer to “ARTISTdirect Overview-Media and E-Commerce Segments” below for additional information.

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At December 31, 2008, we employed 68 full-time employees, none of whom are covered by a collective bargaining agreement. We believe that our relationship with our employees and consultants is good.

Recent Developments

Debt Restructing

Senior Debt Restructuring

Effective January 30, 2009, ARTISTdirect, Inc. (the “Company”) entered into a First Amendment to Note and Warrant Purchase Agreement dated as of December 31, 2008 (the “Senior Amendment”) with the holders of the Company’s senior secured debt (the “Senior Note Holders”).  Pursuant to the Senior Amendment, the Senior Note Holders agreed to extinguish all obligations by the Company under the Note and Warrant Purchase Agreement, dated July 28, 2005, and other documents entered into in connection with the senior secured debt transaction (the “Senior Debt Restructuring”), upon completion of the following: (1) $3,500,000 cash payment to the Senior Note Holders; (2) issuance of new subordinated notes, in the aggregate principal amount of $1,000,000, to the Senior Note Holders (the “New Notes”); (3) issuance of 9,000,000 restricted shares of the Company’s common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months; and (4) the conversion of all of the previously issued Subordinated Notes.  The Senior Debt Restructuring was consummated as of January 30, 2009.

The New Notes are unsecured and bear interest at 6.0% per annum, beginning January 30, 2009. The principal and the interest accrued thereon are payable on the maturity date, January 30, 2014, and are subordinated to the senior indebtedness of the Company.

Additionally, in connection with the Senior Debt Restructuring, Trilogy Capital Partners, Inc. agreed to deliver to the Company for cancellation a warrant to purchase up to 433,333 shares of the Company’s capital stock at an exercise price of $2.00 per share.  Fifty percent of such warrants were beneficially owned by Dimitri Villard, the Company’s Chief Executive Officer, who had acquired such warrants as part of the acquisition of 6,190,000 shares from Trilogy Capital Partners, Inc., which occurred on January 15, 2009.

Conversion of Subordinated Notes

In connection with the Senior Debt Restructuring, effective January 30, 2009, the Company entered into a Second Amendment to the Convertible Subordinated Note with holders of the Subordinated Notes representing no less than the majority of the current outstanding aggregate principal amount to provide for the immediate conversion of the Subordinated Notes (the “Subordinated Amendment”). The Subordinated Amendment also provides for the extinguishment of all obligations of the Company under the Subordinated Notes and related documents, including the Registration Rights Agreement among the Company and the holders.  Such obligations included the outstanding principal amount and accrued and unpaid interest on the Subordinated Notes, accrued and unpaid late charges and amounts owed under the Registration Rights Agreement with the holders of the Subordinated Notes.  Consummation of the transactions under the Subordinated Amendment occurred as of January 30, 2009.

Financing by Factoring Accounts Receivables

On January 30, 2009, the Company’s two wholly-owned subsidiaries, ARTISTdirect Internet Group, Inc. (“ADIG”) and MediaDefender each entered into an Accounts Receivable Purchase & Security Agreement (the “A/R Agreement”) with Pacific Business Capital Corporation (“PBCC”), pursuant to which ADIG and MediaDefender agreed to sell and PBCC agreed to purchase qualified accounts receivable on a recourse basis. On January 30, 2009, PBCC purchased an aggregate of approximately $1,600,000 of unpaid receivables to be acquired by PBCC pursuant to the A/R Agreement, subject to a maximum aggregate amount of $3,000,000. The A/R Agreement is effective for twelve-months and automatically renews for successive 12-month periods unless terminated by written notice by either party 30 days prior to such successive period.

As collateral for the financing, PBCC received a first priority interest in all existing and future assets of the Company, ADIG and MediaDefender, tangible and intangible, including but not limited to, cash and cash equivalents, accounts receivable, inventories, other current assets, furniture, fixtures and equipment and intellectual property. In addition to the foregoing, the Company, ADIG and MediaDefender entered into cross guarantees of their respective obligations under the A/R Agreement.

Convertible short-term note to Director

On March 3, 2009, the Company issued a convertible note (the “Note”) to Frederick W. Field, a director of the Company.  The Note is in the principal amount of $200,000 with the principal amount and accrued interest at the rate of 5% per annum due on July 31, 2009.  The Note is automatically convertible into shares of the Company’s Common Stock at a price of $0.03 per share at such time as the Company has sufficient authorized shares.

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The following table is a proforma presentation of the Consolidated Balance Sheet reflecting the above described Debt Restructuring as if it had occurred as of December 31, 2008.

	December 31, 2008
	Audited			Proforma
Assets:
Cash	$	2,262,000		$	12,000
Other current assets, net	3,480,000			3,480,000
Property and equipment, net	1,201,000			1,201,000
Other non-current assets, net	546,000			153,000
	$	7,489,000		$	4,846,000
Liabilities and Stockholders’ Equity (Deficiency)
Accounts payable and accrued expenses	$	921,000		$	971,000
Accrued interest and liquidated damages	8,890,000			—
New credit facility	—			1,250,000
Senior secured notes, net	12,817,000			—
Subordinated convertible notes, net	26,397,000			—
Other current liabilities	1,228,000			1,183,000
	50,253,000			3,404,000
New subordinated notes, net of discount	—			270,000
Other long-term liabilities	159,000			159,000
	159,000			429,000
Net Stockholders’ Equity (Deficiency), net	(42,923,000		)	1,013,000
	$	7,489,000		$	4,846,000

Management and Director Changes

Effective January 13, 2009, each of Randy Saaf and Octavio Herrera (each, an “Executive”) entered into separate amendments (collectively, the “Amendments”) to their respective Employment, Confidentiality and Noncompetition Agreements (collectively, the “Employment Agreements”) dated as of July 28, 2005 with MediaDefender, Inc..  Under each of the Amendments, commencing January 1, 2009 the term of employment between each Executive and the MediaDefender were at-will, and either the MediaDefender or the Executive may terminate the applicable Employment Agreement upon five days’ written notice, in which case such Executive shall have a period of 60 days from the effective date of termination to exercise all vested stock options.  Effective February 15, 2009, MediaDefender, terminated the employment of Randy Saaf, Chief Executive Officer of MediaDefender, and Octavio Herrera, President of MediaDefender.

Effective February 1, 2009, Dimitri Villard, the Chairman of the Board of Directors,  pursuant to a three year employment agreement, was appointed to serve as the Company’s Chief Executive Officer. Prior to that date, Mr. Villard was the Company’s interim Chief Executive Officer.  Mr. Villard will receive base compensation equal to $25,000 per month subject to increases as determined by the Board of Directors, in its sole discretion.  Mr. Villard was granted options to purchase 3,920,000 shares of the Company’s stock at $0.03 per share vesting monthly over 36 months and will receive a bonus equal to 33% of the amount by which the Company’s EBITDA exceeds a certain threshold amount as determined by the Company’s Compensation Committee for such fiscal year.

Effective February 1, 2009, the Company and Rene Rousselet (“Executive”) entered into an Employment Agreement pursuant to which Mr. Rousselet was employed to continue as the Company’s Corporate Controller and Principal Accounting Officer.  The employment is on an “at will basis.”  Mr. Rousselet will receive a salary of $14,583 per month subject to increases and a bonus as determined by the Board of Directors, in its sole discretion.  Mr. Rousselet was granted options to purchase 560,000 shares of the Common Stock of the Company at $0.03 per share vesting monthly over 36 months commencing February 1, 2009.  If Mr. Rousselet’s employment is terminated without cause, Mr. Rousselet will receive his salary and vesting of options for an additional period of three months from the date of termination.

4

Acquisition of MediaSentry

The Company and its wholly owned subsidiary, MediaDefender entered into an Asset Purchase Agreement dated as of March 30, 2009 (the “Purchase Agreement”) pursuant to which the Company through MediaDefender agreed to purchase from SafeNet, Inc. and MediaSentry, Inc. (collectively the “Sellers”), substantially all the assets of the MediaSentry operating unit (the “Acquired Assets”).  In connection with the acquisition, MediaDefender acquired the receivables, equipment and intellectual property of MediaSentry as well as assumed substantially all the employees, offices and client contracts relating to MediaSentry.  The purchase price of the Acquired Assets was $936,000 consisting of $136,000 in cash and a $800,000 one-year promissory note of the Company.  The acquisition was consummated on March 30, 2009.  The MediaSentry operating unit provides (a) comprehensive business and marketing intelligence services for digital media measurement and (b) services to globally detect, track and deter the unauthorized distribution of digital content.

MediaDefender Overview - Internet Anti-Piracy Segment

MediaDefender was incorporated in July 2000 as a provider of anti-piracy solutions. We completed the acquisition of MediaDefender in the third quarter of fiscal 2005. MediaDefender’s solutions have been adopted by major entertainment companies as a practical means to thwart Internet piracy and drive consumers to pay for digitized content distributed through authorized Internet sites.  MediaDefender charges customers per file it distributes to the P2P audience.

Internet-Based Piracy. Piracy has long been and continues to be a problem for the global content industries. The International Intellectual Property Alliance (“IIPA”) estimates that the worldwide cost of music and computer software piracy costs content providers as much as $18 billion per year in lost sales.  The IIPA provides annual estimates of copyright piracy, but has excluded piracy of movies, video games and books as this information was not available for 2008.  The IIPA 2008 amount indicates a 9% increase in piracy for the reported categories over 2007.  The MPAA has indicated that copyright piracy could reach new highs during the current economic downturn.  Due to the relatively small size of MP3 files, music was the first industry to be severely impacted by Internet piracy.  Worldwide music sales decreased 7% in 2008 which is a decrease in the decline as compared to a 10% drop in 2007.  According to the RIAA, the decline, in sales has been due in part, to widespread copying and illegal Internet downloading of music.  The growth of broadband Internet access is now making larger-sized files, such as movies, software and video games, similarly vulnerable to Internet-based piracy. Already, the majority of motion pictures are available in some form on the Internet before theatrical release.

To date, attempts to limit internet-piracy have been largely unsuccessful. Litigation, legislation, education, commercial innovation, packaged media and digital rights management (“DRM”) anti-piracy technologies have been employed with limited impact.

IPP Solutions. MediaDefender employs a wide array of technical countermeasures on P2P networks to frustrate users’ attempts to find, copy and share unauthorized copyrighted materials.  Users of P2P networks attempting  to download content that is successfully protected by MediaDefender either cannot begin the downloading process, download the specified file to find that it is not the content for which they were searching, or download a file to find that it works for the first few seconds and then reverts to white noise or static. By making it more difficult for P2P users to access unauthorized content on the Internet, MediaDefender induces consumers to pay for content distributed through legitimate means, such as Apple Corporation’s iTunes.

Next-Generation Solutions. Due to the rapidly evolving nature of the P2P environment, MediaDefender must continually adapt its technologies in order to offer customers increasing levels of effectiveness against the latest Internet-piracy threats. MediaDefender’s development team is constantly monitoring advances in peer-to-peer networking and developing solutions to target new networks.

Advertising. During 2008 and 2007 MediaDefender worked with several advertising agencies and their clients to launch innovative programs which distributed branded advertising content on P2P networks. These programs generate ancillary incremental revenue which serves to reduce the potential negative impact of a reduction in the growth of its IPP solutions services in the recorded music and television area.

5

Patent Pending Technology. MediaDefender’s IPP solutions utilize proprietary software and a robust, scalable IT platform. This patent-pending combination of software and IT was created over time and is based upon the successes and failures of real-world trials. Computer equipment and software is monitored and maintained on a 24/7 basis. The use of back-up and redundant systems, combined with constant monitoring, allows MediaDefender to provide continuous coverage and rapidly address potential technical problems.

Intellectual Property. During 2008 MediaDefender obtained an umbrella patent that covers some of its concept and back-end technologies. Due to the evolving nature of P2P networks, these technologies are not based on any one service, but rather have the fluidity to be transferred to any P2P network. The claims in the patent filing are predominantly methods for managing a large array of computers for the purpose of preventing piracy on P2P networks.

Sales and Marketing. MediaDefender’s sales process is relationship-based with a relatively long sales cycle. Initial customer relationships were with music and movie industry clients, targeted due to the impact of piracy on these businesses, and has since expanded to software and gaming clients.

Customers . MediaDefender’s current principal customers include four major record labels and four major motion picture studios.  Approximately 65% of MediaDefender’s consolidated revenues were from three customers.  Of those three customers, the respective customers’ percentages were 32%, 21% and 12% of MediaDefender’s revenues during the year ended December 31, 2008.  During 2007, there were four customers constituting 68% of MediaDefender’s consolidated revenues, one customer accounted for 21%, two customers each were at 18% and one customer accounted for 12%.

Market Share and Competition. Management believes that MediaDefender has the majority of the IPP solution market. The Company recently purchased its major existing competitor, MediaSentry, from Safenet, Inc.,  and Macrovison, a firm which had been competing in the IPP business, recently stopped offering the service due to a lack of performance in the market.

ARTISTdirect Overview – Internet Media and E-Commerce Segments

The ARTISTdirect Network is a network of websites anchored by our flagship website www.artistdirect.com offering multi-media content, music news and information, community around shared music interests, advertising sponsorships, music-related specialty commerce and digital music services.

Our network consists of our music search engine and database containing information on more than 100,000 artists, retail goods, e-commerce offering a wide selection of artist merchandise and music, our proprietary music guide that enables users to browse music by artist, genre or time period, a music-oriented online community and the ability for users to download and listen to music and view music videos.

Technology. Our infrastructure is designed to be integrated, scalable, reliable and secure. The software that we use supports the acquisition, management and publication of content on our websites.  During fiscal 2008, the management of our websites and servers for content, applications, database and electronic commerce was handled internally. Our servers are maintained at three co-location facilities in El Segundo and Los Angeles, California, and Phoenix, Arizona. Our operations depend on the ability to protect our systems against fire, power loss, telecommunications failure, break-ins and other events. All websites, servers, and systems are monitored and periodic backups are stored at our data center.  The Company has a disaster recovery site in Arizona to provide a continued Internet present should the Los Angeles area experience a major operational failure.

Order Processing and Fulfillment. Our websites include an ordering system that is designed to facilitate convenient online purchasing of pre-recorded CD’s and DVD’s.  We utilize an outside fulfillment house to verify orders submitted for credit card payment for fraud detection and sufficient funds before we release the order for shipment.  The fulfillment house insures that the credit card numbers are encrypted, and all customer, commerce and transactional data are stored in secure databases protected by firewalls. The transmission of information over the Internet uses Secure Socket Layer security technology verified by VeriSign, an industry leader in online security.

6

We have an agreement with Alliance Entertainment Corp. (“Alliance”) to be the primary supplier of our music and movie-related merchandise.  Alliance processes and fulfills the orders by our customers and we pay Alliance the wholesale costs of the merchandise plus transaction fees.  Alliance also provides customer service and shipping services.   If we are unable to continue our current agreement with Alliance or identify a suitable alternative fulfillment house, our E-commerce business could be adversely affected.

Sales and Marketing. We sell advertising and sponsorships to companies seeking to reach one or more of the distinct demographic audiences viewing content in the ARTISTdirect network. Advertisers may choose single elements such as targeted or run-of-network banners or sponsorship of fixed placement on our websites. Pricing is negotiated based upon the size of the target audience, the duration and intensity of the campaign and the size and placement of the advertisement.

Effective February 1, 2009, we entered into an exclusive agreement with Traffic Marketplace (“TMP”) for the representation and sale of our advertising inventory for United States users as well as for opt-in email, direct mail and telemarketing list management and co-registration services. In exchange for such exclusive representation, TMP guarantees us a certain level of revenue subject to our achieving a threshold of unique user visits and page views on our sites and our network affiliates’ sites.

We use a number of methods to create awareness of the ARTISTdirect network designed to drive traffic to our websites. We have focused much of our marketing activity on e-mail direct marketing to communicate with registered users about specific artists and the ARTISTdirect network. Campaigns have included direct notification of special merchandise offers, contests, promotions and available music downloads. To the extent our registered users in the future opt out of e-mails or use technology to block marketing e-mails, our operating results could be adversely affected. Ad-blocking technologies may be used to limit the effectiveness of web advertising.

Customers. During the year ended December 31, 2008, one customer accounted for $589,000 or 15% of total media revenue.  During the year ended December 31, 2007, one customer accounted for $1.2 million or 16% of total media revenue.  No other customer accounted for more than 10.0% of our media revenue during either year.

Competition. The market for the online promotion and distribution of music and music-related products and services is highly competitive and rapidly changing. There are a large number of websites competing for the attention and spending of consumers and advertisers, and we expect that number to increase, because there are few barriers to entry to Internet commerce.  In addition, the competition for advertising revenue, both on websites and in more traditional media, is intense. We compete as follows:

·for music consumers and advertisers with providers of music information, community and content such as MTV, America Online, MSN, Yahoo!, Listen.com, myspace.com, mp3.com, billboard.com and various other companies;

·with major online music retailers such as Amazon.com and iTunes Music Store in selling music and merchandise;

·for music consumers and artist relationships with traditional music industry companies, including Sony BMG Music Entertainment, EMI Music, a unit of EMI Group, Warner Music Group, and Universal Music Group, a unit of Vivendi. Some of these companies have established online presences to promote and distribute the music and tours of their respective artists;

·for music consumers and advertisers with publishers and distributors of traditional media, such as television, radio and print, including MTV, CMT, Rolling Stone and Spin and their Internet affiliates; and

·with traditional retailers targeting music consumers, including Wal-Mart and Target and their Internet affiliates, in selling music and merchandise.

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Our competitors have worked together to offer music over the Internet, and we may face increased competitive pressures as a result. We believe that we are able to compete effectively on the basis of:

·the breadth and quality of our search, database and the community features of our site;

·the variety, availability and price of music-related merchandise on our sites; and

·the ease of use and consumer acceptance of the ARTISTdirect network.

Competition is likely to increase significantly as new companies enter the market and current competitors expand their services. Many of our current and potential competitors in the Internet and music entertainment businesses may have substantial competitive advantages over us, including:

·longer operating histories;

·significantly greater financial, technical, management capital and marketing resources;

·greater brand name recognition;

·larger existing customer bases; and

·more popular content or artists.

These competitors may be able to respond more quickly to new or emerging technologies, regulatory developments and changes in customer requirements and to devote greater resources to the development, promotion and sale of their products or services than we can. Websites maintained by our existing and potential competitors may be perceived by consumers, artists, talent management companies and other music-related vendors or advertisers as being superior to ours. In addition, we may not be able to maintain or increase our web-site traffic levels, purchase inquiries and number of click-through on our online advertisements. Further, our competitors may experience greater growth in these areas than we do. Increased competition could result in advertising price reduction, reduced margins or loss of market share, any of which could materially harm our business.

Governmental Regulation. The laws and regulations that govern our business change rapidly. Although our operations are currently based in California, the United States government and the governments of other states and foreign jurisdictions have attempted to regulate activities on the Internet. The following is a general discussion of some of the evolving areas of law that are relevant to our business:

Content Regulation and Privacy Law. The state of privacy law is unsettled, and rapidly changing. Current and proposed federal, state and foreign privacy regulations and other laws restricting the collection, use and disclosure of personal information could limit our ability to use the information in our databases to generate revenues. In late 1998, the Children’s Online Privacy Protection Act, or “COPPA,” was enacted, mandating that measures be taken to safeguard minors under the age of 13. The Federal Trade Commission (“FTC”) promulgated regulations implementing COPPA on October 21, 1999, which became effective on April 21, 2000.

The principal COPPA requirement is that individually identifiable information about minors under the age of 13 not be collected, used, displayed or otherwise collected without first obtaining informed parental consent that is verifiable in light of present technology. The FTC final regulations create a “sliding scale” of permissible methods for obtaining such consent based on how the information will be used. Consent for internal use of the individually identifiable information of children under the age of 13 can be obtained through e-mail plus an additional safeguard, such as confirming consent with a delayed e-mail, telephone call, or letter.

We comply with the COPPA requirements by not collecting or displaying the individually identifying information of users who, when attempting to register on the websites, enter their birth date indicating they are under the age of 13. Complying with the COPPA requirements is costly and may dissuade some of our potential customers.

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Because we have posted a privacy policy pertaining to all users and visitors to our web-site, we are subject the jurisdiction of the FTC.  We may also be subject to the laws and regulations of other states, for example we are aware that California passed the California Online Privacy Protection Act, which took effect July 1, 2004 and mandates content and posting requirements for websites privacy policies of websites that collect personal information from California residents. While we are attempting to be fully compliant with the FTC and California requirements, our efforts may not be entirely successful. In addition, at times we rely upon outside vendors to maintain data-collection software, and there can be no assurance that they will at all times comply with our instructions to comply with COPPA, our Privacy Policy and FTC and California or other state requirements. If our methods of complying with these requirements are inadequate, we may face litigation with the FTC, California governmental authorities or individuals, which would adversely affect our business. Should any of our business practices be found to differ from our privacy policy, we could be subject to sanctions and penalties from the FTC or injunctions and penalties from California governmental authorities. It is also possible that users or visitors could try to recover damages in a civil action as well. Attorney Generals in various States also have in the past sought to enforce posted privacy policies and may continue to do so in the future.

Laws Governing Sending of Unsolicited Commercial E-mail. We typically provide our customers and other visitors to our websites with an opportunity to “opt-in,” or agree to receive e-mail from us. The federal government signed the Controlling the Assault of Non-Solicited Pornography and Marketing Act of 2003 (CAN-SPAM) designed to limit unsolicited commercial e-mail commonly referred to as “spam.” In addition, California and a number of other states regulate the sending of e-mails for commercial purposes to third parties where there is no preexisting business relationship. Further, several states give Internet service providers (“ISPs”) a private right of action against those who send large e-mailings across their servers in contravention of the ISP’s posted policy. There is no guarantee that we will always be fully compliant in all of our communications at all times. Our failure to comply with applicable laws regarding these types of e-mails could result in significant fines, actual or statutory damages, and injunctive actions.

Conformance to E-Commerce Statutory Requirements for Formation of Contracts. We conduct e-commerce on our websites, and through affiliated websites. The applicable law on online formation of contracts is evolving. On June 30, 2000, the federal government enacted the Electronic Signatures in Global and National Commerce Act (“E-SIGN”), which provides that certain electronic signatures and electronic contracts with consumers, of the type that we enter into, are not unenforceable solely because they are electronic.  E-SIGN also specifies requirements for electronic record retention.  On January 1, 2000, California adopted a version of the Uniform Electronic Transactions Act (“UETA”), which also permits electronic signatures and record-keeping for certain types of contracts.  Forty-six states have adopted a version of UETA.  Because all state-UETA laws are not identical, there are potentially conflicting requirements applicable to electronic signatures and electronic contracts.  We attempt to comply with these laws, but there is no guarantee that we will be successful.   Judicial interpretation or issuance of governmental regulations interpreting E-SIGN and potentially conflicting State UETA laws with regard to contracts of the type entered into by our customers throughout websites and affiliated websites could result in customer contracts being set aside or modified. In that case, our e-commerce revenue could be materially adversely affected.

Sales Tax. The tax treatment of goods sold over the Internet is currently unsettled. We collect sales taxes for goods shipped to California and Florida, where we have a physical presence (i.e., a “nexus”). A number of proposals have been made at the state and local level that would impose additional taxes on the sale of goods through the Internet. Such proposals, if adopted, could substantially impair the growth of electronic commerce and could adversely affect our opportunity to derive financial benefit from electronic commerce.

Online Contests and Sweepstakes. We occasionally conduct online promotional contests and sweepstakes. No purchase is necessary to participate. Our official rules, with material terms and conditions, eligibility restrictions, dates of participation, methods of entry, prize descriptions and restrictions, and odds of winning, are posted on our websites. To avoid having to register and bond our online promotions in the states of New York and Florida, the approximate retail value of the prizes we offer is generally less than $5,000 for a single promotion. Although we structure our promotions in a way that attempts to comply with applicable statutes as we believe they are currently interpreted and enforced in all fifty states, many of those statutes were drafted long before the advent of promotions over the Internet, and different states have interpreted substantially similar statutes differently. Thus, our ability to conduct online promotions is subject to the broad discretionary enforcement powers vested in various authorities. Further, our ability to conduct online promotions may be affected in whole or in part by various business method patents that may have been issued. In addition, foreign jurisdictions may attempt to regulate or ban our promotional contests. Under any of those three scenarios, we could face fines or possible exposure to liability or lose an effective tool for increasing traffic to and keeping visitors at our websites, and our business could be adversely affected.

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Intellectual Property. Software, content and other material that we develop, as well as our service marks and domain names relating to the ARTISTdirect or UBL brands, and other proprietary rights are important to our business prospects. Significant impairment of our intellectual property rights could harm our business. We seek to protect certain of our common-law trademarks through Federal registration in the United States of America and State registrations in Puerto Rico. We also have trademark registrations in Argentina, Australia, Brazil, Canada, Chile, Costa Rica, the European Union, Japan, Mexico, Panama, Peru, the United Kingdom and Venezuela. Given the cost of filing, maintaining and protecting federal registrations, we may choose not to register or enforce certain of our trademarks that later turn out to be important. Despite our efforts, it is possible that the scope of protection gained from seeking trademark registration will be insufficient or that the registration may be deemed invalid or unenforceable.

We seek to protect many of our innovations as trade secrets and principally rely upon trade secret and contract law in the Unites States to protect our proprietary rights. We generally enter into confidentiality agreements, “work-made-for-hire” contracts and intellectual property licenses with our employees, consultants and corporate partners, respectively, as part of our efforts to control access to and distribution of our technologies, content and other proprietary information. For example, where consultants develop copyrighted content for us, our general policy is to use written agreements prior to content creation to obtain ownership of that content.

The following sets forth a schedule of our active trademarks:

Federal Trademark Filings

MARK	APPL. NO.	REG. NO.	REG. DATE
ARTISTDIRECT	75927362	2742630	July 29, 2003
CORPORATE LOGO	76072567	2764726	September 16, 2003
CORPORATE LOGO	76072566	2457335	June 5, 2001
CORPORATE LOGO	76072563	2469613	July 17, 2001
CORPORATE LOGO	76072562	2473501	July 31, 2001
CORPORATE LOGO	76072561	2473500	July 31, 2001
CORPORATE LOGO	76072560	2524524	January 1, 2002
THE ULTIMATE BAND LIST	75306059	2407553	November 28, 2000
ARTISTDIRECT	75418187	2355839	June 6, 2000
ARTISTDIRECT	75061781	2288100	October 19, 1999

State Trademark Filings

MARK	STATE	REG. NO.	REG. DATE
THE ULTIMATE BAND LIST	Puerto Rico	50161	May 11, 2000
ARTISTDIRECT	Puerto Rico	50159	May 11, 2000
ARTISTDIRECT	Puerto Rico	49609	May 11, 2000
UBL	Puerto Rico	49616	May 11, 2000
UBL	Puerto Rico	49615	May 11, 2000
THE ULTIMATE BAND LIST	Puerto Rico	49614	May 11, 2000
THE ULTIMATE BAND LIST	Puerto Rico	49613	May 11, 2000
THE ULTIMATE BAND LIST	Puerto Rico	49612	May 11, 2000
UBL	Puerto Rico	50158	May 11, 2000
UBL	Puerto Rico	50157	May 11, 2000

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International Filings

MARK	COUNTRY	APPL. NO.	REG. NO.	REG. DATE
A & Design	Argentina	2,320,737	1911466	1/27/2003
A & Design	Argentina	2,320,739	1911467	1/27/2003
A & Design	Argentina	2,374,722	1988933
A & Design	Australia	908102	908102	3/28/2002
A & Design	Brazil	824492609	*
A & Design	Brazil	822892340	822892340	5/15/2007
A & Design	Brazil	822892359	822892359	5/8/2007
A & Design	Brazil	822892332	*
A & Design	Costa Rica	2002-0003186	136855	1/21/2003
A & Design	European Union	2006336	2006336	6/20/2002
A & Design	France	23158012	23158012	4/8/2002
A & Design	Germany	30217397.8/09	30217397	4/5/2002
A & Design	Japan	2002-24589	4648627	2/28/2003
A & Design	Mexico	464672	708608	7/30/2001
A & Design	Mexico	464671	699283	5/24/2001
A & Design	Mexico	464670	703484	6/21/2001
A & Design	Mexico	541631	785949	3/31/2003
A & Design	Panama	112008	*
A & Design	Panama	112010	*
A & Design	Panama	112009	*
A & Design	Peru	120227	*
A & Design	Peru	120228	*
A & Design	Peru	120229	*
A & Design	Peru	151886-2002	82635	8/22/2002
A & Design	United Kingdom	2296994	2296994	8/30/2002
ARTISTDIRECT	Argentina	2,264,378	1886206	9/20/2002
ARTISTDIRECT	Argentina	2,264,379	1886207	9/20/2002
ARTISTDIRECT	Argentina	2,264,380	1886208	9/20/2002
ARTISTDIRECT	Argentina	2,264,381	1886209	9/20/2002
ARTISTDIRECT	Argentina	2,374,721	1920978	4/3/2003
ARTISTDIRECT	Australia	818867	818867	12/30/1999
ARTISTDIRECT	Australia	908101	908101	3/28/2002
ARTISTDIRECT	Canada	864116	512153	5/25/1999
ARTISTDIRECT	Chile	471162	574481	8/18/2000
ARTISTDIRECT	Chile	471163	574480	8/18/2000
ARTISTDIRECT	Chile	471161	574482	8/18/2000
ARTISTDIRECT	Chile	471160	574469	8/18/2000
ARTISTDIRECT	Costa Rica	1999-0010547	121896	8/24/2000
ARTISTDIRECT	Costa Rica	1999-0010548	121134	7/27/2000
ARTISTDIRECT	Costa Rica	1999-0010549	121133	7/27/2000
ARTISTDIRECT	Costa Rica	1999-0010550	121132	7/27/2000
ARTISTDIRECT	Costa Rica	2002-0003185	136854	1/21/2003
ARTISTDIRECT	European Union	699538	699538	6/5/2000
ARTISTDIRECT	France	23158011	23158011	4/8/2002
ARTISTDIRECT	Germany	30217395.1/09	30217395	4/5/2002
ARTISTDIRECT	Japan	183723/1997	4359836	2/10/2000
ARTISTDIRECT	Japan	2002-24588	4648626	2/28/2003
ARTISTDIRECT	Mexico	409261	645860	3/22/2000
ARTISTDIRECT	Mexico	409262	645861	3/22/2000
ARTISTDIRECT	Mexico	409263	649514	3/31/2000
ARTISTDIRECT	Mexico	409264	645862	3/22/2000
ARTISTDIRECT	Mexico	541632	743912	4/29/2002
ARTISTDIRECT	Panama	105638	105638	2/15/2001
ARTISTDIRECT	Panama	105641	105641	2/15/2001

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ARTISTDIRECT	Panama	105640	105640	2/15/2001
ARTISTDIRECT	Panama	105642	105642	2/15/2001
ARTISTDIRECT	Peru	99622	22837	9/12/2000
ARTISTDIRECT	Peru	99623	22761	9/8/2000
ARTISTDIRECT	Peru	99624	22762	9/8/2000
ARTISTDIRECT	Peru	099625-2000	25765	5/24/2001
ARTISTDIRECT	Peru	151884-2002	82854	9/4/2002
ARTISTDIRECT	United Kingdom	2296996	2296996	10/4/2002
ARTISTDIRECT	Venezuela	2000-003045	S-015483	11/22/2000
ARTISTDIRECT	Venezuela	2000-003043	S-015481	11/22/2000
ARTISTDIRECT	Venezuela	2000-003044	S-015482	11/22/2000
ARTISTDIRECT	Venezuela	2000-003042	S-015480	11/22/2000
ARTISTDIRECT DIGITAL	Japan	2002-095128	4688729	7/4/2003
THE ULTIMATE BAND LIST	Argentina	2.119.984	1720730	2/10/1999
THE ULTIMATE BAND LIST	Argentina	2.119.985	1720731	2/10/1999
THE ULTIMATE BAND LIST	Australia	750646	750646	12/9/1997
THE ULTIMATE BAND LIST	Brazil	820399086	*
THE ULTIMATE BAND LIST	Canada	863917	511964	5/18/1999
THE ULTIMATE BAND LIST	Chile	471173	574472	8/18/2000
THE ULTIMATE BAND LIST	Chile	471172	574473	8/18/2000
THE ULTIMATE BAND LIST	Chile	471171	574474	8/18/2000
THE ULTIMATE BAND LIST	Chile	471170	574475	8/18/2000
THE ULTIMATE BAND LIST	Costa Rica	1999-0010555	121887	8/24/2000
THE ULTIMATE BAND LIST	Costa Rica	1999-0010556	121894	8/24/2000
THE ULTIMATE BAND LIST	Costa Rica	1999-0010557	121130	7/27/2000
THE ULTIMATE BAND LIST	Costa Rica	1999-0010558	121895	8/24/2000
THE ULTIMATE BAND LIST	European Union	699355	699355	2/25/2000
THE ULTIMATE BAND LIST	Japan	183722/1997	4359835	2/10/2000
THE ULTIMATE BAND LIST	Mexico	409269	647112	3/27/2000
THE ULTIMATE BAND LIST	Mexico	409270	647113	3/27/2000
THE ULTIMATE BAND LIST	Mexico	409271	645866	3/22/2000
THE ULTIMATE BAND LIST	Mexico	409272	645867	3/22/2000
THE ULTIMATE BAND LIST	Panama	105628	105628	2/15/2001
THE ULTIMATE BAND LIST	Panama	105627	105627	4/6/2001
THE ULTIMATE BAND LIST	Panama	105626	105626	2/13/2001
THE ULTIMATE BAND LIST	Panama	105629	105629	2/13/2001
THE ULTIMATE BAND LIST	Peru	99630	23005	9/28/2000
THE ULTIMATE BAND LIST	Peru	99631	22959	9/20/2000
THE ULTIMATE BAND LIST	Peru	99632	26107	6/18/2001
THE ULTIMATE BAND LIST	Peru	99633	23034	9/29/2000

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UBL	Argentina	2,119,987	1846303	10/2/2001
UBL	Argentina	2,119,986	1870610	5/10/2002
UBL	Australia	750647	750647	12/9/1997
UBL	Brazil	820399060	*
UBL	Brazil	820399051	820399051	5/23/2006
UBL	Canada	863917	503204	10/28/1998
UBL	Chile	471167	574476	8/18/2000
UBL	Chile	471166	574477	8/18/2000
UBL	Chile	471165	574478	8/18/2000
UBL	Chile	471164	574479	8/18/2000
UBL	Costa Rica	1999-0010551	121890	8/24/2000
UBL	Costa Rica	1999-0010552	121888	8/24/2000
UBL	Costa Rica	1999-0010553	121131	7/27/2000
UBL	Costa Rica	1999-0010554	121889	8/24/2000
UBL	European Union	698951	698951	3/3/2000
UBL	Japan	183721/1997	4359834	2/10/2000
UBL	Mexico	409265	645863	3/22/2000
UBL	Mexico	409266	645864	3/22/2000
UBL	Mexico	409267	684935	1/31/2001
UBL	Mexico	409268	645865	3/22/2000
UBL	Panama	105636	105636	2/15/2001
UBL	Panama	105635	*
UBL	Panama	105634	105634	2/13/2001
UBL	Panama	105637	105637	2/13/2001
UBL	Peru	99626	23004	9/28/2000
UBL	Peru	99627	22958	9/20/2000
UBL	Peru	99628	25918	5/31/2001
UBL	Peru	99629	23033	9/29/2000
UBL	Venezuela	2000-003035	S-015477	11/22/2000
UBL	Venezuela	2000-003036	S-015478	11/22/2000
UBL	Venezuela	2000-003034	S-015476	11/22/2000
UBL	Venezuela	2000-003037	S-015479	11/22/2000

* Indicates that application is pending and not yet registered.

Despite our efforts to protect our proprietary rights from unauthorized use or disclosure, our efforts may not be sufficient or successful. It may be possible that some of our innovations may not be protectable. The steps that we have taken may not prevent misappropriation of our proprietary rights, particularly in foreign countries where laws or law enforcement practices may not protect our proprietary rights at all, or as fully as in the United States. Confidentiality may be compromised intentionally or accidentally by contractors, customers, other third parties or our employees. If third parties were to use or otherwise misappropriate our web-site content, source code, other copyright materials, trademarks, service marks or other proprietary rights without our consent or approval, our competitive position could be harmed, or we could become involved in costly and distracting litigation to enforce our rights.

A copyright gives the owner divisible rights, including those of performance, reproduction and distribution. The music featured by us is typically comprised of copyrighted works owned, controlled or administered by multiple third parties, including record labels, artists, songwriters, music publishers and performance rights and licensing organizations such as (but not limited to) The Harry Fox Agency, Broadcast Music Inc. (“BMI”) and the American Society of Composers, Authors and Publishers (“ASCAP”). Each song often has multiple copyright owners, who control rights which may include performance, reproduction and distribution rights in the “musical composition” comprised of the lyrics and music, as well as with the “sound recording” of the artist’s interpretation of the “musical composition.” In the case of music videos, there are separate copyrights to the visual content, as well as “synchronization rights” for integrating the music and video. We, or our artists, may have different licensing arrangements with some or all of these parties to perform, reproduce and distribute works depending upon how the song or music video is used by us.

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Our websites, depending upon the specific musical work, may offer audio streaming of part or all of an entire song or “Web casting,” or the downloading of an entire song in MP3 or other compressed audio formats. Full-length streaming only occurs in special instances after obtaining a license from the record label or band manager for the “sound recording.” In that case, an ASCAP or BMI blanket music license is also obtained by us or by our artists for rights to perform the associated underlying “musical composition.” Where we offer full-length downloads of songs in MP3 or other compressed audio formats, we seek to obtain the rights to transmit, reproduce and perform the “sound recording” in writing from the person or entity owning or controlling copyrights in such “sound recording.” With respect to rights in the “musical compositions” embodied in such “sound recordings” offered for download, we seek to clear rights in musical composition in one or more of the following three ways:

·a license agreement with the publisher, writer or other owner of such copyright in the “musical composition”;

·a waiver of any fees or royalties that would otherwise be required for such use; and/or

·a representation and warranty from the owner of the copyrights in the “sound recording” that no mechanical royalties are owed to any third parties.

In the event that the foregoing steps are insufficient to clear rights, or we otherwise fail to obtain rights, we could be exposed to claims of copyright infringement, with attendant disruption to our operations and liability including potential statutory or actual damages and loss of profits attributable to infringement, plus payment of attorneys’ fees to the claimant and entry of an injunction against us.

There are other situations, such as a limited 30-second sample of a song that is “streamed,” where we use content relying upon a sub-license from an artist’s record label. However, the laws in this area are uncertain, and we may be obligated to obtain additional licenses or may be prevented from third party content use, and may, in the event proper licenses and clearances have not been secured, further be liable to pay actual or statutory damages, profits attributable to any alleged infringement, as well as attorneys’ fees. Our licensing arrangements for third-party content vary from formal contracts to informal agreements based on the promotional nature of the content. In some cases we pay a fee to the licensor for use of the “sound recording,” “musical composition” or music video and in other cases the use is free. We also use other third-party content, including photographs, artist names, likenesses and concert reviews. While it is our general policy to obtain a written release or license for such use, in many instances we rely only upon an oral license for such use. We rely upon our positive working relationships with copyright owners to obtain licenses on favorable terms. Any changes in the nature or terms of these arrangements, including any requirement that we pay significant fees for the use of the content, could have a negative impact on the availability of content or our business.

Linking and Framing of Third-Party websites. We link to and “frame” third-party websites of our artists without express written permission to do so. In addition, in the past we have provided a search feature to allow users to find music residing elsewhere on the Internet. Those practices are controversial, and have, in instances not involving us, resulted in litigation. Various claims, including trademark and copyright infringement, unfair competition, and commercial misappropriation, as well as infringement of the right of publicity may be asserted against us as a result of these practices. The law regarding linking and framing remains unsettled; it is uncertain as to how existing laws, especially trademark and copyright law, will be applied by the judiciary to the Internet. Also, Congress is increasingly active in passing new laws related to the Internet, and there is uncertainty as to the impact of future potential laws, especially those involving domain names, databases and privacy.

Defamation or Contributory Infringement. Our web-site features a community area where visitors can post comments. We do not censor such comments and it is possible that a customer could use our websites as a forum to make false, misleading or disparaging remarks about others. Such on-line comments could lead to claims for defamation or infringement. As to libel claims brought in the United States, we believe that we qualify for safe harbor protection for third-party postings under 47 U.S.C. Section 230(c)(1). However, other countries, notably the United Kingdom, may impose such liability, and it is possible we could be sued there for third-party postings. Separately, our websites allow consumers to use our personal web publishing tools to post samples of their works. Such postings could be misused to post unlicensed copyrighted content of others. We have obtained limited safe-harbor protection under the Digital Millennium Copyright Act against liability for infringing material of which we do not have control and knowledge.

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Seasonality. The seasonality of our e-commerce segment affects our revenue. Our CDs and other online goods are most often purchased during the winter holiday season and also during the summer months, traditionally when artists go on concert tour.

ITEM 1A.               RISK FACTORS

RISK FACTORS

Our actual results may differ materially from those anticipated in these forward-looking statements. We operate in a market environment that is difficult to predict and that involves significant risks and uncertainties, many of which will be beyond our control. Refer also to “Special Note Regarding Forward-Looking Statements.”

RISKS RELATED TO OUR BUSINESS

It is difficult to evaluate our business and prospects because we have a limited operating history and a rapidly evolving business.

We were incorporated under the laws of the state of Delaware in July 1999. Our limited operating history and rapidly evolving business make it difficult to evaluate our prospects or to accurately predict our future revenue or results of operations. Our revenue and income potential are unproven, and our business model is constantly and rapidly evolving. In particular, the Internet is constantly changing and we may need to modify our business model to adapt to these changes.

The music industry is under extreme pressure to reduce costs.

The major music labels are suffering from significant sales and profit deterioration and wherever possible are reducing expenditures. This has negatively impacted the amount of business that MediaDefender has conducted with these customers and this trend is expected to continue.

Our inability to retain and, as necessary, strengthen our executive management team would be detrimental to the success of our business.

We rely heavily on a small group of senior executives and retaining their services is important to our future success. As we continue to grow the business, the executive management team will face increasing challenges and the possible need to supplement or expand the existing team to enable us to put in place a necessary succession plan. Any failures in this regard could impact, among other factors, our revenues, growth and profitability.

We have substantially reduced operating cash as a result of the debt restructuring, (see Recent Developments).

To obtain sufficient cash resources to affect the payment to the Senior Note holders and the conversion of the balance of the Senior Debt and the Subordinated Notes, we incurred approximately $1.250 million in principal amount of indebtedness.  We utilized substantial amounts of the Company’s operating cash to accomplish the debt restructuring and will need to fund interest on the credit facilities, future capital expenditures and general working capital requirements out of ongoing operations. If we are unable to meet our cash requirements out of cash flow from operations, there can be no assurance that we will be able to obtain alternative financing or be able to raise additional capital in the current economic environment.

The success of our Internet piracy prevention segment depends heavily on the continued success of MediaDefender’s content protection technology.

If current MediaDefender customers, which include both major motion picture studios and record labels, determine that the benefits of MediaDefender’s technology do not justify the expense, or other competitive technologies are superior than those provided by MediaDefender, demand for its IPP technology would decline and our operating results would be significantly harmed.

15

Global sales of recorded music have recently declined and this trend may continue in the future.

Based on data compiled by Nielsen SoundScan, total Internet album sales decreased by 8.6% in 2008 to 27.1 million units as compared to 30.1 million units in 2007.  According to the RIAA, the decline, in sales had been due in part, to widespread copying and illegal Internet downloading of music.  If the overall trend continues, it may affect our e-commerce business and have a material effect on our revenues.

We may not be able to develop or obtain sufficiently compelling content to attract and retain our target audience.

For our media and e-commerce segments to be successful, we must provide content and services that attract consumers who will purchase music and related merchandise online. We may not be able to provide consumers with an acceptable mix of products, services, information and community to attract them to our websites or to encourage them to remain on our websites for an extended period of time. If our audience determines that our content does not reflect its tastes, then our audience size could decrease or the demographic characteristics of our audience could change and we may be unable to react to those changes effectively or in a timely manner. Any of these results would adversely affect our ability to attract advertisers and sell music and other related merchandise.

We depend on a limited number of customers and if we were to lose any of these customers, our business could be adversely affected.

During 2008, no one customer accounted for more than 10.0% of our media revenue. During the year ended December 31, 2008, approximately 65% of MediaDefender’s consolidated revenues were from three customers.  Of those three customers, the respective customers’ percentages of revenue were 32%, 21% and 12%.  In January 2008, MediaDefender was notified by a customer accounting for 12% of 2007 revenue, that they were discontinuing service and were evaluating the use of other methods to offset the negative impact of piracy.  In June 2008, the Company was advised that another customer that accounted for 18% of MediaDefender’s 2007 annual revenues was substantially curtailing its use of MediaDefender’s anti-piracy services subsequent to the expiration of its current contract with MediaDefender on June 30, 2008, citing uncertainty with respect to the effectiveness and cost/benefit of anti-piracy services.  Should MediaDefender, lose any of its remaining major customers, our business and results of operations could be adversely affected.  During 2007, there were four customers constituting 68% of MediaDefender’s consolidated revenues, one customer accounted for 21%, two customers each were at 18% and one customer accounted for 12%.

If we do not build and maintain strong brands, we may not be able to attract a significant number of users to our websites.

To attract users we must develop a brand identity for ARTISTdirect and increase public awareness of the ARTISTdirect network; however, to conserve cash we have not been able to spend large amounts on offline and online advertising and promotional efforts to increase brand awareness, traffic and revenue. Accordingly, our marketing activities may not result in increased revenue and, even if they do, any increased revenue may not offset the expenses we incur in building our brands. Moreover, despite these efforts we may be unable to increase public awareness of our brands, which would have an adverse effect on our results of operations.

The market for online promotion and distribution of music and related merchandise is highly competitive and we may not be able to compete successfully against our current and future competitors.

The market for the online promotion and distribution of music and related merchandise is highly competitive and rapidly changing. There are a significant number of websites promoting and distributing music and related merchandise that compete for the attention and spending of consumers, advertisers and users. We face competitive pressures from numerous actual and potential competitors. Our competitors include America Online, MSN, Yahoo!, Amazon.com, MTV, myspace.com, mp3.com, billboard.com and other websites and traditional music companies.

These competitors may be able to respond more quickly to new or emerging technologies and changes in customer requirements and devote greater resources to develop, promote and sell their products or services than we can. Consumers, artists, talent management companies and other music-related vendors or advertisers may perceive websites maintained by our existing and potential competitors as being superior to ours. In addition, increased competition could result in reduced advertising rates and margins and loss of market share, any of which could harm our business.

16

We depend on a limited number of suppliers for music merchandise, fulfillment and distribution and if we cannot secure alternate suppliers, our business may be harmed.

We rely to a large extent on timely distribution by third parties. During 2008, we relied on Alliance Entertainment to fulfill and distribute our orders for CDs and DVDs. Our contract with Alliance ended in July 2008 and we continue to operate our e-commerce business on a monthly basis in the event that this arrangement is terminated without a suitable replacement our e-commerce business could be adversely affected.

Our media and e-commerce segments are subject to seasonality, which could adversely affect our operating results.

We have experienced and expect to continue to experience seasonal fluctuations in our online sales. These seasonal patterns will cause quarterly fluctuations in our operating results. In particular, a disproportionate amount of our online sales have been realized during the fourth calendar quarter and during the summer months, traditionally when artists go on tour. Due to our limited operating history, it is difficult to predict the seasonal pattern of our online sales and the impact of such seasonality on our business and operating results. Our seasonal online sales patterns may become more pronounced, strain our personnel, warehousing, and order shipment activities and cause our operating results to be significantly less than expected for any given period.

We may be subject to system disruptions, which could reduce our revenue.

Our ability to attract and retain artists, users, advertisers and merchants for our online network depends on the performance, reliability and availability of our websites and network infrastructure. Our own staff performs the maintenance and operation of substantially all of our Internet communications hardware and servers. We have periodic maintenance windows, and we experience outages from time to time caused by temporary problems in our own systems or software. While we have implemented procedures designed to improve the reliability of our systems, these interruptions may continue to occur from time to time. Our users also depend on third party Internet service providers and website operators for access to our websites. These entities have experienced significant outages in the past, and could experience outages, delays and other difficulties due to system failures in the future which are unrelated to our systems, but which could nonetheless adversely affect our business.

If we are unable to protect our intellectual property rights, our competitive position could be harmed or we could be required to incur expenses to enforce our rights.

We rely upon the registered trademark rights in the United States for our commercial use of the ARTISTdirect, Ultimate Band List and other brand names and their respective associated domain names, and the ARTISTdirect logo. We seek to protect our trademarks by registration and copyrights and other proprietary rights through confidentiality requirements and other means, but these actions may be inadequate. It may be possible that some of our innovations may not be protectable. We have trademark applications pending in several jurisdictions, but our registrations may not be accepted or may be preempted by third parties and/or we may not be able to register our trademarks in all jurisdictions in which we intend to do business. We generally enter into confidentiality or license agreements with our employees, consultants and corporate partners, and generally attempt to control access to and distribution of our proprietary information.

The steps we have taken may not prevent misappropriation of our proprietary rights, or disclosure of trade secrets, particularly in foreign jurisdictions where laws or law enforcement practices may not protect our proprietary rights as fully as those in the United States. Confidentiality may be compromised intentionally or accidentally by contractors, customers, other third parties or our employees. If third parties were to use or otherwise misappropriate our copyrighted materials, trademarks or other proprietary rights without our consent or approval, our competitive position could be harmed, or we could become involved in litigation to enforce our rights. In addition, policing unauthorized use of our content, trademarks and other proprietary rights could be very expensive, difficult or impossible, particularly given the global nature of the Internet, and we may not be able to determine the existence or extent of any unauthorized use. We also cannot be certain that others will not develop independently equivalent or superior technology or intellectual property rights.

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Our access to copyrighted content depends upon the willingness of content owners to make their content available.

The music content available on the ARTISTdirect network is typically comprised of copyrighted works owned or controlled by multiple third parties. Most of the content on our artist-specific websites is either owned or licensed by the artist. On other parts of the ARTISTdirect network, depending on the nature of the content and how we use the music content, we typically license such rights from publishers, record labels, performing rights societies or artists.

We frequently either do not have written contracts or have short-term contracts with copyright owners, and, accordingly, our access to copyrighted content depends upon the willingness of such parties to continue to make their content available. If the fees for music content increase substantially or if significant music content becomes unavailable, our ability to offer music content could be materially limited. We have not obtained a license for some of the content offered on the ARTISTdirect network, including links to other music-related sites and thirty-second streamed song samples, because we believe that a license is not required under existing law. However, this area of law remains uncertain and may not be resolved for a number of years. When this area of law is resolved, we may be required to obtain licenses for such content, alter or remove the content from our websites and be forced to pay potentially significant financial damages for past conduct. We continue to discuss the potential for license arrangements with many of the major music publishers.

If our online security measures fail, we could lose visitors to our sites and could be subject to claims for damage from our users, content providers, advertisers and merchants.

Our relationships with consumers would be adversely affected and we may be subject to claims for damages if the security measures that we use to protect their personal information, especially credit card numbers, are ineffective. We rely on security and authentication technology that we license from third parties to perform real-time credit card authorization and verification with our bank. We cannot predict whether events or developments will result in a compromise or breach of the technology we use to protect a customer’s personal information. Our infrastructure may be vulnerable to unauthorized access, physical or electronic computer break-ins, computer viruses and other disruptive problems. Internet service providers have experienced, and may continue to experience, interruptions in service as a result of the accidental or intentional actions of Internet users, current and former employees and others. Anyone who is able to circumvent our security measures could misappropriate proprietary information or cause interruptions in our operations. Security breaches relating to our activities or the activities of third-party contractors that involve the storage and transmission of proprietary information could damage our reputation and our relationships with our content providers, advertisers and merchants. We also could be liable to our content providers, advertisers and merchants for the damages caused by such breaches or we could incur substantial costs as a result of defending claims for those damages. We may need to expend significant capital and other resources to protect against or to address problems caused by such security.  Our security measures may not prevent disruptions or security breaches.

We may be subject to liability if private information provided by our users were misused.

Our privacy policy discloses how we use individually identifiable information that we collect. This policy is displayed and accessible throughout the ARTISTdirect network. Despite this policy, however, if third persons were able to penetrate our network security or otherwise misappropriate our users’ personal information or credit card information, we could be subject to liability. We could also be subject to liability for claims for unauthorized purchases with credit card information, impersonation or other similar fraud claims, or other misuses of personal information, such as for unauthorized marketing purposes. These claims could result in costly and time-consuming litigation.

While we attempt to be fully compliant with our privacy policy, our efforts may not be entirely successful. In addition, at times we rely upon outside vendors to maintain data-collection software, and there can be no assurance that they will at all times comply with our instructions to comply with our privacy policy. If our methods of complying with our privacy policy are inadequate, or our business practices be found to differ from our privacy policy, we may face litigation with the FTC, California and other State’s governmental authorities or individuals, which would adversely affect our business. It is also possible that users or visitors could try to recover damages in a civil action as well.

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We may be sued for content available or posted on our websites or products sold through our websites or for linking and framing of third-party websites.

We may be liable to third parties for content published on our websites and other websites where our syndicated content appears if the music, artwork, text or other content available violates their copyright, trademark or other intellectual property rights or if the available content is defamatory, obscene or pornographic. Similar claims have been brought, sometimes successfully, against website operators in the past. We also may be liable for content uploaded or posted by our users on our websites, such as digitally distributed music files, postings on our message boards, chat room discussions and copyrightable works. In addition, we could have liability to some of our content licensors for claims made against them for content available on our websites.

We also could be exposed to these types of claims for content that may be accessed from our websites or via links to other websites or for products sold through our website. While we have resolved all of these types of claims made against us in the past, we may not be able to do so in the future. Any litigation as a result of defending these types of claims could result in substantial costs and damages. Our insurance may not adequately protect us against these types of claims or the costs of their defense or payment of damages. We link to and “frame” third-party websites of our artists without express written permission to do so. In addition, in the past we have provided a search feature to allow users to find music residing elsewhere on the Internet. Those practices are controversial, and have, in instances not involving us, resulted in litigation. Various claims, including trademark and copyright infringement, unfair competition, and commercial misappropriation, as well as infringement of the right of publicity may be asserted against us as a result. The law regarding linking and framing remains unsettled; it is uncertain as to how existing laws, especially trademark and copyright law, will be applied by the judiciary to the Internet. Also, Congress is increasingly active in passing new laws related to the Internet, and there is uncertainty as to the impact of future potential laws, especially those involving domain names, databases and privacy.

RISKS RELATED TO OUR CAPITAL STRUCTURE

Our stock price is volatile and could decline in the future.

The price of our common stock may fluctuate in the future.  The stock market, in general, and the market price for shares of technology companies in particular, have experienced extreme stock price fluctuations. In some cases, these fluctuations have been unrelated to the operating performance of the affected companies.  Many companies in the technology and related industries have experienced dramatic volatility in the market prices of their common stock.  We believe that a number of factors, both within and outside of our control, could cause the price of our common stock to fluctuate, perhaps substantially.

The limited trading market may cause volatility in the market price of our common stock.

Our common stock is currently traded on a limited basis on the Over-the-Counter Bulletin Board under the symbol “ARTD.OB.”  The quotation of our common stock on the Over-the-Counter Bulletin Board does not assure that a meaningful, consistent and liquid trading market currently exists, and in recent years such market has experienced extreme price and volume fluctuations that have particularly affected the market prices of many smaller companies like us.  Our common stock is thus subject to volatility. In the absence of an active trading market:

·investors may have difficulty buying and selling or obtaining market quotations;

·market visibility for our common stock may be limited; and

·a lack of visibility for our common stock may have a depressive effect on the market for our common stock.

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Our common stock is considered a “penny stock” and may be difficult to sell.

Our common stock is considered to be a “penny stock” since it meets one or more of the definitions in Rule 3a51-1 under the Securities Exchange Act of 1934, as amended (the “Exchange Act”).    The principal result or effect of being designated a “penny stock” is that securities broker-dealers cannot recommend the stock but must trade in it on an unsolicited basis.  Section 15(g) of the Exchange Act and Rule 15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor’s account.

Potential investors in our common stock are urged to obtain and read such disclosure carefully before purchasing any shares that are deemed to be “penny stock.”  Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor.  This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives.  Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.

Standards for compliance with Section 404 of the Sarbanes-Oxley Act of 2002 are uncertain, and if we fail to comply in a timely manner, our business could be harmed and our stock price could decline.

Rules adopted by the SEC pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual assessment of our internal control over financial reporting.  The standards that must be met for management to assess the internal control over financial reporting as effective are new and complex, and require significant documentation, testing and possible remediation to meet the detailed standards.  We may encounter problems or delays in completing activities necessary to make an assessment of our internal control over financial reporting.  If we cannot assess our internal control over financial reporting as effective, investor confidence and share value may be negatively impacted.  We expect to incur additional accounting related expenses associated with compliance with Section 404.

The securities issued by the Company in connection with the restructuring of our senior and subordinated debt could have a negative impact on the market price of our stock.

In connection with the Debt Restructuring and debt conversion, 45,732,492 shares of common stock were issued to the Senior and Subordinated Note holders.  Any sales in the public market of the common stock issued in connection with the Debt Restructuring and debt conversion could adversely affect prevailing market prices of our common stock.  Additionally, the existence of these shares could be perceived as representing a negative overhang on the market for our stock.

Changes in financial accounting standards or interpretations of existing standards could affect reported results of operation.

Generally accepted accounting principles and accompanying accounting pronouncements, implementation guidelines, and interpretations for many aspects of our business are complex and involve subjective judgments.  Changes in these accounting standards, new accounting pronouncements and interpretations, by us or by our regulatory agencies, may occur that could adversely affect the Company’s reported financial position, results of operations and/or cash flows.

ITEM 1B                UNRESOLVED STAFF COMMENTS

Not applicable.

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ITEM 2.PROPERTIES

The following table provides a schedule of corporate offices and facilities leased by us:

Location	Primary Function	Square Footage	Lease Term
Santa Monica, California	Corporate headquarters for ARTISTdirect and MediaDefender	14,817	Lease ends November 30, 2011
Morristown, New Jersey	Regional office space	5,000	Rental agreement ends September 30, 2009
Kettering, Ohio	Regional office space	3,932	Lease ends June 30, 2009
Los Angeles, California	Secured co-location space	300	Monthly
Los Angeles, California	Secured co-location facility	NA	Lease ends February 2010
El Segundo, California	Secured co-location facility	NA	Lease ends February 2010
Scottsdale, Arizona	Secured co-location facility	NA	Lease ends August 2009

We believe that all real property and facilities leased by us are in good repair and adequate for our purposes for the next 12 months.

ITEM 3.LEGAL PROCEEDINGS

We are periodically subject to various pending and threatened legal actions, which arise in the normal course of business. Our management currently believes that the impact of any such litigation will not have a material adverse impact on our financial position or results of operations.

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

There were no matters submitted to a vote of our stockholders during the fourth quarter of the fiscal year ended December 31, 2008.

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PART II

ITEM 5.MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock has been listed on the Over-the-Counter Bulletin Board under the symbol “ARTD.OB” since May 9, 2003.  The following table sets forth the high and low sales prices for our common stock, as reported by the Over-the-Counter Bulletin Board for fiscal 2008 and 2007, respectively:

	High		Low
2008
First Quarter	$	0.51	$	0.37
Second Quarter	$	0.45	$	0.27
Third Quarter	$	0.27	$	0.03
Fourth Quarter	$	0.03	$	0.01
2007
First Quarter	$	2.40	$	1.40
Second Quarter	$	2.38	$	1.75
Third Quarter	$	2.30	$	1.75
Fourth Quarter	$	1.90	$	0.38

The closing price of our common stock on March 31, 2009 was $0.01 per share, as reported on the Over-The-Counter Bulletin Board.  The Over-the-Counter quotations reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not represent actual transactions.

Holders of Record

As of March 31, 2009, we had 278 holders of record of our common stock, excluding shares held in “street name” by brokerage firms and other nominees who hold shares for multiple investors.

Dividends

The Company has not declared or paid any cash dividends on our common stock since its inception.  The Company’s various senior and subordinated financing documents prevent the Company from paying any cash dividends on account of our common stock.  Subject to the Company’s obligations to our senior and subordinated lenders, the Company intends to retain any future earnings, if any, to finance the Company’s business, and we do not expect to declare or pay any cash dividends in the foreseeable future.

Equity Compensation Plan Information

Refer to Item 11 “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” below for information with respect to our equity compensation plans.

Additional Information

Copies of our prior Annual Reports on Form 10-K, Quarterly Reports, Current Reports on Form 8-K, and any amendments to those reports, are available free of charge on the Internet at www.sec.gov. All statements made in any of our filings, including all forward-looking statements, are made as of the date of the document in which the statement is included, and we do not assume or undertake any obligation to update any of those statements unless we are required to do so by law.

ITEM 6.  SELECTED FINANCIAL DATA

Not applicable.

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ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview:

The Company conducts its media business operations through an online music network appealing to music fans, artists and marketing partners.  The ARTISTdirect Network is a network of websites offering multi-media content, music news and information, communities organized around shared music interests, music-related specialty commerce and digital music services.

The Company acquired MediaDefender, Inc., a privately-held Delaware corporation, (“MediaDefender”) in July of 2005, which added media protection services to ArtistDirect’s Internet operations.  MediaDefender is the leading provider of anti-piracy solutions in the Internet-piracy-protection (“IPP”) industry.  Revenues related to anti-piracy activities declined in 2008 from 2007 and management anticipates a further decline in 2009.  The industry wide reduction in technological anti-piracy services reflects a change by media conglomerates to explore alternative online distribution initiatives, including an ad supported free access to television programming and reduced costs or a subscription based model for digital music downloads.  This decline in industry wide anti-piracy spending is also a reflection of general economic conditions, whereby media copyright holders attempt to maintain profitability through general costs cutting measures, which would include anti-piracy programs.

Recent Developments

Debt Restructing

Senior Debt Restructuring

Effective January 30, 2009, ARTISTdirect, Inc. (the “Company”) entered into a First Amendment to Note and Warrant Purchase Agreement dated as of December 31, 2008 (the “Senior Amendment”) with the holders of the Company’s senior secured debt (the “Senior Note Holders”).  Pursuant to the Senior Amendment, the Senior Note Holders agreed to extinguish all obligations by the Company under the Note and Warrant Purchase Agreement, dated July 28, 2005, and other documents entered into in connection with the senior secured debt transaction (the “Senior Debt Restructuring”), upon completion of the following: (1) $3,500,000 cash payment to the Senior Note Holders; (2) issuance of new subordinated notes, in the aggregate principal amount of $1,000,000, to the Senior Note Holders (the “New Notes”); (3) issuance of 9,000,000 restricted shares of the Company’s common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months; and (4) the conversion of all of the previously issued Subordinated Notes.  The Senior Debt Restructuring was consummated as of January 30, 2009.

The New Notes are unsecured and bear interest at 6.0% per annum, beginning January 30, 2009. The principal and the interest accrued thereon are payable on the maturity date, January 30, 2014, and are subordinated to the senior indebtedness of the Company.

Additionally, in connection with the Senior Debt Restructuring, Trilogy Capital Partners, Inc. agreed to deliver to the Company for cancellation a warrant to purchase up to 433,333 shares of the Company’s capital stock at an exercise price of $2.00 per share.  Fifty percent of such warrants were beneficially owned by Dimitri Villard, the Company’s Chief Executive Officer, who had acquired such warrants as part of the acquisition of 6,190,000 shares from Trilogy Capital Partners, Inc., which occurred on January 15, 2009.

Conversion of Subordinated Notes

In connection with the Senior Debt Restructuring, effective January 30, 2009, the Company entered into a Second Amendment to the Convertible Subordinated Note with holders of the Subordinated Notes representing no less than the majority of the current outstanding aggregate principal amount to provide for the immediate conversion of the Subordinated Notes (the “Subordinated Amendment”). The Subordinated Amendment also provides for the extinguishment of all obligations of the Company under the Subordinated Notes and related documents, including the Registration Rights Agreement among the Company and the holders.  Such obligations included the outstanding principal amount and accrued and unpaid interest on the Subordinated Notes, accrued and unpaid late charges and amounts owed under the Registration Rights Agreement with the holders of the Subordinated Notes.  Consummation of the transactions under the Subordinated Amendment occurred as of January 30, 2009.

Financing by Factoring Accounts Receivables

On January 30, 2009, the Company’s two wholly-owned subsidiaries, ARTISTdirect Internet Group, Inc. (“ADIG”) and MediaDefender each entered into an Accounts Receivable Purchase & Security Agreement (the “A/R Agreement”) with Pacific Business Capital Corporation (“PBCC”), pursuant to which ADIG and MediaDefender agreed to sell and PBCC agreed to purchase qualified accounts receivable on a recourse basis. On January 30, 2009, PBCC purchased an aggregate of approximately $1,600,000 of unpaid receivables to be acquired by PBCC pursuant to the A/R Agreement, subject to a maximum aggregate amount of $3,000,000. The A/R Agreement is effective for twelve-months and automatically renews for successive 12-month periods unless terminated by written notice by either party 30 days prior to such successive period.

As collateral for the financing, PBCC received a first priority interest in all existing and future assets of the Company, ADIG and MediaDefender, tangible and intangible, including but not limited to, cash and cash equivalents, accounts receivable, inventories, other current assets, furniture, fixtures and equipment and intellectual property. In addition to the foregoing, the Company, ADIG and MediaDefender entered into cross guarantees of their respective obligations under the A/R Agreement.

Convertible short-term note to Director

On March 3, 2009, the Company issued a convertible note (the “Note”) to Frederick W. Field, a director of the Company.  The Note is in the principal amount of $200,000 with the principal amount and accrued interest at the rate of 5% per annum due on July 31, 2009.  The Note is automatically convertible into shares of the Company’s Common Stock at a price of $0.03 per share at such time as the Company has sufficient authorized shares.

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The following table is a proforma presentation of the Consolidated Balance Sheet reflecting the above described Debt Restructuring as if it had occurred as of December 31, 2008.

	December 31, 2008
	Audited			Proforma
Assets:
Cash	$	2,262,000		$	12,000
Other current assets, net	3,480,000			3,480,000
Property and equipment, net	1,201,000			1,201,000
Other non-current assets, net	546,000			153,000
	$	7,489,000		$	4,846,000
Liabilities and Stockholders’ Equity (Deficiency)
Accounts payable and accrued expenses	$	921,000		$	971,000
Accrued interest and liquidated damages	8,890,000			—
New credit facility	—			1,250,000
Senior secured notes, net	12,817,000			—
Subordinated convertible notes, net	26,397,000			—
Other current liabilities	1,228,000			1,183,000
	50,253,000			3,404,000
New subordinated notes, net of discount	—			270,000
Other long-term liabilities	159,000			159,000
	159,000			429,000
Net Stockholders’ Equity (Deficiency), net	(42,923,000		)	1,013,000
	$	7,489,000		$	4,846,000

Management and Director Changes

Effective January 13, 2009, each of Randy Saaf and Octavio Herrera (each, an “Executive”) entered into separate amendments (collectively, the “Amendments”) to their respective Employment, Confidentiality and Noncompetition Agreements (collectively, the “Employment Agreements”) dated as of July 28, 2005 with MediaDefender, Inc..  Under each of the Amendments, commencing January 1, 2009 the term of employment between each Executive and the MediaDefender were at-will, and either the MediaDefender or the Executive may terminate the applicable Employment Agreement upon five days’ written notice, in which case such Executive shall have a period of 60 days from the effective date of termination to exercise all vested stock options.  Effective February 15, 2009, MediaDefender, terminated the employment of Randy Saaf, Chief Executive Officer of MediaDefender, and Octavio Herrera, President of MediaDefender.

Effective February 1, 2009, Dimitri Villard, the Chairman of the Board of Directors,  pursuant to a three year employment agreement, was appointed to serve as the Company’s Chief Executive Officer. Prior to that date, Mr. Villard was the Company’s interim Chief Executive Officer.  Mr. Villard will receive base compensation equal to $25,000 per month subject to increases as determined by the Board of Directors, in its sole discretion.  Mr. Villard was granted options to purchase 3,920,000 shares of the Company’s stock at $0.03 per share vesting monthly over 36 months and will receive a bonus equal to 33% of the amount by which the Company’s EBITDA exceeds a certain threshold amount as determined by the Company’s Compensation Committee for such fiscal year.

Effective February 1, 2009, the Company and Rene Rousselet (“Executive”) entered into an Employment Agreement pursuant to which Mr. Rousselet was employed to continue as the Company’s Corporate Controller and Principal Accounting Officer.  The employment is on an “at will basis.”  Mr. Rousselet will receive a salary of $14,583 per month subject to increases and a bonus as determined by the Board of Directors, in its sole discretion.  Mr. Rousselet was granted options to purchase 560,000 shares of the Common Stock of the Company at $0.03 per share vesting monthly over 36 months commencing February 1, 2009.  If Mr. Rousselet’s employment is terminated without cause, Mr. Rousselet will receive his salary and vesting of options for an additional period of three months from the date of termination.

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Acquisition of MediaSentry

The Company and its wholly owned subsidiary, MediaDefender entered into an Asset Purchase Agreement dated as of March 30, 2009 (the “Purchase Agreement”) pursuant to which the Company through MediaDefender agreed to purchase from SafeNet, Inc. and MediaSentry, Inc. (collectively the “Sellers”), substantially all the assets of the MediaSentry operating unit (the “Acquired Assets”).  In connection with the acquisition, MediaDefender acquired the receivables, equipment and intellectual property of MediaSentry as well as assumed substantially all the employees, offices and client contracts relating to MediaSentry.  The purchase price of the Acquired Assets was $936,000 consisting of $136,000 in cash and a $800,000 one-year promissory note of the Company.  The acquisition was consummated on March 30, 2009.  The MediaSentry operating unit provides (a) comprehensive business and marketing intelligence services for digital media measurement and (b) services to globally detect, track and deter the unauthorized distribution of digital content.

Going Concern:

As a result of communications with the Staff of the Securities and Exchange Commission in 2006, in particular regarding the application of accounting rules and interpretations related to embedded derivatives associated with the Company’s subordinated convertible notes payable issued in July 2005, the Company determined that it was necessary to restate previously issued financial statements. As a result, in December 2006, the Company was required to suspend the use of its then effective registration statement for the holders of its senior and subordinated indebtedness.  In addition to this initial default, the Company has since entered into other events of default which continued to be in effect as of December 31, 2008.

As of December 31, 2008, approximately $12,994,000 principal amount was outstanding with respect to the Senior Financing, and approximately $27,658,000 principal amount was outstanding with respect to the Sub-Debt Financing.  In addition, at December 31, 2008, approximately $2,415,000 was outstanding with respect to accrued registration delay liability to the holders of the Sub-Debt Financing and approximately $6,475,000 was outstanding with respect to accrued interest payable to the holders of the Senior Financing and the Sub-Debt Financing.  The Senior Notes and the Subordinated Notes were due in June and July 2009, respectively.

As more fully described in recent developments, the Senior Financing and Sub-Debt Financing have been restructured.  In accordance with the restructure, the Company paid $3,500,000 to the Senior Note Holders, issued new subordinated notes in the aggregate principal amount of $1,000,000 to the Senior Note Holders, issued 9,000,000 restricted shares of the Company's common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months, and converted the Sub-Debt to equity.  In order to obtain funds to accomplish the restructure, and to fund future operations, the Company obtained financing by factoring its accounts receivable.

As a result of the successful debt restructuring, the Company anticipates that it will have sufficient access to working capital from operations and the factoring of account receivable.  However, because of the Companys’ declining revenues, negative working capital, net loss, and uncertainties related to improving its operating results under current economic conditions, our independent auditors, in their report on the Companys’ financial statements for the year ended December 31, 2008 expressed substantial doubt about the Companys’ ability to continue as a going concern.  The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

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Critical Accounting Policies:

The discussion and analysis of the Company’s financial condition and results of operations is based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.  The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.  On an ongoing basis, the Company evaluates its estimates, including those related to accounts receivable, tangible and intangible assets, warrant and derivative liabilities, income taxes, and contingencies and litigation, among others.  The Company bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results may differ from these estimates under different assumptions or conditions.  The Company believes that the following critical accounting policies affect the more significant judgments and estimates used in the preparation of its consolidated financial statements:   revenue recognition, stock-based compensation, goodwill, intangible assets and long-lived assets, derivative instruments, income taxes and accounts receivable.

Revenue Recognition.  The Company complies with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB No. 104, and recognizes revenue when all four of the following criteria are met:  (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is both fixed and determinable; and (iv) collectability is reasonably assured.

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 has a contract with a fulfillment house to service its music-related e-commerce activity.  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.  In certain circumstances, e-commerce revenue is subject to royalties, and such expense is recorded as part of cost of e-commerce revenue.

The Company records amounts charged to customers for shipping and handling in accordance with EITF 00-10, “Accounting for Shipping and Handling Fees and Costs” (“EITF 00-10”).  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 statement of operations.

Media revenue consists primarily of the sale of advertisements and sponsorships under short-term contracts.  To date, the duration of the Company’s advertising commitments has generally averaged from one to three months, although certain programs can last up to one year.  The Company’s online obligations typically include the guarantee of a minimum number of times (“impressions”) 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.  To the extent that minimum guaranteed page deliveries are not met, recognition of the corresponding revenue is deferred until the guaranteed impressions are delivered.

The Company recognizes revenue for sponsorship arrangements over the period during which the advertising is provided, generally on a straight-line basis.  The Company recognizes revenue for a banner impression deliverable as the banner impressions are delivered.  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.

Anti-piracy and file-sharing marketing services revenue is recognized on a monthly basis as services are provided to customers.  Deferred revenue is recorded for customers who prepay the full, or any portion, of their respective contracts.

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Stock-Based Compensation.  Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standard No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS No. 123R requires that the Company measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards, with the cost to be recognized as compensation expense in the Company’s financial statements over the vesting period of the awards.  Accordingly, the Company recognizes compensation cost for equity-based compensation for all new or modified grants issued after December 31, 2005.  In addition, commencing January 1, 2006, the Company recognized the unvested portion of the grant date fair value of awards issued prior to adoption of SFAS No. 123R based on the fair values previously calculated for disclosure purposes over the remaining vesting period of the outstanding stock options and warrants.

The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with 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”, and EITF 00-18, “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees”, whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached or (b) at the date at which the necessary performance to earn the equity instrument is complete.

Goodwill, Intangible Assets and Long-Lived Assets.  Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite.

SFAS No. 142 requires goodwill to be tested for impairment at least on an annual basis and more often under certain circumstances, and written down when impaired.  An interim impairment test is required if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below the carrying value.

During the year ended December 31, 2008, the Company recorded a non-cash charge to operations aggregating $31,085,000 with respect to the impairment of the goodwill recognized in conjunction with the acquisition of MediaDefender in July 2005.  This charge to operations was based on various factors and developments occurring in 2008, including continuing erosion in the demand for MediaDefender’s core Internet anti-piracy services within the entertainment industry, the unexpected non-renewal by MediaDefender’s largest customer in mid-2008, continuing deterioration of operating margins and valuation metrics, and the inability to implement new advertising initiatives on a large-scale basis.

Derivative Instruments. Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), requires all derivatives to be recorded on the balance sheet at fair value.  When multiple derivatives (both assets and liabilities) exist within a financial instrument, they are bundled together as a single hybrid compound instrument in accordance with SFAS No. 133 Implementation Issue No. B15, “Embedded Derivatives:  Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”.  The calculation of the fair value of derivatives utilizes highly subjective and theoretical assumptions that can materially affect fair values from period to period.  The change in the fair value of the derivatives from period to period is recorded in other income (expense) in the statement of operations.  As a result, the Company’s financial statements are impacted quarterly based on factors such as the price of the Company’s common stock and the principal amount of Sub-Debt Notes converted into common stock.  Consequently, the Company’s results of operations and financial position may vary from quarter to quarter based on factors other than those directly associated with the Company’s operating revenues and expenses.  The recognition of these derivative amounts does not have any impact on cash flows.

EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, an asset or a liability.  When the ability to physically or net-share settle a conversion option or the exercise of freestanding options or warrants is deemed to be not within the control of the Company, the embedded conversion option or freestanding options or warrants may be required to be accounted for as a derivative liability.  Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value on a company’s balance sheet, with any changes in fair value recorded in a company’s results of operations.

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The Company accounts for derivatives, including the embedded derivatives associated with the Sub-Debt Notes and the warrants issued in conjunction with the Senior Financing and the Sub-Debt Financing, at fair value, adjusted at the end of each reporting period to reflect any material changes, with any such changes included in other income (expense) in the statement of operations.

At the date of the conversion of Sub-Debt Notes into common stock or the principal repayment of Senior Notes, the pro rata portion of the related unamortized discount on debt and deferred financing costs is charged to operations and included in other income (expense).  At the date of exercise of any of the warrants, or the conversion of Sub-Debt Notes into common stock, the pro rata portion of the fair value of the related warrant liability and/or embedded derivative liability is transferred to additional paid-in capital.

Income Taxes.  The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”).  SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.  A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

Accounts Receivable.  The Company grants credit to its customers generally in the form of short-term trade accounts receivable.  Accounts receivable are stated at the amount that management expects to collect from outstanding balances.  When appropriate, management provides for probable uncollectible amounts through a provision for doubtful accounts and an adjustment to a valuation allowance.  Management primarily determines the allowance based on the aging of accounts receivable balances, historical write-off experience, customer concentrations, customer creditworthiness and current industry and economic trends.  Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.  Concentrations of credit risk with respect to trade receivables generated by the Company’s operations are generally limited.  However, MediaDefender’s customers consist primarily of large reputable companies in the music and entertainment industries.

Adoption of New Accounting Policies:

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes” (“FIN 48”).  FIN 48 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.

The Company files income tax returns in the U.S. federal jurisdiction and various states.  The Company is subject to U.S. federal or state income tax examinations by tax authorities for years after 2003 (see Note 11).

The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense.

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Recent Accounting Pronouncements:

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”), which establishes a formal framework for measuring fair value under Generally Accepted Accounting Principles (“GAAP”). SFAS No. 157 defines and codifies the many definitions of fair value included among various other authoritative literature, clarifies and, in some instances, expands on the guidance for implementing fair value measurements, and increases the level of disclosure required for fair value measurements. Although SFAS No. 157 applies to and amends the provisions of existing FASB and American Institute of Certified Public Accountants (“AICPA”) pronouncements, it does not, of itself, require any new fair value measurements, nor does it establish valuation standards. SFAS No. 157 applies to all other accounting pronouncements requiring or permitting fair value measurements, except for: SFAS No. 123R, share-based payment and related pronouncements, the practicability exceptions to fair value determinations allowed by various other authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9 that deal with software revenue recognition. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. Generally accepted account principles have required different measurement attributes for different assets and liabilities that can create artificial volatility in earnings. SFAS No. 159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. Management has determined that SFAS No. 157 does not have a material impact on our financial position.

SFAS No. 159 also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS No. 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157 and SFAS No. 107. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year beginning after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided the company makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of SFAS No. 157. Management has determined that SFAS No. 159 does not have a material impact on our financial position.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which requires an acquirer to recognize in its financial statements as of the acquisition date (i) the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, measured at their fair values on the acquisition date, and (ii) goodwill as the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired.  Acquisition-related costs, which are the costs an acquirer incurs to effect a business combination, will be accounted for as expenses in the periods in which the costs are incurred and the services are received, except that costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP.  SFAS No. 141(R) makes significant amendments to other Statements and other authoritative guidance to provide additional guidance or to conform the guidance in that literature to that provided in SFAS No. 141(R).  SFAS No. 141(R) also provides guidance as to what information is to be disclosed to enable users of financial statements to evaluate the nature and financial effects of a business combination.  SFAS No. 141(R) is effective for financial statements issued for fiscal years beginning on or after December 15, 2008. Early adoption is prohibited. The Company has not yet determined the effect on its consolidated financial statements, if any, upon adoption of SFAS No. 141(R).

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In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51” (“SFAS No. 160”), which revises the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards that require (i) the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity, (ii) the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income, (iii) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently as equity transactions, (iv) when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value, with the gain or loss on the deconsolidation of the subsidiary being measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment, and (v) entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 amends FASB No. 128 to provide that the calculation of earnings per share amounts in the consolidated financial statements will continue to be based on the amounts attributable to the parent. SFAS No. 160 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. SFAS No. 160 shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The requirements of SFAS No. 160 does not apply to the Company as it is currently structured.

In March 2008—The Financial Accounting Standards Board (FASB) issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.

In June 2008, the FASB issued Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (“FSP EITF 03-6-1”).  FSP EITF 03-6-1 provides that unvested share –based payment awards that contain nonforfeitable rights to dividends are participating securities and should be included in the computation of earnings per share pursuant to the two-class method.  FSP EITF 03-6-1 is effective for fiscal years beginning after December 15, 2008.  The Company is currently assessing the potential effect of FSP EITF 03-6-1 on its financial statements.

In June 2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-05, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity's Own Stock” (“EITF 07-05”). EITF 07-05 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity's own stock. Warrants that a company issues that contain a strike price adjustment feature, upon the adoption of EITF 07-05, results in the instruments no longer being considered indexed to the company's own stock. Accordingly, adoption of EITF 07-05 will change the current classification (from equity to liability) and the related accounting for such warrants outstanding at that date. EITF 07-05 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company does not currently anticipate that the adoption of EITF 07-05 on January 1, 2009 will have any impact on its consolidated financial statement presentation or disclosures.

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Results of Operations - Years Ended December 31, 2008 and 2007:

The table shown below presents information with respect to the Company’s consolidated statements of operations as to actual amounts and as a percentage of total net revenue, for the years ended December 31, 2008 and 2007.

	Years Ended December 31,
	2008					2007
	$			$		%			%
Net revenue
E-commerce	$	336		2.8	%	$	1,497		6.2	%
Media	3,995			32.9	%	7,500			31.0	%
Anti-piracy and file-sharing marketing services	7,810			64.3	%	15,174			62.8	%
Total net revenue	12,141			100.0	%	24,171			100.0	%
Cost of revenue:
E-commerce	320			2.6	%	1,531			6.3	%
Media	2,606			21.5	%	3,688			15.3	%
Anti-piracy and file-sharing marketing services	7,429			61.2	%	9,414			38.9	%
Total cost of revenue	10,355			85.3	%	14,633			60.5	%
Gross profit	1,786			14.7	%	9,538			39.5	%
Operating expenses:
Sales and marketing	1,535			12.6	%	1,993			8.2	%
General and administrative (including stock-based compensation)	7,022			57.9	%	10,867			45.0	%
Development and engineering	437			3.6	%	525			2.2	%
Goodwill impairment	31,085			256.0	%
Write-off of fixed assets	—			—	%	97			0.4	%
Total operating costs	40,079			330.1	%	13,482			55.8	%
Loss from operations	(38,293		)	(315.4	)%	(3,944		)	(16.3	)%
Interest income	51			0.4	%	211			0.9	%
Interest expense	(8,740		)	(72.0	)%	(7,923		)	(32.8	)%
Loss on foreign currency	(65		)	(0.5	)%	(14		)	(0.1	)%
Other income	340			2.8	%	—			—	%
Liquidated damages under registration rights agreements	—			—	%	395			1.6	%
Change in fair value of warrant liability	130			1.0	%	4,551			18.8	%
Change in fair value of derivative liability	302			2.5	%	18,043			74.7	%
Amortization of deferred financing costs	(842		)	(6.9	)%	(841		)	(3.4	)%
Write-off of unamortized discount on debt and deferred financing costs resulting from principal payments on senior secured notes payable	(25		)	(0.2	)%	—			—	%
Income (loss) before income taxes	(47,142		)	(388.3	)%	10,478			43.4	%
Provision (benefit) for income tax	814			6.7	%	(1,039		)	(4.3	)%
Net income (loss)	$	(47,956	)	(395.0	)%	$	11,517		47.7	%

The Company evaluates performance based on, among other factors, earnings or loss before interest, taxes, depreciation and amortization (“Adjusted EBITDA”), which is a non-GAAP financial measure.  Adjusted EBITDA also excludes stock-based compensation, changes in the fair value of warrant liability and derivative liability, and other non-cash write-offs and charges.  Management excludes these items in assessing financial performance, primarily due to their non-operational nature or because they are outside of the Company’s normal operations.  The Company has provided this information because management believes that it is useful to investors in understanding the Company’s financial condition and results of operations.

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Management believes that Adjusted EBITDA enhances an overall understanding of the Company’s financial performance by investors because it is frequently used by securities analysts and other interested parties in evaluating companies in its industry segment.  In addition, management believes that Adjusted EBITDA is useful in evaluating the Company’s operating performance compared to that of other companies in its industry segment because the calculation of Adjusted EBITDA eliminates the accounting effects of financing costs, income taxes and capital spending, which items may vary for different companies for reasons unrelated to overall operating performance.

However, Adjusted EBITDA has certain limitations.  Adjusted EBITDA is not a recognized measurement under GAAP, and when analyzing the Company’s operating performance, investors should use Adjusted EBITDA in addition to, and not as an alternative for, standard GAAP financial measures such as net income (loss) or cash flow from operations, or any other measure utilized in determining the Company’s operating performance that is calculated in accordance with GAAP.  Because Adjusted EBITDA is not calculated in accordance with GAAP, it may not be comparable to similarly-titled measures utilized by other companies.  Adjusted EBITDA eliminates certain substantial recurring items from net income (loss), such as depreciation, amortization, interest expense and income taxes, among others.  Each of these items has been incurred in the past, will continue to be incurred in the future, and should be considered in the overall evaluation of the Company’s operating performance.  The Company compensates for these limitations by providing the relevant disclosure of the items excluded in the calculation of Adjusted EBITDA, both in the reconciliation to the GAAP financial measure of net income (loss) and in the consolidated financial statements and footnotes, all of which should be considered when evaluating the Company’s operating performance.  Furthermore, Adjusted EBITDA is not intended to be a measure of the Company’s free cash flow or liquidity in general, as it does not consider certain ongoing cash requirements, such as a required debt service payments and income taxes.

Included in Adjusted EBITDA are direct operating expenses for each segment.  Corporate expenses consist of general operating expenses that are not directly related to the operations of the segments

The table shown below summarizes net revenue and Adjusted EBITDA by operating segment for the years ended December 31, 2008 and 2007, respectively.  A reconciliation of Net Income (Loss) to Adjusted EBITDA is also provided.

	Years Ended December 31,
	2008			2007
	(in thousands)
Net Revenue:
E-commerce	$	336		$	1,497
Media	3,995			7,500
Anti-piracy and file-sharing marketing services	7,810			15,174
	$	12,141		$	24,171
Adjusted EBITDA:
E-commerce	$	(88	)	$	(218	)
Media	264			2,604
Anti-piracy and file-sharing marketing services	264			5,304
	440			7,690
Corporate:
General and administrative expenses	(3,635		)	(4,824		)
Liquidated damages under registration rights agreements	—			395
	$	(3,195	)	$	3,261

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	Years Ended December 31,
	2008			2007
	(in thousands)
Reconciliation of Adjusted EBITDA to Net Income (Loss):
Adjusted EBITDA per segments	$	(3,195	)	$	3,261
Stock-based compensation	(991		)	(2,110		)
Depreciation and amortization	(906		)	(1,015		)
Amortization of intangible assets	(2,181		)	(3,602		)
Amortization of deferred financing costs	(842		)	(841		)
Goodwill impairment	(31,085		)	—
Write-off of unamortized discount on debt and deferred financing costs resulting from principal payments on senior secured notes payable	(25		)	—
Interest income	51			211
Other income	340			—
Write-off of fixed assets	—			(97		)
Interest expense, including amortization of discount on debt of $3,088 and $3,081 in 2008 and 2007, respectively	(8,740		)	(7,923		)
Change in fair value of warrant liability	130			4,551
Change in fair value of derivative liability	302			18,043
Provision (benefit) for income taxes	(814		)	1,039
Net income (loss)	$	(47,956	)	$	11,517

Net Revenue.  The Company’s net revenue decreased by $12,030,000 or 50%, to 12,141,000 for the year ended December 31, 2008, as compared to $24,171,000 for the year ended December 31, 2007.

MediaDefender provided $7,810,000 of revenue for the year ended December 31, 2008, as compared to $15,174,000 for the year ended December 31, 2007.  MediaDefender’s anti-piracy revenues in 2008 were negatively impacted by the loss of one customer in November 2007 that accounted for 4% of MediaDefender’s 2007 annual revenue, which cited cost pressures subsequent to a change in ownership, and the loss of a second customer in January 2008 that accounted for 12% of MediaDefender’s 2007 annual revenues, which noted that they were evaluating the use of alternative methods to deal with piracy.  In June 2008, the Company was advised that a third customer that accounted for 18% of MediaDefender’s 2007 annual revenues was substantially curtailing its use of MediaDefender’s anti-piracy services subsequent to the expiration of its current contract with MediaDefender on June 30, 2008, citing uncertainty with respect to the effectiveness and cost/benefit of anti-piracy services.

The loss of revenues from these for customers represented the bulk in the decrease in MediaDefender’s television and catalogue library anti-piracy revenues during 2008, as major entertainment conglomerates discontinued or reduced technological based anti-piracy measures for libraries and television network programming.  These major entertainment companies have indicated that they are exploring alternative means to combat Internet piracy by distributing television programs via websites utilizing an advertising supported model.  However, major media companies continue to utilize a variety of anti-piracy counter measures to protect major theatrical movies and new music album releases in order to protect traditional marketing revenue channels as well as retail sales transactions.

During 2008 MediaDefender continued to offer advertising opportunities for brand specific programs over the peer-to-peer network.  These programs generated $410,000 during 2008 as compared to $560,000 for similar advertising programs in 2007.  Due to the evolving nature of the peer-to-peer Internet network, limited development resources and a significant reduction in Internet advertising campaigns in the fourth quarter of 2008, MediaDefender was unable to reach anticipated revenue levels from peer-to-peer advertising initiatives.  However, the Company anticipates that peer-to-peer advertising will continue to provide accretive revenues with negligible costs.

MediaDefender’s revenue accounted for 64.3% of the Company’s total net revenue for the year ended December 31, 2008, as compared to 62.8% of the Company’s total net revenue for the year ended December 31, 2007.  The Company expects that revenues from MediaDefender will continue to represent a significant proportion of its total revenues for the foreseeable future.

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Media revenue decreased by $3,505,000 or 46.7%, to $3,995,000 for the year ended December 31, 2008, as compared to $7,500,000 for the year ended December 31, 2007.  Media revenue decreased in 2008 as compared to 2007 as a result of a significant slow-down in online advertising, in particular banner and display advertising, and increased competition from new music-related websites.  In addition, in April 2007, the Company entered into a strategic partnership with T-Mobile with the launch of a specially designed United Kingdom counterpart to the Company’s United States-based online music destination website.  The United Kingdom version of ARTISTdirect.com (www.ARTISTdirect.com/uk) included numerous T-Mobile enhancements, including exclusive branded content provided by T-Mobile.  This contract concluded during June 2008.  During the year ended December 31, 2008 and 2007, approximately $204,000 and $1,270,000, respectively, of media revenues were generated by T-Mobile.

The Company markets and sells advertising on a CPM basis to advertising agencies and directly to various companies seeking to reach one or more of the distinct demographic audiences viewing content in the ARTISTdirect Network.  The Company also markets and sells sponsorships for various portions of the ARTISTdirect Network.  Customers may purchase advertising space on the entire ARTISTdirect Network, or they may tailor advertising to specific areas or sections of the Company’s websites.

During the years ended December 31, 2008 and 2007, the Company’s media revenues were generated by two outside sales organizations that represented the Company with respect to advertising and sponsorship on the Company’s website and through affiliated websites, as well as by in-house sales personnel.  During the year ended December 31, 2008, one customer accounted for accounted for $589,000 or 14.7% of media revenues.  During the year ended December 31, 2007, one customer accounted for approximately $1,270,000 or 16.9% of media revenues.

E-commerce revenue decreased by $1,161,000, or 77.6%, to $336,000 for the year ended December 31, 2008, as compared to $1,497,000 for the year ended December 31, 2007.  Due to limited opportunities for revenue growth and acceptable gross margins, the Company has been de-emphasizing e-commerce activities over the past few years.  During the years ended December 31, 2008 and 2007, approximately 0% and 59% of e-commerce revenues were generated from the products related to a single music merchandising entity.  Effective August 31, 2007, the Company restructured its relationship with this merchandising entity to eliminate such merchandise sales and focus on music sales, which had a negative impact on e-commerce sales for the remainder of 2007, and will have a significant negative impact on future e-commerce revenues, although such restructuring is expected to have limited impact on operating margins.

Cost of Revenue.  The Company’s total cost of revenue decreased by $4,280,000 or 36.0%, to $10,355,000 for the year ended December 31, 2008, as compared to $14,633,000 for the year ended December 31, 2007, primarily as a result of a decrease in MediaDefender cost of revenues of $1,985,000, media cost of revenues of $1,082,000, and e-commerce cost of revenues of $1,211,000.  The decline in costs of revenue is the result of significantly lower amortization and depreciation costs related to fully depreciated capitalized assets, property and equipment acquired in the MediaDefender acquisition, the absence of e-commerce inventory costs and an overall decrease in business activity for all business segments.

MediaDefender’s cost of revenue decreased by $1,985,000 or 21.1%, to $7,429,000 for the year ended December 31, 2008, as compared to $9,414,000 for the year ended December 31, 2007.  The reduction in costs of revenue reflects costs savings in bandwidth of $675,000 and lower amortization and depreciation costs of $1,216,000 and the balance of the reduced costs were in lower personnel costs.  Included in MediaDefender’s cost of revenue for the years ended December 31, was the amortization of proprietary technology acquired in the MediaDefender transaction of $1,478,000 and $2,534,000, respectively.  Approximately $1,056,000 of the decrease in MediaDefender cost of revenues reflects the completion of amortization in July 2008 of the proprietary technology and $160,000 of reduced depreciation expense from the expiration of costs associated with assets with a three-year life which were acquired in the July 2005 MediaDefender transaction.

Cost of revenue relating to media decreased by $1,082,000 or 29.3% to $2,606,000 for the year ended December 31, 2008, as compared to $3,688,000 for the year ended December 31, 2007.  The majority of the decrease in costs is the result of the absence of $350,000 of content costs in 2008 for a unique advertising campaign which occurred in 2007 and a reduction in outside commissions and affiliate website costs of $386,000 and 325,000, respectively.  The balance of reduced costs was associated with ad serving and other costs reflecting a decrease in advertising activity during 2008.

E-commerce costs of revenue decreased by $1,161,000, or 77.60%, to $336,000 for the year ended December 31, 2008, as compared to $1,497,000 for the year ended December 31, 2007, primarily as a result of decreased inventory and related costs from the discontinuation of selling teen apparel and merchandise on the www.Artistdirect.com website as of August 2007.

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As a result of the foregoing, gross profit was $1,786,000 for the year ended December 31, 2008, as compared to $9,538,000 for the year ended December 31, 2007, reflecting a combined gross margin of 14.7% and 39.5%, respectively.  A summary of gross profit and gross margin by segment is as follows ($000):

	Years Ended December 31,
	2008				2007
Segment:	Gross Profit		Gross Margin		Gross Profit			Gross Margin
E-commerce	$	16	4.8	%	$	(34	)	(2.3	)%
Media	1,389		34.8	%	3,812			50.8	%
Anti-piracy and file-sharing marketing services	381		4.9	%	5,760			38.0	%
Totals	$	1,786	14.7	%	$	9,538		39.5	%

Sales and Marketing.  The Company’s sales and marketing expense decreased by $458,000 or 23.0%, to $1,535,000 for the year ended December 31, 2008, as compared to $1,993,000 for the year ended December 31, 2007.  Also included in sales and marketing expense for the years ended December 31, 2008 and 2007 is the amortization of customer relationships acquired in the MediaDefender transaction of $440,000 and $755,000, respectively.  Approximately $315,000 of the decrease in sales and marketing expense reflects the completion of amortization in July 2008 of the customer relationships with a three-year life that were acquired in the July 2005 MediaDefender transaction.  The balance of the reduced costs is due to reduced wages, commissions and bonus costs associated with the departure of the Vice President of Sales in November 2008.

General and Administrative.  The Company’s general and administrative expense decreased by $3,845,000 or 35.4%, to $7,022,000 for the year ended December 31, 2008, as compared to $10,867,000 for the year ended December 31, 2007.  General and administrative expense decreased significantly in 2008 as compared to 2007 as a result of various factors, including a reduction in bonus accruals, and reduced legal and accounting fees, travel expenses, and equity-based compensation.

Significant components of general and administrative expense consists of management compensation (and bonuses, when applicable), personnel and personnel-related costs, insurance, legal and accounting fees, board compensation, consulting fees, occupancy costs and the provision for doubtful accounts.  Also included in general and administrative expense for the years ended December 31, 2008 and 2007 are stock-based compensation costs of $991,000 and $2,110,000, board fees of $76,000 and $250,000, and the amortization of non-competition agreements of $263,000 and $313,000, respectively, resulting from the MediaDefender transaction.

During the years ended December 31, 2008 and 2007, the Company incurred legal, accounting, consulting and printing fees and costs of approximately $2,274,000 and $1,880,000, respectively, relating to the preparation and filing of various documents with the SEC, negotiations with senior and subordinated note holders, review and analysis of various restructuring alternatives, amendments to financing agreements, and other ordinary course legal and accounting matters.  As a result of the event of defaults related to the Company’s senior and subordinated debt agreements (see “Going Concern” above), the Company has continued to incur significant costs in this regard in 2008.

During the year ended December 31, 2008, the Company was not required to accrue any performance bonuses for the senior management of MediaDefender.  During the years ended December 31, 2008 and 2007, the Company incurred bonus expense of $20,000 and $793,000 respectively.  In 2007, the Company incurred $700,000 with respect to the accrual of annual performance bonuses payable to MediaDefender’s senior management pursuant to their respective employment agreements.

During the year ended December 31, 2008, the Company recorded a charge to operations of $350,000 for the severance payment with respect to the Amended and Restated Services Agreement dated as of March 6, 2008 between the Company and the Company’s former Chief Executive Officer.  The Company also recorded stock-based compensation costs of $571,000 during the year ended December 31, 2008 with respect to this settlement, which is included in the $991,000 above.

Development and Engineering.  Development and engineering costs were $437,000 for the year ended December 31, 2008, as compared to $525,000 for the year ended December 31, 2007.  Development and engineering costs consist primarily of third-party development costs and payroll and related expenses for in-house development costs incurred in the design and production of the Company’s content and services, including revisions to the Company’s website, and are charged to operations as incurred.

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Goodwill Impairment. During the year ended December 31, 2008, the Company recorded a non-cash charge to operations aggregating $31,085,000 with respect to the impairment of the goodwill recognized in conjunction with the acquisition of MediaDefender in July 2005.  This charge to operations was based on various factors and developments occurring in 2008, including continuing erosion in the demand for MediaDefender’s core Internet anti-piracy services within the entertainment industry, the unexpected non-renewal by MediaDefender’s largest customer in mid-2008, continuing deterioration of operating margins and valuation metrics, and the inability to implement new advertising initiatives on a large-scale basis.

Write-Off of Fixed Assets. During the year ended December 31, 2007, the Company recorded a charge to operations of $97,000 to write-off the net book value of obsolete computer equipment that it did not expect to utilize in future periods.  The Company did not write-off any fixed assets during the year ended December 31, 2008.

Loss from Operations. As a result of the aforementioned factors, the loss from operations was $38,293,000 for the year ended December 31, 2008, as compared to a loss from operations of $3,944,000 for the year ended December 31, 2007.

Interest Income.  Interest income was $51,000 for the year ended December 31, 2008, as compared to $211,000 for the year ended December 31, 2007.

Interest Expense.  Interest expense of $8,740,000 and $7,923,000 for the years ended December 31, 2008 and 2007, respectively, relates to the $15,000,000 of 11.25% secured notes payable issued in the Senior Financing and the $30,000,000 of 4.0% subordinated convertible notes payable issued in the Sub-Debt Financing, both of which were issued to finance the acquisition of MediaDefender in July 2005.  Effective January 1, 2007, the interest rate on the Sub-Debt Financing increased from 4.0% to 12.0% due to the default on the Company’s senior and subordinated debt agreements in January 2007 (see “Going Concern” above).  On March 17, 2008, the Company entered into a Forbearance and Consent Agreement with the investors in the Senior Financing, which was effective as of February 20, 2008, whereby the investors agreed to forbear from exercising any of their rights and remedies under the Senior Financing transaction documents through December 31, 2008 in exchange for an adjustment in the interest rate associated with the 11.25% secured notes payable from 11.25% to 16.0% per annum.

Additional consideration in the form of warrants issued to the lenders was accounted for at fair value and recorded as a reduction to the carrying amount of the debt, and is being amortized to interest expense over the term of the debt.  Accordingly, the amortization of this discount on debt included in interest expense for the years ended December 31, 2008 and 2007 was $716,000 and $717,000, respectively.

The Sub-Debt Notes contain several embedded derivative features that have been accounted for at fair value.  The various embedded derivative features of the Sub-Debt Notes have been valued at the date of inception of the Sub-Debt Financing and at the end of each reporting period thereafter.  The value of the embedded derivatives was bifurcated from the Sub-Debt Notes and recorded as derivative liability, with the initial amount recorded as discount on the related Sub-Debt Notes.  This discount was amortized to interest expense over the life of the Sub-Debt Notes.  Accordingly, the amortization of this discount on debt included in interest expense for the years ended December 31, 2008 and 2007 was $2,372,000 and $2,365,000, respectively.

Loss on Foreign Currency Transactions. The loss on foreign currency transactions was $65,000 and $14,000 for the years ended December 31, 2008 and 2007, respectively.

Other Income.  Other income was $340,000 for the year ended December 31, 2008, reflecting primarily a reduction in certain old accrued liabilities.  The Company did not have any other income for the year ended December 31, 2007.

Liquidated Damages Under Registration Rights Agreements. The Company did not have any additional liquidated damages during the year ended December 31, 2008.  In accordance with EITF 00-19-2, which the Company adopted as of December 31, 2006, and SFAS No. 5, the Company accrued seven months liquidated damages (through mid-August 2007) under the registration rights agreements aggregating approximately $3,777,000 as a charge to operations at December 31, 2006. As a result of the Company’s registration statement being declared effective on July 6, 2007, which was earlier than originally estimated, the Company recorded a net reduction to the original accrual of $395,000 in other income during the year ended December 31, 2007.

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Change in Fair Value of Warrant Liability. In accordance with EITF 00-19, the fair value of the warrants issued in connection with the financing of the MediaDefender acquisition in July 2005 was recorded as a warrant liability. The carrying value of the warrants is adjusted quarterly to reflect any changes in the fair value such liability and is included in the statement of operations as other income (expense). For the years ended December 31, 2008 and 2007, the Company recorded income of $130,000 and $4,551,000, respectively, to reflect the change in warrant liability during such periods.

Change in Fair Value of Derivative Liability. In accordance with EITF 00-19, the fair value of the embedded derivatives was bifurcated from the subordinated convertible notes payable issued in connection with the financing of the MediaDefender acquisition in July 2005 and recorded as a derivative liability. The carrying value of the derivative liability is adjusted quarterly to reflect any changes in the fair value of such liability and is included in the statement of operations as other income (expense). For the years ended December 31, 2008 and 2007, the Company recorded income of $302,000 and $18,043,000, respectively, to reflect the change in derivative liability during such periods.

Amortization of Deferred Financing Costs. Amortization of deferred financing costs was $842,000 and $841,000 for the years ended December 31, 2008 and 2007, respectively. Deferred financing costs consist of consideration paid to third parties with respect to the acquisition and financing of the MediaDefender transaction, including cash payments, subordinated convertible notes payable and the fair value of warrants issued for placement agent fees, which were deferred and are being amortized over the term of the related debt.

Write-Off of Unamortized Discount on Debt and Deferred Financing Costs Resulting from Principal Payments on Senior Secured Notes Payable and Conversion of Subordinated Convertible Notes Payable. Deferred financing costs and debt discount costs aggregating $17,000 were charged to operations as a result of the principal payments on senior secured notes payable during the year ended December 31, 2008.

Income (Loss) Before Income Taxes. As a result of the aforementioned factors, loss before income taxes was $(47,142,000) for the year ended December 31, 2008, as compared to income before income taxes of $10,478,000 for the year ended December 31, 2007.

Provision (benefit) for Income Taxes. The Company recorded $814,000 during the year ended December 31, 2008 to accrue for potential additional taxes and interest as a result of a pending audit of the Companys 2005 and 2006 tax returns. The Company received a tax refund and a benefit for income taxes of $1,039,000 for the year ended December 31, 2007, as a result of the carryback of 2007 tax losses to 2005 and 2006.

Net Income (Loss). As a result of the foregoing factors, the net loss was $(47,956,000) for the year ended December 31, 2008, as compared to a net income of $11,517,000 for the year ended December 31, 2007.

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Liquidity and Capital Resources:

As of December 31, 2008, approximately $12,994,000 principal amount was outstanding with respect to the Senior Financing, and approximately $27,658,000 principal amount was outstanding with respect to the Sub-Debt Financing.  In addition, at December 31, 2008, approximately $0 and $2,415,000 were outstanding with respect to accrued registration delay liability to the holders of the Senior Financing and the Sub-Debt Financing, respectively, and approximately $113,000 and $6,362,000 was outstanding with respect to accrued interest payable to the holders of the Senior Financing and the Sub-Debt Financing, respectively.  The Senior Notes and the Subordinated Notes would have been due in June and July 2009, respectively.

Effective January 30, 2009, the Company entered into a First Amendment to Note and Warrant Purchase Agreement dated as of December 31, 2008 (the “Senior Amendment”) with the holders of the Company’s senior secured debt (the “Senior Note Holders”).  Pursuant to the Senior Amendment, the Senior Note Holders agreed to extinguish all obligations by the Company under the Note and Warrant Purchase Agreement, dated July 28, 2005, and other documents entered into in connection with the senior secured debt transaction (the “Senior Debt Restructuring”), upon completion of the following: (1) $3,500,000 cash payment to the Senior Note Holders; (2) issuance of new subordinated notes, in the aggregate principal amount of $1,000,000, to the Senior Note Holders (the “New Notes”); (3) issuance of 9,000,000 restricted shares of the Company’s common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months; and (4) the conversion of all of the previously issued Subordinated Notes. The restructuring of the senior debt was consummated on January 30, 2009.

The New Notes are unsecured and bear interest at 6.0% per annum, beginning January 30, 2009. The principal and the interest accrued thereon are payable on the maturity date, January 30, 2014, and are subordinated to the senior indebtedness of the Company.

In connection with the Senior Debt Restructuring, effective January 30, 2009, the Company entered into a Second Amendment to the Convertible Subordinated Note with holders of the Subordinated Notes representing no less than the majority of the current outstanding aggregate principal amount to provide for the immediate conversion of the Subordinated Notes (the “Subordinated Amendment”). The Subordinated Amendment also provides for the extinguishment of all obligations of the Company under the Subordinated Notes and related documents, including the Registration Rights Agreement among the Company and the holders.  Such obligations included the outstanding principal amount and accrued and unpaid interest on the Subordinated Notes, accrued and unpaid late charges and amounts owed under the Registration Rights Agreement with the holders of the Subordinated Notes.  Consummation of the transactions under the Subordinated Amendment occurred as of January 30, 2009.

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In order to obtain the additional funds of $1,250,000 to close the restructure and recapitalization plan on January 30, 2009, the Company’s two wholly-owned subsidiaries, ARTISTdirect Internet Group, Inc. (“ADIG”) and MediaDefender each entered into an Accounts Receivable Purchase & Security Agreement (the “A/R Agreement”) with Pacific Business Capital Corporation (“PBCC”), pursuant to which ADIG and Mediadefender agreed to sell and PBCC agreed to purchase qualified accounts receivable on a recourse basis. On January 30, 2009, PBCC purchased an aggregate of approximately $1,600,000 of unpaid receivables to be acquired by PBCC pursuant to the A/R Agreement, subject to a maximum aggregate amount of $3,000,000. The A/R Agreement is effective for twelve-months and automatically renews for successive 12-month periods unless terminated by written notice by either party 30 days prior to such successive period.

As collateral for the financing, PBCC received a first priority interest in all existing and future assets of the Company, ADIG and Mediadefender, tangible and intangible, including but not limited to, cash and cash equivalents, accounts receivable, inventories, other current assets, furniture, fixtures and equipment and intellectual property. In addition to the foregoing, the Company, ADIG and Mediadefender entered into cross guarantees of their respective obligations under the A/R Agreement.

The Company anticipates that there will be sufficient access to working capital from the A/R Agreement and the consolidated operations of Artist Direct Internet Group and MediaDefender to pay the interest under the A/R Agreement and fund the ongoing costs of operations.  Although there can be no assurance of continued profitability, the Company anticipates that it will be able to raise additional capital as needed or obtain additional financing to operate the Company.

The Companys’ consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern.  Because of the Companys’ declining revenues, negative working capital, net loss, and uncertainties related to improving our operating results under current economic conditions, our independent auditors, in their report on the Companys’ financial statements for the year ended December 31, 2008 expressed substantial doubt about the Companys’ ability to continue as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Overview:

As of December 31, 2008 and 2007, the Company had $1,994,000 and $4,268,000 of unrestricted cash and cash equivalents, respectively.

At December 31, 2008, the Company had a working capital deficiency of $44,512,000, primarily because of the classification of senior secured notes payable and subordinated convertible notes payable as current liabilities, the accrual of default interest on the subordinated convertible notes payable of $6,362,000, liquidated damages payable under registration rights agreements of $1,972,000, warrant liability of $35,000, and derivative liability of $11,000 at such date.

At December 31, 2007, the Company had a working capital deficiency of $32,273,000, primarily because of the classification of senior secured notes payable and subordinated convertible notes payable as current liabilities, the accrual of default interest on the subordinated convertible notes payable of $3,034,000, liquidated damages payable under registration rights agreements of $2,382,000, warrant liability of $164,000, and derivative liability of $313,000 at such date.

The increase in the working capital deficiency at December 31, 2008 as compared to December 31, 2007 of $12,239,000 was primarily attributable to an increase in the interest owed to the senior and subordinated note holders of $5,947,000 and a reduction in accounts receivable and cash of $5,626,000 and $2,286,000 respectively, offset by a $2,503,000 reduction in accounts payable and accrued expenses.

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Operating. Net cash used in operating activities was $1,704,000 for the year ended December 31, 2008, as compared to net cash used by operating activities for the year ended December 31, 2007 of $1,038,000. Operating cash flow decreased in 2008 as compared to 2007 primarily as a result of the decrease in operating profitability at MediaDefender.

Investing. Net cash used in investing activities for the year ended December 31, 2008 was $269,000, which consisted of additions to property and equipment. Net cash used in investing activities for the year ended December 31, 2007 was $481,000, which consisted of additions to property and equipment.

Financing. Net cash used by financing activities for the year ended December 31, 2008 was $301,000, which consisted of principal payments on senior secured notes.  Net cash provided by financing for the year ended December 31, 2007 was $185,000, which was comprised of $101,000 from the exercise of stock options and a net decrease of $84,000 in restricted cash that secures certain letters of credit.

Contractual Obligations:

The Company’s principal commitments for the next five fiscal years consisted of contractual commitments as summarized below. The summary shown below reflects the debt restructuring consummated on January 30, 2009 and the purchase of MediaSentry assets on March 30, 2009.

			Payments Due by Year (in thousands)
Contractual cash obligations	Total		2009		2010		2011		2012
Employment contracts (1)	$	900	$	275	$	300	$	300	$	25
Lease obligations (2)	2,796		1,604		722		470		—
MediaSentry asset purchase and Safenet promissory note (5)	936		136		800		—		—
Interest on SafeNet note	99		48		51		—		—
Senior secured notes payable debt restructuring (3)	3,500		3,500		—		—		—
Accounts receivable credit facilities (4)(7)	1,250		—		1,250		—		—
Convertible short-term note	200		200		—		—		—
Total contractual cash obligations	$	9,681	$	5,763	$	3,123	$	770	$	25

(1)Base compensation only; does not include any performance bonuses.

(2)Lease obligations include property leases and co-location bandwidth contracts.

(3)In connection with the debt restructuring the Company paid $3,500,000 on January 30, 2009 to the senior note holders.

(4)The credit facilities obtained from Pacific Business Capital Corporation in connection with the debt restructing are due in February 2010 and bear interest at 2% per month of the outstanding balance funded against pledged receivables.

(5)In connection with the MediaSentry asset purchase completed on March 30, 2009, the Company paid SafeNet Inc. $136,000 and issued a $800,000 note at 6% interest due in March 2010.

(6)The above table does not reflect the new five year subordinated 6% notes issued to the senior note holders in connection with the debt restructuring as the principle and interest are due in January 2014.

(7)Short Term automatically convertible note dated March 3, 2009 to Fredrick Field, a director, for $200,000, which is due July 31, 2009 with interest at 5% per year.

Capital Expenditures. The Company estimates that it will have capital expenditures aggregating approximately $250,000 for the year ending December 31, 2009, primarily related to the expansion of MediaDefender’s operations.

Off-Balance Sheet Arrangements. At December 31, 2008, the Company did not have any transactions, obligations or relationships that could be considered off-balance sheet arrangements.

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ITEM 7A.               QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Annual Report contains statements relating to our future business and/or results, including, without limitation, the statements under the captions “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Description of Business.”  These statements include certain projections and business trends that are “forward-looking” within the meaning of the United States Private Securities Litigation Reform Act of 1995.  You can identify these statements by the use of words like “may,” “will,” “could,” “should,” “project,” “believe,” “anticipate,” “expect,” “plan,” “estimate,” “forecast,” “potential,” “intend,” “continue” and variations of these words or comparable words.

Forward-looking statements do not guarantee future performance and involve risks and uncertainties.  Actual results will differ, and may differ materially, from projected results as a result of certain risks and uncertainties.  These risks and uncertainties include, without limitation, those described under “Risk Factors” and those detailed from time to time in our filings with the SEC, and include, among others, the following:

·Our limited operating history;

·Our ability to protect our intellectual property rights;

·Our ability to successfully develop and commercialize our proposed products;

·The degree and nature of our competition;

·Our ability to employ and retain qualified employees;

·The limited trading market for our common stock; and

·The other factors referenced in this report, including, without limitation, under the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and “Description of Business.”

These risks are not exhaustive.  Other sections of this Annual Report may include additional factors which could adversely impact our business and financial performance.  Moreover, we operate in a very competitive and rapidly changing environment.  New risk factors emerge from time to time and it is not possible for our management to predict all risk factors, nor can we assess the impact of all factors on our business or to the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.  These forward-looking statements are made only as of the date of this Annual Report.  Except for our ongoing obligation to disclose material information as required by federal securities laws, we do not intend to update you concerning any future revisions to any forward-looking statements to reflect events or circumstances occurring after the date of this Annual Report.

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ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our consolidated financial statements appear in a separate section of this Annual Report, see “Index to Consolidated Financial Statements.”  Such information is incorporated herein by reference.

ITEM 8.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not Applicable.

ITEM 9A(T) - - MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) under the Exchange Act.  Our internal control over financial reporting is designed to ensure that material information regarding our operations is made available to management and the board of directors to provide them reasonable assurance that the published financial statements are fairly presented.  There are limitations inherent in any internal control, such as the possibility of human error and the circumvention or overriding of controls.  As a result, even effective internal controls can provide only reasonable assurance with respect to financial statement preparation.  As conditions change over time so too may the effectiveness of internal controls.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the chief executive officer and chief financial officer as appropriate, to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Our chief executive officer and principal financial officer, have evaluated our disclosure controls and procedures and determined that they were effective as of December 31, 2008.

Our management, with the participation of our chief executive officer and chief accounting officer evaluated our internal controls over financial reporting as of December 31, 2008 based on the framework in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2008.

This annual report does not include an attestation report of the Company’s registered public accounting firm regarding internal control over financial reporting.  Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to temporary rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this Annual Report.

Changes in Internal Control Over Financial Reporting

There were no changes to our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our most recently completed fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.OTHER INFORMATION

Not Applicable.

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PART III

ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Directors

The following table sets forth, as of March 24, 2009, the names of, and certain information concerning, our directors:

Name	Age	Position	Director Since	End of Term
Dimitri Villard	66	Chief Executive Officer and Chairman of the Board	2005	2009
Frederick W. Field	56	Director	2001	2009
Fred Davis	49	Director	2005	2009

Dimitri Villard.   Mr. Villard served as Interim Chief Executive officer since March 6, 2008 and as a director since January 2005. Effective February 1, 2009, Mr. Villard was appointed Chief Executive Officer of the Company and its two wholly owned subsidiaries.  Mr. Villard has also served as President and a director of Pivotal BioSciences, Inc., a biotechnology company, since September 1998. In addition, since January 1982 to present, he has served as President and director of Byzantine Productions, Inc. Previously, Mr. Villard was a director at the investment banking firm of SG Cowen and affiliated entities, a position he held from January 1997 to July 1999. From 2004 to 2008 Mr. Villard served as Chairman of the Board of Dax Solutions, Inc. (“Dax”), an entertainment industry digital asset management venture. He is also a member of the Executive Committee of the Los Angeles chapter of the Tech Coast Angels, a private venture capital group. Mr. Villard received a B.A. from Harvard University and a Master of Science degree from China International Medical University.

Frederick W. Field.   Mr. Field served as Chairman of the Board from June 2001 to March 2008 and served as our Chief Executive Officer from June 2001 until September 2003. Mr. Field also currently serves as Chief Executive Officer of ARTISTdirect Records, LLC and as Chairman of the Board and Chief Executive Officer of Radar Pictures, Inc., a film production company. From 1990 to 2001, Mr. Field served as Co-Chairman of Interscope Records, a music production company. From 1979 to 1997, Mr. Field served as Chairman of the Board and Chief Executive Officer of Interscope Communications, Inc.

Fred Davis.   Mr. Davis has served as a director since November 2005. Mr. Davis currently serves as a Senior Partner at the Law Firm of Davis, Shapiro, Lewit, & Hayes which he co-founded in 1997. Prior to 1997, Mr. Davis served as an Executive Vice President at EMI Records. Mr. Davis received a B.A. degree from Tufts University and a J.D. degree from Fordham School of Law.

Executive Officers

The following table sets forth, as of March 24, 2009, the name of, and certain information concerning, our executive officer who does not also serve as a director:

Name	Age	Position
Rene Rousselet	53	Corporate Controller and Principal Accounting Officer

René Rousselet. Mr. Rousselet has served as Corporate Controller since September 2006 and as Principal Accounting Officer since February 2007. From May 2006 to September 2006, Mr. Rousselet worked as a consultant for Tag-It Pacific, Inc. (TAG), a publicly-traded apparel company. From November 2004 to May 2006, he served as the Chief Financial Officer of Asbestos Control Testing, Inc., a privately held interior demolition company, and from 1999 to 2004 he was the President and Chief Financial Officer of ProService Inc., a privately held professional employment organization.  Prior to 1999, Mr. Rousselet served as either the Chief Financial Officer or Corporate Controller for a variety of entertainment companies in Los Angeles including two public companies Hemdale Communications Inc. (no longer in existence) and The Kushner-Locke Company (KLOC.PK), a television programming company. Mr. Rousselet received a Degree in Accounting from California State University Northridge in 1977 and became a Certified Public Accountant in 1979 while working as a Senior Auditor at Arthur Andersen & Co.

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Family Relationships

There are no family relationships among the directors and executive officers.

Term of Office

Our directors and officers hold office until the earlier of their death, resignation, or removal or until their successors have been qualified.

Procedure for Consideration of Director-Nominees

Stockholder Nominees.

The Nominating Committee considers nominees to the Board proposed by stockholders.  The Nominating Committee was established to ensure that the Company is able to attract and retain qualified individuals to serve on the Board of Directors and to establish a fair process for the handling of stockholder nominations to the Board of Directors.

Section 16(a) Beneficial Ownership Compliance

Section 16(a) of the Securities Exchange Act of 1934 requires our directors and certain executive officers and persons who own more than ten percent of a registered class of ARTISTdirect’s equity securities (collectively, the “Reporting Persons”), to file reports of ownership and changes in ownership with the Securities and Exchange Commission. The Reporting Persons are required by Securities and Exchange Commission regulation to furnish the Company with copies of all Section 16(a) forms they file.

To our knowledge, based solely on our review of the copies of such forms received by us, or written representations from the Reporting Persons, all Section 16(a) forms were timely filed during fiscal 2008.

Code of Ethics

We have adopted a Code of Ethics that is applicable to our directors and our employees, including our principal executive officer, principal financial officer, principal accounting officer, controller, or persons performing similar functions. The Code of Ethics was included as an exhibit to our Form 10-K filed with the Securities and Exchange Commission on May 17, 2004. A copy is available free of charge on the Securities and Exchange Commission’s website located on the Internet at www.sec.gov. Amendments to and waivers from the Code of Ethics will also be disclosed in future filings with the Securities and Exchange Commission.

The Board of Directors and Committees

The Board is responsible for the supervision of the overall affairs of the Company. The Board met multiple times during the year ended December 31, 2008.  During 2008, each director attended either in-person or by telephone, at least 90% percent of all Board meetings.

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Audit Committee

The Board re-established an Audit Committee in November 2005. For the years of 2006 and 2007, the Committee had the following responsibilities, but were not limited to:

·appointing, evaluating and retaining the independent registered public accounting firm,

·reviewing and discussing with management and the independent registered public accounting firm our annual and quarterly financial statements and disclosures,

·discussing our systems of internal control over financial reporting, and

·meeting independently with the independent registered public accounting firm and management.

The Audit Committee consisted of James N. Lane and Dimitri Villard, both of whom were considered “independent” for the year ended December 31, 2007.  On March 24, 2008, Mr. James Lane advised the Company that he would no longer serve as a Director and member of the Audit Committee.  As Mr. Lane was, at that time, the only independent member of the Audit Committee, the Company has suspended the activities of the Audit Committee until a new independent Director is appointed. In the interim, the functions of the Audit Committee have been assumed by the Board of Directors.

Compensation Committee

The Board established a Compensation Committee in November 2005. The Compensation Committee administers the Company’s compensation and benefit plans, in particular, the incentive compensation and equity-based plans, and approves salaries, bonuses, and other compensation arrangements and policies for the Company’s officers, including the Chief Executive Officer. The Board has adopted a written charter for the Compensation Committee, a copy of which was filed as an exhibit to the Company’s Proxy Statement filed on May 8, 2006 with the Securities and Exchange Commission. The Compensation Committee currently consists of Fred Davis and Frederick Field, both of whom were considered “independent” for the year ended December 31, 2008.

Nominating Committee

The Board established a Nominating Committee in June 2006.  The Nominating Committee during 2007 consisted of Frederick Field and Fred Davis, both of whom were considered “independent”.  The Nominating Committee was established to ensure that the Company is able to attract and retain qualified individuals to serve on the Board of Directors and to establish a fair process for the handling of stockholder nominations to the Board of Directors.  There were no meetings of the Nominating Committee during 2008.

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ITEM 11.EXECUTIVE COMPENSATION

Overview of Executive Compensation Program

The Compensation Committee of our board of directors has responsibility for establishing, implementing and monitoring our executive compensation program philosophy and practices. The Compensation Committee seeks to ensure that the total compensation paid to our named executive officers is fair, reasonable and competitive. Generally, the types of compensation and benefits provided to the named executive officers are similar to those provided to our other officers.

Throughout this Annual Report, the individuals included in the Summary Compensation Table are referred to as the “named executive officers.”

Compensation Philosophy and Objectives

The components of our executive compensation consist of salary, annual cash bonuses awarded based on the Compensation Committee’s subjective assessment of each individual executive’s job performance during the past year, stock option grants to provide executives with longer-term incentives, and occasional special compensation awards (either cash or stock options) to reward extraordinary efforts or results.

The Compensation Committee believes that an effective executive compensation program should provide base annual compensation that is reasonable in relation to individual executive’s job responsibilities and reward the achievement of both annual and long-term strategic goals of our Company. The Compensation Committee uses annual and other periodic cash bonuses to reward an officer’s achievement of specific goals and employee stock options as a retention tool and as a means to align the executive’s long-term interests with those of our stockholders, with the ultimate objective of improving stockholder value. The Compensation Committee evaluates both performance and compensation to maintain our company’s ability to attract and retain excellent employees in key positions and to assure that compensation provided to key employees remains competitive relative to the compensation paid to similarly situated executives of comparable companies. To that end, the Compensation Committee believes executive compensation packages provided by us to our named executive officers should include both cash compensation and stock options.

Because of the size of our Company, the small number of executive officers in our Company, and our company’s financial priorities, the Compensation Committee has decided not to implement or offer any pension benefits, deferred compensation plans, or other similar plans for our named executive officers.

Role of Executive Officers in Compensation Decisions

The Compensation Committee makes all compensation decisions for the named executive officers and approves recommendations regarding equity awards to all of our officers. Decisions regarding the non-equity compensation of our other officers are made by our Chief Executive Officer.

The Compensation Committee and the Chief Executive Officer annually review the performance of each named executive officer (other than the Chief Executive Officer, whose performance is reviewed only by the Compensation Committee). The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and annual award amounts, are presented to the Compensation Committee. The Compensation Committee can exercise its discretion in modifying any recommended adjustments or awards to executives.

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Setting Executive Compensation

Based on the foregoing objectives, the Compensation Committee has structured the Company’s annual cash and incentive-based cash and non-cash executive compensation to seek to motivate our named executives to achieve the business goals set by the Company, to reward the executives for achieving such goals, and to retain the executives. In doing so, the Compensation Committee historically has not employed outside compensation consultants. The Compensation Committee utilizes data to set compensation for our executive officers at levels targeted at or around a range of compensation amounts provided to executives at comparable companies considering, for each individual, their individual experience level related to their position with us. There is no pre-established policy or target for the allocation between either cash and non-cash incentive compensation.

2008 Executive Compensation Components

For 2008, the principal components of compensation for the named executive officers were:

·base salary;

·annual bonuses; and

·equity incentive compensation.

Base Salary

The Company provides named executive officers and other employees with base salary to compensate them for services rendered during the year. Base salary ranges for the named executive officers are determined for each named executive officer based on his position and responsibility.

During its review of base salaries for executives, the Compensation Committee primarily considers:

·the negotiated terms of each executive employment agreement;

·internal review of the executive’s compensation, both individually and relative to other named executive officers; and

·individual performance of the executive.

Salary levels are typically considered annually as part of the company’s performance review process, as well as upon a change in job responsibility. Merit-based increases to salaries are based on the Compensation Committee’s assessment of the individual’s performance.

Annual and Special Bonuses

The Compensation Committee has not established an incentive compensation program with fixed performance targets. Because we do not generate significant profits, the Compensation Committee bases its discretionary compensation awards on the achievement of milestones, and effective fund-raising efforts, and effective management of personnel and capital resources, among other criteria.

Equity Incentive Compensation

As indicated above, the Compensation Committee also aims to encourage the company’s executive officers to focus on long-term company performance by allocating to them stock options that vest over a period of several years. There were no equity grants during 2008.  All stock options had an exercise price equal to the closing market price on the date of grant, and also vest monthly over three years, provided that such executives remain in our employ through such monthly vesting periods

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Retirement Plans, Perquisites and Other Personal Benefits

We have adopted a tax-qualified employee savings and retirement plan, the 401(k) Plan, for eligible United States employees, including our named executive officers. Eligible employees may elect to defer a percentage of their eligible compensation in the 401(k) Plan, subject to the statutorily prescribed annual limit. We may make matching contributions on behalf of all participants in the 401(k) Plan in an amount determined by our board of directors. Matching and profit sharing contributions, if any, are subject to a vesting schedule; all other contributions are at all times fully vested. We intend the 401(k) Plan, and the accompanying trust, to qualify under Sections 401(k) and 501 of the Internal Revenue Code so that contributions by employees to the 401(k) Plan, and income earned (if any) on plan contributions, are not taxable to employees until withdrawn from the 401(k) Plan, and so that we will be able to deduct our contributions, if any, when made. The trustee under the 401(k) Plan, at the direction of each participant, may invest the assets of the 401(k) Plan in any of a number of investment options.

Ownership Guidelines

The Compensation Committee has no requirement that each named executive officer maintain a minimum ownership interest in our company.

Our long-term incentive compensation consists solely of periodic grants of stock options to our named executive officers. The stock option program:

·links the creation of stockholder value with executive compensation;

·provides increased equity ownership by executives;

·functions as a retention tool, because of the vesting features included in all options granted by the Compensation Committee; and

·maintains competitive levels of total compensation.

We normally grant stock options to new executive officers when they join our company based upon their position with us and their relevant prior experience. The options granted by the Compensation Committee generally vest monthly over the first three years of the option term. Vesting and exercise rights cease upon termination of employment (or, in the case of exercise rights, 90 days thereafter), except in the case of death (subject to a one-year limitation), disability or retirement. Prior to the exercise of an option, the holder has no rights as a stockholder with respect to the shares subject to such option, including voting rights and the right to receive dividends or dividend equivalents. In addition to the initial option grants, our Compensation Committee may grant additional options to retain our executives and reward, or provide incentive for, the achievement of corporate goals and strong individual performance. Options are granted based on a combination of individual contributions to our company and on general corporate achievements, which may include the attainment of product development milestones and attaining other annual corporate goals and objectives.

On an annual basis, the Compensation Committee assesses the appropriate individual and corporate goals for our new executives and provides additional option grants based upon the achievement by the new executives of both individual and corporate goals. We expect that we will continue to provide new employees with initial option grants in the future to provide long-term compensation incentives and will continue to rely on performance-based and retention grants to provide additional incentives for current employees. Additionally, in the future, the Compensation Committee may consider awarding additional or alternative forms of equity incentives, such as grants of restricted stock, restricted stock units and other performance-based awards.

We have no program, practice or plan to grant stock options to our executive officers, including new executive officers, in coordination with the release of material nonpublic information. We also have not timed the release of material nonpublic information for the purpose of affecting the value of stock options or other compensation to our executive officers, and we have no plan to do so. We have no policy regarding the adjustment or recovery of stock option awards in connection with the restatement of our financial statements, as our stock option awards have not been tied to the achievement of specific financial goals.

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Tax and Accounting Implications

Deductibility of Executive Compensation

As part of its role, the Compensation Committee reviews and considers the deductibility of executive compensation under Section 162(m) of the Internal Revenue Code, which provides that corporations may not deduct compensation of more than $1,000,000 that is paid to certain individuals. We believe that compensation paid to our executive officers generally is fully deductible for federal income tax purposes.

Accounting for Share-Based Compensation

Beginning on January 1, 2006, we began accounting for share-based compensation in accordance with the requirements of FASB Statement 123(R), Share-Based Payment. This accounting treatment has not significantly affected our compensation decisions. The Compensation Committee takes into consideration the tax consequences of compensation to the named executive officers, but tax considerations are not a significant part of the company’s compensation policy.

Compensation Committee Interlocks and Insider Participation in Compensation Decisions

There are no “interlocks,” as defined by the SEC, with respect to any member of the Compensation Committee.

Compensation Committee Report

The Compensation Committee has reviewed and discussed with management the “Compensation Discussion and Analysis” required by Item 402(b) of Regulation S-K and, based on such review and discussions, has recommended to our board of directors that the foregoing “Compensation Discussion and Analysis” be included in this Annual Report.

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Executive Compensation

The following table sets forth information concerning the compensation earned by our Chief Executive Officer, our other most highly compensated executive officers (who served during fiscal years ended December 31, 2008 and 2007, and whose total compensation during fiscal years ended December 31, 2008 and 2007 exceeded $100,000) (collectively, the “Named Executive Officers”).  We have also included two additional individuals who serve as executive officers of MediaDefender, our wholly-owned subsidiary.

Summary Compensation Table

								Compensation
Name and Principal Position	Year	Salary ($)	Bonus ($)		Stock Awards ($)	Option Awards ($)		Non-Equity Incentive Plan ($)	Nonqualified Deferred ($)	All Other ($)		Total ($)
Dimitri Villard	2008	281,080										281,090
Interim Chief Executive Officer
Jonathan V. Diamond	2008	58,333								405,446	(3)	463,779
Former Chief Executive Officer	2007	350,000								9,600	(1)	359,600
Rene Rousselet	2008	150,000	20,000	(2)								170,000
Senior Accounting Officer	2007	136,667	19,000	(2)		59,500	(4)					215,167
Randy Saaf - MediaDefender	2008	350,000								9,600	(1)	359,600
Chief Executive Officer	2007	350,000								9,600	(1)	359,600
Octavio Herrera	2008	350,000								9,600	(1)	359,600
President, MediaDefender	2007	350,000								9,600	(1)	359,600

(1)Auto allowance.

(2)Discretionary bonus.

(3)Severance of $350,000, vacation pay-out of $53,846 and $1,600 auto allowance.

(4)50,000 options granted with a Black-Scholes value of $1.19

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OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END

The following table sets forth certain information relating to unexercised and outstanding options for each named executive officer as of December 31, 2008. No other equity awards otherwise reportable in this table have been granted to any of our named executive officers.

	Option Awards
Name	Number of Securities Underlying Unexercised Options (#) Exercisable	Number of Securities Underlying Unexercised Options (#) Unexercisable	Option Exercise Price ($)		Option Expiration Date
Jonathan V. Diamond	1,304,659	—	$	1.62	02/05/11
Chief Executive Officer
Rene Rousselet	50,000	—	1.50		02/02/12
Senior Finance Officer
Randy Saaf	195,238	4,762	3.00		07/28/12
Chief Executive Officer, MediaDefender(1)
Octavio Herrera	195,238	4,762	3.00		07/28/12
President, MediaDefender(1)

(1) The Options vest over a three and one-half (3.5) year period on a quarterly basis for each named executive officer.

Director Compensation

Board of Directors Compensation:

For the year ended December 31, 2008, each non-employee member of the Company’s Board of Directors received a cash retainer of $15,000.  In addition, each director that serves on a Committee of the Board of Directors received, for each committee served, an additional cash retainer of $10,000 annually, which is paid quarterly.  No stock option grants were made during the year ended December 31, 2008 under the 2006 Equity Plan.

Tabular Format

The following table sets forth the compensation paid to all persons who served as members of our board of directors (other than our named executive officers) during the 2008 fiscal year. No director who is also a named executive officer received any compensation for services as a director in 2008.

We reimburse each of our non-employee directors for their reasonable expenses incurred in connection with attending meetings of the board of directors and related committees.  Fees also include amounts paid to our directors for their services as consultants to the Company in connection with its restructuring.

				Compensation
Name	Fees Earned or Paid in Cash ($)	Stock Awards ($)	Option Awards ($)	Non-Equity Incentive Plan ($)	Nonqualified Deferred ($)	All Other ($)	Total ($)
Jim Lane (5)	5,770	0	0	0	0	0	5,770
Frederick W. Field	15,000	0	0	0	0	0	15,000
Fred Davis (4)	22,500	0	0	0	0	0	22,500
Teymour BoutrosGhali (1)	9,252	0	0	0	0	0	9,252
Eric Pulier (1)	9,252	0	0	0	0	0	9,252
Jon Diamond (2)	7,305	0	0	0	0	0	7,305
Dimitri Villard (3)	6,923	0	0	0	0	0	6,923

(1)On August 12, 2008 Eric Pulier and Teymour Boutros-Ghali resigned as directors of the Company.

(2)On March 12, 2008 Jon Diamond became Chairman of the Board and he resigned on September 5, 2008.

(3)On March 12, 2008 Dimitri Villard became the interim CEO and his Board fees were discontinued.

(4)There were no committee meetings in the fourth quarter of 2008.

(5)On March 24, 2008 Jim Lane resigned as a director of the Company.

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ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth, as of March 24, 2009, the number and percentage of shares of Common Stock beneficially owned, directly or indirectly, by each of our directors, director-nominees, the Named Executive Officers (as defined below), beneficial owners known by the Company of more than five percent of the outstanding shares of our Common Stock and by our directors and executive officers as a group. Beneficial ownership is determined in accordance with the Rule 13d-3(a) of the Securities Exchange Act of 1934, as amended, and do not necessarily indicate ownership for any other purpose, and generally includes voting or investment power with respect to the shares and shares which such person has the right to acquire within 60 days of March 24, 2009.

		Amount and Nature
	Title of Class	of Beneficial		Percent
Beneficial Owner(1)	of Stock	Ownership(2)		of Class**
5% Stockholders:
DKR Capital Partners, L.P. 1281 East Main Street Stamford, CT 06902	Common	8,845,803	(3)	15.8
Trilogy Capital Partners, Inc. c/o Robert Rein, Esq. 10866 Wilshire Boulevard, Suite 400 Los Angeles, CA 90024	Common	8,376,627	(4)	14.9
JMB Capital Partners, L.P. 1999 Avenue of the Stars, Suite 2040 Los Angeles, California 90067	Common	7,826,304	(3)	14.0
Longview Fund LP. 60 Montgomery Street, 44th Floor San Francisco, CA  94111	Common	3,687,651	(5)	6.6
Octavio Herrera 2461 Santa Monica Blvd., Suite d-520 Santa Monica, CA  90404	Common	3,164,205	(6)	5.6
Randy Saaf 2461 Santa Monica Blvd., Suite d-520 Santa Monica, CA  90404	Common	3,164,205	(6)	5.6
Current Executive Officers and Directors:
Dimitri Villard	Common	8,504,515	(7)	15.0
Frederick W. Field	Common	6,991,360	(8)	*
Fred Davis	Common	41,409	(9)	*
Rene Rousselet	Common	112,222	(9)	*
All current directors and executive officers as a group (4 Persons)	Common	8,533,248		15.2

*	Indicates less than 1.0%
**	Based on 56,087,216 shares of Common Stock outstanding as of March 24, 2009.
(1)	Unless otherwise indicated, the address for each of the individuals listed in the table is c/o ARTISTdirect, Inc., 1601 Cloverfield Boulevard, Suite 400 South, Santa Monica, California, 90404-4082.
(2)	Unless otherwise indicated, the persons named in the table have sole voting and investment power with respect to all shares of common stock shown as beneficially owned by them, subject to applicable community property laws.
(3)	Based on Schedule 13G/A filed on February 12, 2009.
(4)	Based on Schedule 13D/A filed on February 17, 2009.
(5)	Based on Schedule 13G filed on February 17, 2009.
(6)	Based on Schedule 13D/A filed on February 17, 2009.
(7)	Includes options to purchase 345,662 shares that have fully vested as of March 15, 2009.
(8)	Consist of options that have fully vested as of March 15, 2009 and 6,666,666 shares issuable upon conversion of a promissory note.
(9)	Consists of options that have fully vested as of March 15, 2009.

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Employment Agreements

As of March 6, 2008, the Company entered into an Amended and Restated Services Agreement (the “Services Agreement”) with Jon Diamond under which his employment as Chief Executive Officer was ended and he was elected as the Company’s Chairman of the Board of Directors.  Under the Services Agreement, the Company agreed to (a) pay a severance payment of $350,000 payable in semi-monthly installments over a period of six months, (b) accelerate the vesting of  the Time Vesting Options under his previous employment agreement, (c) accelerate the vesting of options granted in 2004 to purchase 259,659 shares, (d) extend to February 5, 2011 the period for exercising the Time Vesting Options and to March 29, 2011 for the 2004 Options, and (e) pay 40 days of accrued vacation time.

Effective February 1, 2009, Dimitri Villard, pursuant to a three year employment agreement, the Chairman of the Board of Directors, was appointed to serve as the Company’s Chief Executive Officer. Prior to that date, Mr. Villard was the Company’s interim Chief Executive Officer.  Mr. Villard will receive base compensation equal to $25,000 per month subject to increases as determined by the Board of Directors, in its sole discretion.  Mr. Villard was granted options to purchase 3,920,000 shares of the Company’s stock at $0.03 per share vesting monthly over 36 months and will receive a bonus equal to 33% of the amount by which the Company’s EBITDA exceeds a certain threshold amount as determined by the Company’s Compensation Committee for such fiscal year.

Effective February 1, 2009, the Company and Rene Rousselet (“Executive”) entered into an Employment Agreement pursuant to which Mr. Rousselet was employed to continue as the Company’s Corporate Controller and Principal Accounting Officer.  The employment is on an “at will basis.”  Mr. Rousselet will receive a salary of $14,583 per month subject to increases and a bonus as determined by the Board of Directors, in its sole discretion.  Mr. Rousselet was granted options to purchase 560,000 shares of the Common Stock of the Company at $0.03 per share vesting monthly over 36 months commencing February 1, 2009.  If Mr. Rousselet’s employment is terminated without cause, Mr. Rousselet will receive his salary and vesting of options for an additional period of three months from the date of termination.

In accordance with the MediaDefender transaction, the Company acknowledged the terms of Employment Agreements entered into on July 28, 2005 by MediaDefender with each of Randy Saaf, who serves as Chief Executive Officer of MediaDefender, and Octavio Herrera, who serves as President of MediaDefender.  Mr. Saaf and Mr. Herrera will each earn a base salary of no less than $350,000 per annum during the initial term of the agreements, which shall continue until December 31, 2008.  In addition, the Company granted stock options to purchase 200,000 shares of common stock to each of Mr. Saaf and Mr. Herrera, exercisable for a period of five years at $3.00 per share.  On January 13, 2009, the Company entered into agreements with Mr. Saaf and Mr. Herrera to amend their employment agreement such that commencing January 1, 2009, either Executive or the Company may terminate this Agreement upon five days written notice.  Upon the effective date of termination, with respect to the period commencing January 1, 2009 through such effective date, Each executive is entitled to receive his base compensation, vacation pay and reimbursement of expenses related to his employment with the Company.  Each executive was granted the right to have a period of sixty days from the effective date of termination to exercise all vested stock options issued to him.  Effective February 15, 2009, MediaDefender terminated the employment of Messrs, Saaf and Herrera.

Future payments under employment agreements are as follows:

Years Ending December 31,	(in thousands)
2009	$	275
2010	300
2011	300
2012	25
	$	900

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Consulting Agreements

Effective August 31, 2007, Robert N. Weingarten, the Chief Financial Officer and Secretary of the Company resigned from all positions he held with the Company.  As a result of this resignation, the Company and Mr. Weingarten entered into a twelve month consulting agreement under which he is paid $16,250 per month.

In addition, the Company and Mr. Weingarten entered into an Omnibus Stock Option Amendment Agreement which extended the exercise date for 120,000 stock options granted to him in 2004 until March 29, 2011; altered the terms of his time vesting options to acquire 275,000 shares to accelerate their vesting to August 31, 2007 and extend their exercise date to August 5, 2010.   In addition, Mr. Weingarten will be able to exercise the time vesting options and the performance vesting options, if vested, until August 5, 2010, provided he does not breach his Consulting Agreement.

Option Plans

We currently maintain our 2006 Equity Incentive Plan, our 1999 Employee Stock Option Plan, our 1999 Artist Plan, our 1999 Artist and Artist Advisor Plan and our 2004 Consultant Plan (collectively, the “Current Option Plans”). At March 24, 2008, an aggregate of 1,223,941 stock options were outstanding under the Current Option Plans. There are an additional 1,709,659 stock options outstanding at March 24, 2008 that were issued by us outside of the Current Option Plans.

EQUITY COMPENSATION PLAN INFORMATION

The following table provides information as of March 24, 2009 regarding compensation plans (including individual compensation arrangements) under which our securities are authorized for issuance. Information is included for both equity compensation plans approved by our stockholders and equity compensation plans not approved by our stockholders.

Plan Category Teri to revise data	Number of Securities to be Issued Upon Exercise of Outstanding Options, Warrants and Rights (a)	Weighted-average Exercise Price of Outstanding Options, Warrants and Rights (b)		Number of Securities Remaining Available for Future Issuance Under Equity Compensation Plans (excluding securities reflected in column (a)) (c)
Equity compensation plans approved by stockholders	302,370	$	7.50	142,110
Equity compensation plans not approved by stockholders	3,404,287	$	1.92	2,973,762
Total	3,706,657	$	2.54	3,115,872

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1999 Employee Stock Option Plan

The 1999 Employee Stock Option Plan became effective on October 6, 1999 in connection with our conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to purchase membership units in the limited liability company which were outstanding at the time of such conversion were assumed by the corporation and converted into options for shares of our Common Stock. The number of shares subject to each assumed and converted option was equal to the number of membership units in the limited liability company which were subject to that option immediately prior to the conversion, and the exercise price per share remained the same as the per unit exercise price in effect under the option at the time of conversion.

Except for the conversion of the securities subject to the option into shares of our Common Stock, each option will continue to be governed by the terms of the agreement evidencing that option at the time of our conversion into a corporation.

The 1999 Employee Stock Option Plan is a non-stockholder approved plan under which options may be granted to employees, non-employee members of our Board, and consultants and other independent advisors in our employ or service. The number of shares of Common Stock issuable over the term of the 1999 Employee Stock Option Plan was initially 650,000 shares and automatically increases each year by two percent of the total number of shares of our Common Stock outstanding on the last trading day in December in the immediately preceding calendar year, provided that no annual increase shall exceed 87,500.

All option grants under the 1999 Employee Stock Option Plan will have an exercise price per share equal to the fair market value per share of our Common Stock on the grant date, subject to certain adjustments for stock splits, recapitalizations and similar transactions. Each option will vest in installments over the optionee’s period of service with us. The options will vest on an accelerated basis in the event we are acquired and those options are not assumed or replaced by the acquiring entity. The options that were granted while we were a limited liability company, however, will terminate in the event we are acquired and those options are not assumed by the acquiring entity (unless their vesting is accelerated by our Compensation Committee). Each option will have a maximum term (not to exceed ten years) set by the plan administrator at the time of grant, subject to earlier termination following the optionee’s cessation of employment. All options are non-statutory options under the Federal tax law, unless they are incentive stock options granted to employees.

1999 Artist Plan

The 1999 Artist Plan became effective on October 6, 1999 in connection with our conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to purchase membership units in the limited liability company which were outstanding at the time of such conversion were assumed by the corporation and converted into options for shares of our Common Stock. The number of shares subject to each assumed and converted option was equal to the number of membership units in the limited liability company which were subject to that option immediately prior to the conversion, and the exercise price per share remained the same as the per unit exercise price in effect under the option at the time of conversion. Except for the conversion of the securities subject to the option into shares of our Common Stock, each option will continue to be governed by the terms of the agreement evidencing that option at the time of our conversion into a corporation.

The 1999 Artist Plan is a non-stockholder approved plan under which options were granted to performing artists who provided products and services through the ARTISTchannel Web sites we operate and maintain for them pursuant to ARTISTchannel agreements. The number of shares of Common Stock issuable over the term of the 1999 Artist Plan was initially 400,000 shares and automatically increases each year by two percent of the total number of shares of our Common Stock outstanding on the last trading day in December in the immediately preceding calendar year, provided that no annual increase shall exceed 87,500.

All option grants under the 1999 Artist Plan have an exercise price per share equal to the fair market value per share of our Common Stock on the grant date. Each option vests in installments over the period the optionee’s ARTISTchannel agreement remains in effect. The options will vest on an accelerated basis in the event ARTISTdirect is acquired and those options are not assumed or replaced by the acquiring entity. Each option has a maximum term (not to exceed ten years) set by the plan administrator (our Compensation Committee) at the time of grant, subject to earlier termination following the termination of the optionee’s ARTISTchannel agreement. All options are non-statutory options under the Federal tax law.

55

1999 Artist and Artist Advisor Plan

The 1999 Artist and Artist Advisor Plan became effective on October 6, 1999 in connection with our conversion from ARTISTdirect, LLC into ARTISTdirect, Inc. All options to purchase membership units in the limited liability company which were outstanding at the time of such conversion were assumed by the corporation and converted into options for shares of our Common Stock. The number of shares subject to each assumed and converted option was equal to the number of membership units in the limited liability company which were subject to that option immediately prior to the conversion, and the exercise price per share remained the same as the per unit exercise price in effect under the option at the time of conversion. Except for the conversion of the securities subject to the option into shares of our Common Stock, each option will continue to be governed by the terms of the agreement evidencing that option at the time of our conversion into a corporation.

The 1999 Artist and Artist Advisor Plan is a non-stockholder approved plan under which options were granted to performing artists and their attorneys, business managers, agents and other advisors who provided services to us. The number of shares of Common Stock issuable over the term of the 1999 Artist and Artist Advisor Stock Option Plan was initially 185,000 shares and increased by 37,500 shares on January 1, 2001 and 2002, respectively to a total of 260,000 as of December 31, 2002 (subject to adjustment for certain changes in our capital structure). The share reserve will automatically increase on the first trading day in January each calendar year by an amount equal to one percent of the total number of shares of our Common Stock outstanding on the last trading day in December in the immediately preceding calendar year, but in no event will any such annual increase exceed 37,500 shares.

All option grants under the 1999 Artist and Artist Advisor Stock Option Plan have an exercise price per share equal to the fair market value per share of our Common Stock on the grant date. Each option vests in installments over the optionee’s period of service with us. The options will vest on an accelerated basis in the event we are acquired and those options are not assumed or replaced by the acquiring entity. Each option has a maximum term (not to exceed ten years) set by the plan administrator at the time of grant, subject to earlier termination following the termination of the optionee’s service for cause. All options are non-statutory options under the Federal tax law.

Share issuances under the 1999 Employee Stock Option Plan, the 1999 Artist Plan and the 1999 Artist and Artist Advisor Plan will not reduce or otherwise affect the number of shares of Common Stock available for issuance under the 1999 Employee Stock Purchase Plan, and share issuances under 1999 Employee Stock Purchase Plan will not reduce or otherwise affect the number of shares of Common Stock available for issuance under the 1999 Employee Stock Option Plan, the 1999 Artist Plan and the 1999 Artist and Artist Advisor Plan.

2004 Consultant Stock Plan

Effective September 29, 2004, the Board adopted the 2004 Consultant Stock Plan in order for us to be able to compensate consultants, at our option, who provide bona fide services to us not in connection with capital raising or promotion of our securities. The 2004 Consultant Stock Plan will expire on September 29, 2014, and provides for the issuance of up to 500,000 shares of Common Stock to consultants at fair market value. The 2004 Consultant Stock Plan is a non-stockholder approved plan.

56

2006 Equity Incentive Plan

The ARTISTdirect, Inc. 2006 Equity Incentive Plan, referred to as the 2006 Equity Plan, became effective on June 19, 2006, the effective date of stockholder approval of such plan. The Board of Directors of ARTISTdirect, Inc., a Delaware corporation (the “Registrant”), had approved the 2006 Equity Plan in April 2006. The Registrant’s stockholders approved the 2006 Equity Plan at the Annual Meeting of Stockholders held June 19, 2006 (the “Annual Meeting”).

A total of 1,500,000 new shares of the Registrant’s common stock have initially been reserved for issuance under the 2006 Equity Plan.

Awards under the 2006 Equity Plan may be granted to any of the Registrant’s employees, directors, officers, consultants or those of the Registrant’s affiliates. Awards may consist of stock options (both incentive stock options and non-statutory stock options), stock awards, stock appreciation rights and cash awards. An incentive stock option may be granted under the 2006 Equity Plan only to a person who, at the time of the grant, is an employee of the Registrant or a parent or subsidiary of the Registrant.

The 2006 Equity Plan will be administered by the Registrant’s Compensation Committee, which the Board of Directors appointed to be the “Administrator” of the plan, with full power to authorize the issuance of shares of the Registrant’s common stock and to grant options or rights to purchase shares of the Registrant’s common stock. The Administrator has the power to determine the terms of the awards, including the exercise price, the number of shares subject to each award, the exercisability of the awards and the form of consideration payable upon exercise. The Compensation Committee may delegate the day-to-day administration of the 2006 Equity Plan to one or more individuals.

The 2006 Equity Plan provides that in the event of a merger of the Registrant with or into another corporation or of a “change in control” of the Registrant, including the sale of all or substantially all of the Registrant’s assets, and certain other events, the Board of Directors or the Compensation Committee may, in its discretion, provide for the assumption or substitution of, or adjustment to, each outstanding award, accelerate the vesting of options and stock appreciation rights, and terminate any restrictions on stock awards or cash awards or provide for the cancellation of awards in exchange for a cash payment to the participant.

The 2006 Equity Plan will terminate on June 19, 2016, unless terminated earlier by the Board of Directors or the Compensation Committee. No awards may be made after the termination date; however, unless otherwise expressly provided in an applicable award agreement, any award granted under the plan prior to the expiration may extend beyond the end of such period through the award’s normal expiration date.

The Board of Directors or the Compensation Committee may generally amend or terminate the 2006 Equity Plan as determined to be advisable. The Internal Revenue Code or the rules of the Securities and Exchange Commission may also require the Registrant’s stockholders to approve certain amendments. The Board of Directors or the Compensation Committee may amend the 2006 Equity Plan without stockholder approval to comply with legal, regulatory and listing requirements and to avoid unanticipated consequences determined to be inconsistent with the purpose of the plan or any award agreement.

A complete copy of the 2006 Equity Plan can be found in the Registrant’s definitive proxy statement on Schedule 14A filed with the Securities and Exchange Commission on May 8, 2006.

Non-Plan; Non-Stockholder Approved Stock Option Grants

Effective May 31, 2001, we issued to Frederick W. (Ted) Field, our then Chairman and former Chief Executive Officer, a non-qualified stock option to purchase 302,370 shares of common stock exercisable at $7.50 per share through May 30, 2008.  The option vested over a period of five years from June 29, 2001, and was fully vested in 2006.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $2,006,000.  The five year vesting period ended in 2006 and no amounts have been charged since 2006.

57

Effective September 29, 2003, we issued to Jonathan V. Diamond, our Chief Executive Officer, a non-plan, non-qualified stock option to purchase 259,659 shares of common stock exercisable through August 15, 2010 at $0.85 per share, which was the approximate fair market value of the common stock on the date of grant.  The option vested over a period of three years from the date of grant, and was fully vested in 2006.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $221, 000, as the three year vesting period ended in 2006, no amount was charged off since 2006.

Effective March 29, 2004, we issued to Robert N. Weingarten, our Chief Financial Officer, a non-plan, non-qualified stock option to purchase 120,000 shares at $0.50 per share, which was not less than the fair market value on the date of grant, exercisable through March 29, 2011.  The option vests and becomes exercisable in a series of thirty-six successive equal monthly installments from March 29, 2004 through March 29, 2007.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $42,000, of which $4,000 was charged to operations in 2007 and no amounts were charged off in 2008.

On July 28, 2005, we issued Jonathan Diamond, our President and Chief Executive Officer, a non-plan, non-qualified stock option to purchase 2,753,098 shares of Common Stock exercisable at $1.55 per share, which was the approximate fair market value of the Common Stock on the date of grant, through August 25, 2010. Approximately 38 percent of such stock options vests at the rate of 1/3rd per year over a three-year period and the remaining approximately 62 percent vests upon the achievement of certain financial milestones by ARTISTdirect. The fair value of the time-vested options, calculated pursuant to the Black-Scholes option-pricing model, was determined to be $2,936,450, of which $570,976 was recorded as stock-based compensation in 2008 and $979,000 was recorded as stock-based compensation cost in 2007.

On July 28, 2005, we issued Robert Weingarten, our Chief Financial Officer, a non-plan, non-qualified stock option to purchase 550,000 shares of Common Stock exercisable at $1.55 per share, which was not less than the fair market value on the date of grant, through August 25, 2010. One half of such stock option vests at the rate of 1/3 per year over a three year period and one half will vest upon the achievement of certain financial milestones by ARTISTdirect.  The fair value of the time-vested options, calculated pursuant to the Black-Scholes option-pricing model, was determined to be $772,750, of which $386,000 (due to acceleration) was recorded as stock-based compensation cost in 2007.

The above-referenced stock option grants were issued without registration in reliance upon the exemption afforded by Section 4(2) of the Securities Act of 1933, as amended, based on certain representations made to us by the recipients.

ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Certain Relationships and Related Transactions

Transactions Related to MediaDefender Acquisition

In conjunction with the acquisition of MediaDefender, the Company issued 1,109,032 shares of common stock and a seven-year warrant to purchase 114,985 shares of common stock with an exercise price of $1.55 per share to WNT07 Holdings, LLC.  The managers of WNT07 Holdings, LLC are Eric Pulier and Teymour Boutros-Ghali, both of whom were members of the Company’s Board of Directors.  The shares and warrants were issued as consideration for services provided by Mr. Pulier and Mr. Boutros-Ghali as consultants to the Company in connection with the acquisition of MediaDefender.  On August 12, 2008, Eric Pulier and Teymour Boutros-Ghali resigned as directors of the Company.

The Company also acknowledged the terms of Non-Competition Agreements entered into on July 28, 2005 by MediaDefender and Mr. Saaf and Mr. Herrera.  The Non-Competition Agreements prohibit Mr. Saaf and Mr. Herrera from (i) engaging in certain competitive business activities, (ii) soliciting customers of MediaDefender or the Company, (iii) soliciting existing employees of MediaDefender or the Company and (iv) disclosing any confidential information regarding MediaDefender or the Company.  Each agreement has a term of four years and shall continue to remain in force and effect in the event the above-referenced Employment Agreements are terminated prior to the end of the four-year term of the Non-Competition Agreements.  In consideration, Mr. Saaf and Mr. Herrera were each entitled to a cash payment of $525,000 from MediaDefender on December 31, 2006, which payments were timely made.

58

Randy Saaf and Octavio Herrera, formerly principals and stockholders of MediaDefender and both executive officers of the Company’s wholly-owned subsidiary, MediaDefender until February 15,2009, each invested $2,250,000 in the Sub-Debt Financing on the same terms and conditions as the other Sub-Debt Financing investors.

Eric Pulier

Effective as of January 1, 2006, the Company entered into a one-year consulting agreement with Eric Pulier, a director of the Company, through WNT Consulting Group, a California limited liability company wholly-owned by Mr. Pulier (“WNT”).  The consulting agreement was approved by the disinterested members of the Company’s Board of Directors.  Effective January 12, 2007, the parties mutually agreed to terminate this consulting agreement, which had automatically renewed for a second one-year term through December 31, 2007.  Under the terms of the original consulting agreement, Mr. Pulier received a base fee of $10,000 per month, certain other mandatory payments, and was also eligible to receive cash bonuses on the achievement of certain specified milestones.  The termination agreement provided for a one-time cash payment to Mr. Pulier (through WNT) in the amount of $100,000, in consideration for the termination of the consulting agreement and an acknowledgement and complete release of any and all claims related to unpaid compensation, bonus amounts or other out-of-pocket expenses that may have been owed by the Company as of January 12, 2007.  Mr. Pulier continued to serve as a member of the Company’s Board of Directors until his resignation on August 12, 2008.  The termination agreement was approved by the Compensation Committee of the Company’s Board of Directors.

Fred Davis

During the years ended December 31, 2008 and 2007, the Company incurred legal fees of approximately $22,000 and $16,000, respectively, to Davis Shapiro Lewit & Hayes, LLP, a law firm in which Fred Davis, a director of the Company, is a partner.

Director Independence

Our board of directors is comprised of a majority of independent directors as defined by NASDAQ Rules.

Independent Directors.  As of December 31, 2008 the independent directors of the Board were Frederick W. Field and Fred Davis (members of Compensation and Nominating Committees).  Each of these directors qualifies as an independent director in accordance with the published listing requirements of the Nasdaq Stock Market. In addition, our board of directors has made a subjective determination as to each independent director that no relationships exist which, in the opinion of our board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. In making these determinations, our directors reviewed and discussed information provided by the directors and us with regard to each director’s business and personal activities as they may relate to us and our management.

59

ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICES

Aggregate fees billed by our current independent registered public accounting firms, for the years ended December 31, 2008 and 2007, respectively, are as follows:

	2008		2007
Audit fees	$	309,500	$	185,460
Audit-related and restatement related fees	$		$	298,575
Tax Fees	$	103,850	$	103,970

Audit Fees; Audit-Related Fees

Audit and audit-related fees consist of fees for the audit of our financial statements, the review of our interim financial statements and other audit services, including the review of and, as applicable, consent to documents filed by us with the Securities and Exchange Commission.

Tax Fees

Tax fees consist of fees for tax compliance, including the preparation of tax returns, tax advice, and tax planning services. Tax advice and tax planning services relate to advice regarding mergers and acquisitions and assistance with tax audits and appeals.

During 2007 and 2008 Polices on Accounting Matters; Pre-Approval of Audit and Non-Audit Services of Independent Registered Public Accounting Firm

The primary purpose of the Audit Committee during 2007 and 2008 was to assist the Board in monitoring (i) the integrity of our financial statements and disclosures, including oversight of the accounting and financial reporting processes and the audits of our financial statements (ii) the compliance by us with our legal, ethical and regulatory requirements and (iii) the independence and performance of our independent registered public accounting firm.

The Audit Committee’s policy is to pre-approve all audit and non-audit services, other than de minimis non-audit services, provided by the independent registered public accounting firm. These services may include, among others, audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to particular service or category of services and is generally subject to a specific budget. The independent registered public accounting firm and management are required to periodically report to the full Board regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date.

ITEM 15.EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

The information required by this Item is set forth in the section of this Annual Report on Form 10-K entitled “EXHIBIT INDEX” and is incorporated herein by reference.

60

The Audit Committee has considered the provision of non-audit services provided by our independent registered public accounting firm to be compatible with maintaining their independence.  As a result of Mr. James Lane’s resignation from the Audit Committee on March 24, 2008, the Company has suspended the activities of the Audit Committee and the full board has assumed the Audit Committee’s responsibilities.

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		ARTISTdirect, Inc.
Date:	April 14, 2009	By:	/s/ Dimitri Villard
			Dimitri Villard
			Chief Executive Officer (Principal Executive Officer)
Date:	April 14, 2009	By:	/s/ Rene’ Rousselet
			Rene’ Rousselet
			Corporate Controller (Principal Accounting Officer)

61

In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant in the capacity and on the dates indicated.

Signature	Title	Date
/s/ Dimitri Villard		April 15, 2009
Dimitri Villard	Chairman of the Board and Chief Executive Officer
	(Principal Executive Officer)
/s/ Rene Rousselet
Rene Rousselet	Corporate Controller (Principal Accounting Officer)	April 15, 2009
/s/ Fred Davis
Fred Davis	Director	April 15, 2009
/s/ Frederick W. Field
Frederick W. Field	Director	April 15, 2009

62

ARTISTDIRECT, INC. AND SUBSIDIARIES

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2008 AND 2007

Table of Contents
Report of Independent Registered Public Accounting Firm:.	64
Consolidated Financial Statements:
Balance Sheets — December 31, 2008 and 2007	65
Statements of Operations — Years Ended December 31, 2008 and 2007	67
Statements of Changes in Stockholders’ Deficiency — Years Ended December 31, 2008 and 2007	68
Statements of Cash Flows — Years Ended December 31, 2008 and 2007	69
Notes to Consolidated Financial Statements — Years Ended December 31, 2008 and 2007	70

63

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders

ARTISTdirect, Inc.

We have audited the accompanying consolidated balance sheets of ARTISTdirect, Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity (deficiency) and cash flows for each of the years then ended.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ARTISTdirect, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years then ended in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern.  As more fully described in Note 1, the Company has experienced declining revenues, negative working capital, a net loss, and uncertainty relating to its ability to improve its operating results under current economic conditions.  These conditions raise substantial doubt regarding 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.

/s/ Gumbiner Savett Inc.

GUMBINER SAVETT INC.

April 14, 2009

Santa Monica, California

64

ARTISTdirect, Inc. and Subsidiaries

Consolidated Balance Sheets

(amounts in thousands, except for share data)

	December 31,
	2008			2007
Assets
Current assets:
Cash and cash equivalents	$	1,994		$	4,268
Restricted cash	268			280
Accounts receivable, net of allowance for doubtful accounts of $229 and $418 at December 31, 2008 and 2007, respectively	2,542			8,168
Income taxes refundable	622			1,147
Prepaid expenses and other current assets	315			351
Total current assets	5,741			14,214
Property and equipment	4,721			4,452
Less accumulated depreciation and amortization	(3,519		)	(2,614		)
Property and equipment, net	1,202			1,838
Other assets:
Intangible assets:
Customer relationships, net	—			440
Proprietary technology, net	—			1,478
Non-competition agreements, net	153			416
Goodwill	—			31,085
Total intangible assets, net	153			33,419
Deferred financing costs, net	393			1,243
Deposits	—			20
Total other assets	546			34,682
	$	7,489		$	50,734

(continued)

65

ARTISTdirect, Inc. and Subsidiaries

Consolidated Balance Sheets (continued)

(amounts in thousands, except for share data)

	December 31,
	2008			2007
Liabilities and stockholders’ equity (deficiency)
Current liabilities:
Accounts payable	$	487		$	1,539
Accrued expenses	434			1,885
Accrued interest payable	6,918			3,352
Deferred revenue	379			230
Income taxes payable	803			200
Liquidated damages payable under registration rights agreements, net of payments	1,972			2,382
Warrant liability	35			164
Derivative liability	11			313
Senior secured notes payable, net of discount of $177 and $651 at December 31, 2008 and 2007, respectively (in default)	12,817			12,656
Subordinated convertible notes payable, net of discount of $1,261 and $3,892 at December 31, 2008 and 2007, respectively (in default)	26,397			23,766
Total current liabilities	50,253			46,487
Long-term liabilities:
Deferred rent	159			186
Financing agreements	—			19
Total long-term liabilities	159			205
Commitments and contingencies
Stockholders’ equity (deficiency):
Common stock, $0.01 par value - Authorized - 60,000,000 shares
Issued and outstanding - 10,344,666 shares and 10,338,896 shares at December 31, 2008 and 2007, respectively	103			103
Additional paid-in-capital	236,398			235,407
Accumulated deficit	(279,424		)	(231,468		)
Total stockholders’ equity (deficiency)	(42,923		)	4,042
	$	7,489		$	50,734

See accompanying notes to consolidated financial statements.

66

ARTISTdirect, Inc. and Subsidiaries

Consolidated Statements of Operations

(amounts in thousands, except for share data)

	Years Ended December 31,
	2008			2007
Net revenue:
E-commerce	$	336		$	1,497
Media	3,995			7,500
Anti-piracy and file-sharing marketing services	7,810			15,174
Total net revenue	12,141			24,171
Cost of revenue:
E-commerce	320			1,531
Media	2,606			3,688
Anti-piracy and file-sharing marketing services	7,429			9,414
Total cost of revenue	10,355			14,633
Gross profit	1,786			9,538
Operating expenses:
Sales and marketing	1,535			1,993
General and administrative, including stock-based compensation costs of $991 and $2,110 in 2008 and 2007, respectively	7,022			10,867
Development and engineering	437			525
Goodwill impairment	31,085
Write-off of fixed assets	—			97
Total operating costs	40,079			13,482
Loss from operations	(38,293		)	(3,944		)
Other income (expense):
Interest income	51			211
Interest expense	(8,740		)	(7,923		)
Loss on foreign currency transactions	(65		)	(14		)
Other income	340			—
Liquidated damages under registration rights agreements	—			395
Change in fair value of warrant liability	130			4,551
Change in fair value of derivative liability	302			18,043
Amortization of deferred financing costs	(842		)	(841		)
Write-off of unamortized discount on debt and deferred financing costs resulting from principal payments on senior secured notes payable	(25		)	—
Income (loss) before income taxes	(47,142		)	10,478
Provision (benefit) for income tax	814			(1,039		)
Net income (loss)	$	(47,956	)	$	11,517
Net income (loss) per common share:
Basic	$	(4.64	)	$	0.41
Diluted	$	(4.64	)	$	(0.23	)
Weighted average common shares outstanding:
Basic	10,344,666			28,100,179
Diluted	10,344,666			29,669,682

See accompanying notes to consolidated financial statements.

67

ARTISTdirect, Inc. and Subsidiaries

Consolidated Statement of Stockholders’ Equity (Deficiency)

(amounts in thousands, except for share data)

	Common Stock			Additional Paid-In		Accumulated			Total Stockholders’
	Shares	Amount		Capital		Deficit			Equity (Deficiency)
Balance at January 1, 2007	10,188,445	$	102	$	233,197	$	(242,985	)	$	(9,686	)
Fair value of stock options	—	—		2,035		—			2,035
Common stock issued for consulting services	23,076	—		75		—			75
Common stock issued upon exercise of stock options	127,375	1		100		—			101
Net income	—	—		—		11,517			11,517
Balance at December 31, 2007	10,338,896		103		235,407		(231,468	)		4,042
Fair value of stock options	—	—		972		—			972
Common stock issued for consulting services	5,770	—		19		—			19
Net loss	—	—		—		(47,956		)	(47,956		)
Balance at December 31, 2008	10,344,666	$	103	$	236,398	$	(279,424	)	$	(42,923	)

See accompanying notes to consolidated financial statements.

68

ARTISTdirect, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(amounts in thousands)

	Years Ended December 31,
	2008			2007
Cash flows from operating activities:
Net income (loss)	$	(47,956	)	$	11,517
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization	7,016			8,539
Other Income
Write-off of accruals	(340		)	—
Write-off of unamortized discount on debt and deferred financing costs resulting from principal payments on senior secured notes	25			—
Provision for doubtful accounts	(153		)	203
Stock-based compensation	991			2,110
Goodwill impairment	31,085			—
Deferred income taxes	—			(264		)
Change in fair value of warrant liability	(130		)	(4,551		)
Change in fair value of derivative liability	(302		)	(18,043		)
Changes in liquidated damages payable under registration rights agreements	—			(395		)
Write-off of fixed assets	—			97
Sub-total	(9,764		)	(787		)
Changes in operating assets and liabilities:
(Increase) decrease in -
Accounts receivable	5,779			(1,443		)
Finished goods inventory	—			281
Prepaid expenses and other current assets	35			(1,147		)
Income taxes refundable	525			(147		)
Deposits and other assets	20			1
Increase (decrease) in -
Accounts payable	(1,052		)	(293		)
Accrued expenses	(1,110		)	363
Accrued interest payable	3,566			3,285
Deferred revenue	149			191
Deferred rent	(27		)	(13		)
Financing agreements	(19		)	(34		)
Income taxes payable	604			(295		)
Liquidated damages payable under registration rights agreements	(410		)	(1,000		)
Net cash used in operating activities	(1,704		)	(1,038		)
Cash flows from investing activities:
Purchases of property and equipment	(269		)	(481		)
Net cash used in investing activities	(269		)	(481		)
Cash flows from financing activities:
Proceeds from exercise of stock options	—			101
Principal payments on senior secured notes payable	(313		)	—
Decrease in restricted cash	12			84
Net cash provided by used in financing activities	(301		)	185
Cash and cash equivalents:
Net decrease	(2,274		)	(1,334		)
Balance at beginning of year	4,268			5,602
Balance at end of year	$	1,994		$	4,268
Supplemental disclosure of cash flow information:
Cash paid for -
Interest	$	1,995		$	1,527
Income taxes	$	5		$	678

See accompanying notes to consolidated financial statements.

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ARTISTDIRECT, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2008 AND 2007

1.  BASIS OF PRESENTATION

Organization and Business Activities

ARTISTdirect, Inc., a Delaware corporation, is a digital media entertainment company that is home to an online music network and, through its MediaDefender subsidiary, is a leading provider of anti-piracy solutions in the Internet-piracy-protection (“IPP”) industry.  The ARTISTdirect Network (www.artistdirect.com) is a network of websites appealing to music fans, artists and marketing partners that offers multi-media content, music news and information, communities organized around shared music interests, music-related specialty commerce and digital music services.  The Company is headquartered in Santa Monica, California.  Unless the context indicates otherwise, ARTISTdirect, Inc. and its subsidiaries are referred to herein as the “Company”.

Principles of Consolidation

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

Going Concern (See “Note 18 Subsequent Events”)

As a result of communications with the Staff of the Securities and Exchange Commission in 2006, in particular regarding the application of accounting rules and interpretations related to embedded derivatives associated with the Company’s subordinated convertible notes payable issued in July 2005, the Company determined that it was necessary to restate previously issued financial statements. As a result, in December 2006, the Company was required to suspend the use of its then effective registration statement for the holders of its senior and subordinated indebtedness.  In addition to this initial default, the Company has since experienced other events of default which continued to be in effect as of December 31, 2008.

As a result of the registration failure, the failure to pay the registration delay penalties and the various financial covenants and other breaches of the terms of the Senior Financing and the Sub-Debt Financing, multiple events of default exist under the Senior Financing and the Sub-Debt Financing.  The terms of the Subordination Agreement among the Company and the creditor parties thereto (the “Subordination Agreement”) prevent the Company from making any cash payments to the Sub-Debt Note holders until the events of default under the Senior Financing are either cured or waived.  Furthermore, upon the occurrence of an event of default, holders of at least 25% of the outstanding senior indebtedness may declare the outstanding principal and accrued interest on all senior notes immediately due and payable upon written notice to the Company, and each holder of outstanding subordinated indebtedness may only demand redemption of all or any portion of their respective notes under certain circumstances as described in the Subordination Agreement. The Company did not have the capital resources necessary to cure the existing events of default, or to repay any accelerated indebtedness or redemption or penalty amounts.

As of December 31, 2008, approximately $12,994,000 principal amount was outstanding with respect to the Senior Financing, and approximately $27,658,000 principal amount was outstanding with respect to the Sub-Debt Financing.  In addition, at December 31, 2008, approximately $2,415,000 was outstanding with respect to accrued registration delay liability to the holders of the Sub-Debt Financing and approximately $6,475,000 was outstanding with respect to accrued interest payable to the holders of the Senior Financing and the Sub-Debt Financing.  The Senior Notes and the Subordinated Notes would have been due in June and July 2009, respectively.

As more fully described in Note 18, the Senior Financing and Sub-Debt Financing have been restructured.  In accordance with the restructuring, the Company paid $3,500,000 to the Senior Note Holders, issued new subordinated notes in the aggregate principal amount of $1,000,000 to the Senior Note Holders, issued 9,000,000 restricted shares of the Company's common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months, and converted the Sub-Debt to common stock.  In order to obtain the necessary funds to accomplish the restructuring, and to fund future operations, the Company obtained financing by factoring its accounts receivable.

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As a result of the successful debt restructuring, the Company anticipates that it will have sufficient access to working capital from operations and the factoring of accounts receivable.  However, because of the Companys’ declining revenues, negative working capital, net loss, and uncertainties related to improving its operating results under current economic conditions, our independent auditors, in their report on the Companys’ financial statements for the year ended December 31, 2008 expressed substantial doubt about the Companys’ ability to continue as a going concern.  The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate continuation of the Company as a going concern.  The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

2.  SIGNIFICANT ACCOUNTING POLICIES

Cash Equivalents

Cash equivalents consist of investments, which are readily convertible into cash and have maturities of three months or less at the time of purchase.

Restricted Cash

As of December 31, 2008 and 2007, restricted cash consisted of a bank certificate of deposit with balances of $178,000 and $190,000, respectively, securing a bank letter of credit provided as security for charge-backs to the Company’s e-commerce credit card processor.  In addition, at December 31, 2008 and 2007, the Company had classified $90,000 as restricted cash as such cash was pledged to secure an irrevocable bank stand-by letter of credit for the same amount issued in conjunction with the Company’s office lease which commenced in February 2006 (see Note 16).

Accounts Receivable

The Company grants credit to its customers generally in the form of short-term trade accounts receivable.  Accounts receivable are stated at the amount that management expects to collect from outstanding balances.  When appropriate, management provides for probable uncollectible amounts through a provision for doubtful accounts and an adjustment to a valuation allowance.  Management primarily determines the allowance based on the aging of accounts receivable balances, historical write-off experience, customer concentrations, customer creditworthiness and current industry and economic trends.  Balances that are still outstanding after management has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable. (See Note 18)

Property and Equipment

Expenditures for major renewal and betterments that extend the useful lives of property and equipment are capitalized.  Expenditures for maintenance and repairs are charged to expense as incurred.  When property and equipment is sold or otherwise disposed of, the assets and related accumulated depreciation accounts are relieved, and any gain or loss is included in operations.

Depreciation is computed on the straight-line method based on the estimated useful lives of the assets, which is generally three years for computer equipment and software and seven years for furniture and fixtures.  Leasehold improvements are amortized over the remaining life of the related lease, which has been determined to be shorter than the life of the asset.

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Goodwill, Intangible Assets and Long-Lived Assets

Statement of Financial Accounting Standards No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”), requires purchased intangible assets other than goodwill to be amortized over their useful lives unless these lives are determined to be indefinite.  Accordingly, with respect to the MediaDefender transaction, non-compete agreements are being amortized over the life of the respective non-compete agreements, ranging from 20 months to 4 years, and customer relationships and proprietary technology are being amortized over 3 years.  Asset allocations and amortization periods with respect to the MediaDefender transaction were determined with the assistance of an independent valuation firm.

SFAS No. 142 also requires goodwill to be tested for impairment at least on an annual basis and more often under certain circumstances, and written down when impaired.  An interim impairment test is required if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below the carrying value.  The Company accounts for the impairment of long-lived assets, such as property and equipment and intangible assets, under the provisions of Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment of Long-Lived Assets” (“SFAS No. 144”).  SFAS No. 144 establishes the accounting for impairment of long-lived tangible and intangible assets other than goodwill and for the disposal of a business.  Pursuant to SFAS No. 144, the Company periodically evaluates, at least annually, whether facts or circumstances indicate that the carrying value of its depreciable assets to be held and used may not be recoverable.  If such circumstances are determined to exist, an estimate of undiscounted future cash flows produced by the long-lived asset, or the appropriate grouping of assets, is compared to the carrying value to determine whether impairment exists.  In the event that the carrying amount of long-lived assets exceeds the undiscounted future cash flows, then the carrying amount of such assets is adjusted to their fair value.  The Company reports an impairment cost as a charge to operations at the time it is recognized.

Goodwill at December 31, 2008 was $0 as compared to $31,085,000 at December 31, 2007, which was recorded in conjunction with the acquisition of MediaDefender in July 2005 (see Note 3).  In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, an intangible asset that is not subject to amortization such as goodwill shall be tested for impairment at least on an annual basis, and more often under certain circumstances, and written down when impaired.  An interim impairment test is required if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below its carrying value.  The first step of the impairment test consists of a comparison of the total fair value of each reporting unit to the reporting unit’s net assets on the date of the test.  If the fair value is in excess of the net assets, there is no indication of impairment and thus no need to perform the second step of the impairment test.

During the year ended December 31, 2008, the Company recorded a non-cash charge to operations aggregating $31,085,000 with respect to the impairment of the goodwill recognized in conjunction with the acquisition of MediaDefender in July 2005.  This charge to operations was based on various factors and developments occurring in 2008, including continuing erosion in the demand for MediaDefender’s core Internet anti-piracy services within the entertainment industry, the unexpected non-renewal by MediaDefender’s largest customer in mid-2008, continuing deterioration of operating margins and valuation metrics, and the inability to implement new advertising initiatives on a large-scale basis.

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Derivative Financial Instruments

Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), requires all derivatives to be recorded on the balance sheet at fair value.  When multiple derivatives (both assets and liabilities) exist within a financial instrument, they are bundled together as a single hybrid compound instrument in accordance with SFAS No. 133 Implementation Issue No. B15, “Embedded Derivatives:  Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”.  The calculation of the fair value of derivatives utilizes highly subjective and theoretical assumptions that can materially affect fair values from period to period.  The change in the fair value of the derivatives from period to period is recorded in other income (expense) in the statement of operations.  As a result, the Company’s financial statements are impacted quarterly based on factors such as the price of the Company’s common stock and the principal amount of Sub-Debt Notes converted into common stock.  Consequently, the Company’s results of operations and financial position may vary from quarter to quarter based on factors other than those directly associated with the Company’s operating revenues and expenses.  The recognition of these derivative amounts does not have any impact on cash flows.

EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock (“EITF 00-19”), requires freestanding contracts that are settled in a company’s own stock, including common stock warrants, to be designated as an equity instrument, an asset or a liability.  When the ability to physically or net-share settle a conversion option or the exercise of freestanding options or warrants is deemed to be not within the control of the Company, the embedded conversion option or freestanding options or warrants may be required to be accounted for as a derivative liability.  Under the provisions of EITF 00-19, a contract designated as an asset or a liability must be carried at fair value on a company’s balance sheet, with any changes in fair value recorded in a company’s results of operations.

The Company has accounted for registration rights penalties in accordance with EITF 00-19-2, “Accounting for Registration Payment Arrangements”, which the Company adopted as of December 31, 2006, and Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”.  Since the registration rights component of the derivative liabilities was not material through September 30, 2006, there was no cumulative-effect adjustment recorded as a result of the transition rules with respect to the adoption of EITF-00-19-2 at December 31, 2006.

The Company accounts for derivatives, including the embedded derivatives associated with the Sub-Debt Notes and the warrants issued in conjunction with the Senior Financing and the Sub-Debt Financing, at fair value, adjusted at the end of each reporting period to reflect any material changes, with any such changes included in other income (expense) in the statement of operations.

At the date of the conversion of Sub-Debt Notes into common stock or the principal repayment of Senior Notes, the pro rata portion of the related unamortized discount on debt and deferred financing costs is charged to operations and included in other income (expense).  At the date of exercise of any of the warrants, or the conversion of Sub-Debt Notes into common stock, the pro rata portion of the fair value of the related warrant liability and/or embedded derivative liability is transferred to additional paid-in capital.

Deferred Financing Costs

Deferred financing costs consist of cash and non-cash consideration paid to third parties with respect to the acquisition and financing of the MediaDefender transaction, including legal fees and placement agent fees.  Such costs are being deferred and amortized over the term of the related debt.  Upon the conversion of subordinated convertible notes payable into common stock and the partial repayment of the senior secured notes payable, the pro rata portion of any related unamortized deferred financing costs are charged to operations.

Discount on Debt

Additional consideration in the form of warrants and other derivative financial instruments issued to lenders was accounted for at fair value based on reports prepared by independent valuation firms.  The fair value of warrants and derivatives was recorded as a reduction to the carrying amount of the related debt, and is being amortized to interest expense over the term of such debt, with the initial offsetting entries recorded as warrant liability and derivative liability on the balance sheet.  Upon the conversion of subordinated convertible notes payable into common stock, the pro rata portion of any related unamortized discount on debt is charged to operations.

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Revenue Recognition

The Company complies with the provisions of Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition in Financial Statements”, as amended by SAB No. 104, and recognizes revenue when all four of the following criteria are met:  (i) persuasive evidence that an arrangement exists; (ii) delivery of the products and/or services has occurred; (iii) the selling price is both fixed and determinable; and (iv) collectability is reasonably assured.

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 has a contract with a fulfillment house to service its music-related e-commerce activity. 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.  In certain circumstances, e-commerce revenue is subject to royalties, and such expense is recorded as part of cost of e-commerce revenue.

The Company records amounts charged to customers for shipping and handling in accordance with EITF 00-10, “Accounting for Shipping and Handling Fees and Costs” (“EITF 00-10”).  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 statement of operations.  For the years ended December 31, 2008 and 2007, the Company recorded $63,000 and $236,000, respectively, as revenue for shipping and handling fees charged to customers. For the years ended December 31, 2007 and 2006, the Company recorded $48,000 and $253,000, respectively, of shipping and handling costs as direct cost of product sales in the statements of operations.

Media revenue consists primarily of the sale of advertisements and sponsorships under short-term contracts.  To date, the duration of the Company’s advertising commitments has generally averaged from one to three months, although certain programs can last up to one year.  The Company’s online obligations typically include the guarantee of a minimum number of times (“impressions”) 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.  To the extent that minimum guaranteed page deliveries are not met, recognition of the corresponding revenue is deferred until the guaranteed impressions are delivered.

The Company recognizes revenue for sponsorship arrangements over the period during which the advertising is provided, generally on a straight-line basis.  The Company recognizes revenue for a banner impression deliverable as the banner impressions are delivered.  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.

Anti-piracy and file sharing marketing services revenue is recognized on a monthly basis as services are provided to customers.  Deferred revenue is recorded for customers who prepay the full, or any portion, of their respective contracts.

Cost of Revenue

Cost of product sales consists of amounts payable related to e-commerce sales, which includes the cost of merchandise sold and royalties, and online commerce transaction costs, including credit card fees, fulfillment charges and shipping costs.  Distribution expenses consist of various distribution costs, including the cost of processing returns and warehousing inventory.  The Company has a contract with a fulfillment house to service its music-related e-commerce activity.

Media cost of revenue consists primarily of web-site hosting and maintenance costs, online content programming costs, online advertising serving costs, sales commissions, payments to affiliated websites, and payroll and related expenses for staff involved with the web-site.  Costs related to the web-site are charged to operations as incurred.  Anti-piracy and file sharing marketing services cost of revenue consists primarily of bandwidth, labor and occupancy costs.  Amortization of proprietary technology is included in anti-piracy and file sharing marketing services cost of revenue.

Depreciation expense is included in the related cost of revenue category.

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Inventories

As a result of the Company restructuring its relationship with a merchandising entity effective August 31, 2007 to eliminate merchandise sales (and the related inventory) and focus on music sales, the Company does not currently carry any inventory.

Income Taxes

The Company accounts for income taxes under Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes” (“SFAS No. 109”).  SFAS No. 109 requires recognition of deferred tax assets and liabilities for the expected future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the statement of operations in the period that includes the enactment date.  A valuation allowance is established, when necessary, to reduce deferred tax assets to the amount expected to be realized.

Development and Engineering Costs

Development and engineering costs consist primarily of third-party development costs and payroll and related expenses for in-house development costs incurred in the design and production of the Company’s content and services, including revisions to the Company’s web-site.  These costs are charged to operations as incurred.

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Concentration of Risk

Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash, short-term investments and trade accounts receivable.  The Company places its cash and short-term investments in high credit quality instruments.  Cash balances at certain financial institutions may exceed the FDIC insurance limits.  The Company performs ongoing credit evaluations of its customers but does not require collateral.  Exposure to losses on receivables is principally dependent on each customer’s financial condition.  The Company monitors its exposure to credit losses and maintains appropriate allowances for anticipated losses.

Concentrations of credit risk with respect to trade receivables generated by the Company’s operations are generally limited.  However, MediaDefender’s customers consist primarily of large reputable companies in the music and entertainment industries.

During the year ended December 31, 2008, one customer accounted for accounted for $589,000 or 14.7% of media revenues.  During the year ended December 31, 2007, one customer accounted for $1,270,000 or 16% of total media revenue, of which $423,000 was due from this customer at December 31, 2007.

The Company’s media revenues were generated primarily by two outside sales organizations that represented the Company with respect to advertising and sponsorship sales on the Company’s web-site and through affiliated websites, as well as by in-house sales personnel.

During the year ended December 31, 2008, approximately 65% of MediaDefender’s revenues were from three customers, with one customer accounting for 32%, another customer accounting for 21% and a third customer accounting for 12%.  At December 31, 2008, the amounts due from such customers were $395,774, $214,275 and $162,737, respectively, which were included in accounts receivable.  In January 2008, MediaDefender was notified by a customer accounting for 12% of 2007 revenue, that they were discontinuing service and were evaluating the use of other methods to offset the negative impact of piracy.  In June 2008, the Company was advised by one of MediaDefender’s larger customers, which represented approximately 18% of MediaDefender’s revenues for the year ended December 31, 2007, that it intended to substantially curtail its use of MediaDefender’s anti-piracy services subsequent to the expiration of its current contract with MediaDefender on June 30, 2008.

During the year ended December 31, 2007, approximately 38% of MediaDefender’s revenues were from two customers, with one customer accounting for 21% and another customer accounting for 17%.  At December 31, 2007, the amounts due from such customers were $1,872,000 and $677,000, respectively, which were included in accounts receivable.  In November 2007, a record label customer, which accounted for 4% of MediaDefenders’ 2007 revenue, also discontinued service citing costs pressures subsequent to a change in ownership.

During the year ended December 31, 2008, MediaDefender purchased approximately 94% of its bandwidth from four suppliers.  At December 31, 2008, amounts payable to of these suppliers aggregated $161,000.  During the year ended December 31, 2007, MediaDefender purchased approximately 55% of its bandwidth from three suppliers.  At December 31, 2007, amounts payable to two of these suppliers aggregated $124,000.  Although there are other suppliers of bandwidth, a change in suppliers could cause delays, which could adversely affect operations in the short-term

Foreign Currency Transactions

The Company’s reporting currency and functional currency is the United States dollar.  The Company periodically receives payments for services in Canadian dollars and British pounds, which are translated into United States dollars using the exchange rate in effect at the date of payment.  Gains or losses resulting from foreign currency transactions, to the extent material, are included in other income (expense) in the statement of operations.

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Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and liquidated damages payable under registration rights agreements approximate their respective fair values because of the short maturity of these instruments.  The carrying amounts of senior secured notes payable and subordinated convertible notes payable approximate their respective fair values because of their current interest rates payable and other features of such debt in relation to current market conditions.  The carrying value of warrant liability and derivative liability approximate their respective fair values since they are adjusted to fair value at each period end.

Earnings Per Share

The Company calculates earnings per share in accordance with Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (“SFAS No. 128”), and EITF 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128”.  EITF 03-6 clarifies the use of the “two-class” method of calculating earnings per share as originally prescribed in SFAS No. 128 and provides guidance on how to determine whether a security should be considered a “participating security”.

The Company has determined that its convertible subordinated notes payable are a participating security, as each note holder is entitled to receive any dividends paid and distributions made to the common stockholders as if the note had been converted into common stock on the record date.

Under the two-class method, basic income (loss) per common share is computed by dividing net income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding for the reporting period.  Diluted income (loss) per common share is computed using the more dilutive of the “two-class” method or the “if-converted” method.  Net losses are not allocable to the holders of the subordinated convertible notes payable.  Diluted income (loss) per share gives effect to all potentially dilutive securities, including stock options, senior and sub-debt warrants, and convertible subordinated notes payable, unless they are anti-dilutive.

The calculation of diluted weighted average common shares outstanding for the years ended December 31, 2008 and 2007 is based on the average of the closing price of the Company’s common stock during each respective period.

The calculation of diluted loss per share for the year ended December 31, 2008 excluded the effect from the conversion of subordinated convertible notes payable and the exercise of stock options and senior and sub-debt warrants aggregating approximately 25,785,830 shares of common stock, respectively, since their effect would have been anti-dilutive.

The calculation of diluted income per share for the year ended December 31, 2007 included the impact from dilutive stock options and senior and sub-debt warrants, but excluded the effect from the conversion of subordinated convertible notes payable, as well as stock options and warrants representing 1,217,940 shares and 433,333 shares, respectively, since their effect would have been anti-dilutive.

Issued but unvested shares of common stock are excluded from the calculation of basic earnings per share, but are included in the calculation of diluted earnings per share, to the extent that they are not anti-dilutive.

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The calculation of earnings per share is summarized as follows:

	Years Ended December 31,
	2008			2007
Numerator:
Net income (loss), as reported	$	(47,956,000	)	$	11,517,000
Allocation of net (loss) income:
Basic:
Net income (loss) applicable to common stockholders	$	(47,956,000	)	$	4,204,000
Net income (loss) applicable to convertible subordinated notes	—			7,313,000
Net income (loss)	$	(47,956,000	)	$	11,517,000
Diluted:
Net income (loss) applicable to common stockholders	$	(47,956,000	)	$	(2,710,000	)
Net income (loss) applicable to convertible subordinated notes	—			(4,090,000		)
Net income (loss)	$	(47,956,000	)	$	(6,800,000	)
Denominator:
Weighted average common shares outstanding	10,344,666			10,256,127
Weighted average common shares attributable to subordinated notes	—			17,844,052
Weighted average common shares used in calculating basic net income (loss) per common share	10,344,666			28,100,179
Weighted average common shares issuable upon exercise of outstanding stock options based on the treasury stock method	—			964,767
Weighted average common shares issuable upon exercise of sub- debt warrants, based on the treasury stock method	—			604,735
Weighted average common shares used in computing diluted net income (loss) per common share	10,344,666			29,669,682
Calculation of net income (loss) per common share:
Basic:
Net income (loss) applicable to common stockholders	$	(47,956,000	)	$	11,517,000
Weighted average common shares used in calculating basic net income (loss) per common share	10,344,666			28,100,179
Net income (loss) per share applicable to common stockholders	$	(4.64	)	$	0.41
Diluted:
Net income (loss) applicable to common stockholders	$	(47,956,000	)	$	(6,800,000	)
Weighted average common shares used in calculating diluted net income (loss) per common share	10,344,666			29,669,682
Net income (loss) per common share applicable to common stockholders	$	(4.64	)	$	(0.23	)

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Stock-Based Compensation

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), a revision to SFAS No. 123, “Accounting for Stock-Based Compensation”.  SFAS No. 123R requires that the Company measure the cost of employee services received in exchange for equity awards based on the grant date fair value of the awards, with the cost to be recognized as compensation expense in the Company’s financial statements over the vesting period of the awards.  Accordingly, the Company recognizes compensation cost for equity-based compensation for all new or modified grants issued after December 31, 2005.  In addition, commencing January 1, 2006, the Company recognized the unvested portion of the grant date fair value of awards issued prior to adoption of SFAS No. 123R based on the fair values previously calculated for disclosure purposes over the remaining vesting period of the outstanding stock options and warrants.

The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with 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”, and EITF 00-18, “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees”, whereas the value of the stock compensation is based upon the measurement date as determined at either (a) the date at which a performance commitment is reached or (b) at the date at which the necessary performance to earn the equity instruments is complete.

During the years ended December 31, 2008 and 2007, the Company recorded $883,000 and $1,677,000, respectively, as a charge to operations to recognize the unvested portion of the grant date fair value of awards issued prior to the adoption of SFAS No. 123R.

At December 31, 2008, the unvested portion of the grant date fair value of awards issued prior to adoption of SFAS No. 123R on January 1, 2006, based on the fair values previously calculated, the amount which will be charged to operations in 2009 is $26,000.

For the past several years and in accordance with established public company accounting practice, the Company has consistently utilized the Black-Scholes option-pricing model to calculate the fair value of stock options and warrants issued as compensation, primarily to management, employees and directors.  The Black-Scholes option-pricing model is a widely-accepted method of valuation that public companies typically utilize to calculate the fair value of options and warrants that they issue in such circumstances.

In calculating the Black-Scholes value of stock options and warrants issued, the Company uses the full term of the option, an appropriate risk-free interest rate (generally from 4% to 5%), and a 0% dividend yield.

The Company utilizes the daily closing stock prices of its common stock as quoted on the OTC Bulletin Board to calculate the expected volatility used in the Black-Scholes option-pricing model.  By utilizing daily trading data related to the period of time that reflects the Company’s current business operations, the Company believes that this methodology generates volatility factors that more accurately reflect, as well as adjust for, normal market fluctuations in the Company’s common stock over an extended period of time.  This methodology has generated volatility factors ranging from approximately 156% to 269% during 2007 and 2008.  These volatility factors reflected sporadic trading, relative uncertainty as it related to the Company’s ability to restructure its debt and a general economic deterioration in the stock market during the latter half of 2008.  These volatility factors have generally trended upward during 2007 and 2008.  As there were no stock-based compensation issued during 2008, a Black-Scholes calculation was not necessary during 2008.

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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 disclosure 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 include allowances for bad debts and sales returns, impairment of long-lived assets, impairment of fixed assets, stock-based compensation, the valuation allowance on deferred tax assets, and the change in fair value of the warrant liability and derivative liability.  Actual results could differ from those estimates.

Adoption of New Accounting Policies

Effective January 1, 2007, the Company adopted FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, Accounting for Income Taxes” (“FIN 48”).  FIN 48 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement.  FIN 48 also provides guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.  The adoption of the provisions of FIN 48 did not have a material effect on the Company’s financial statements.  As of December 31, 2008, no liability for unrecognized tax benefits was required to be recorded.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (“SFAS No. 157”), which establishes a formal framework for measuring fair value under Generally Accepted Accounting Principles (“GAAP”). SFAS No. 157 defines and codifies the many definitions of fair value included among various other authoritative literature, clarifies and, in some instances, expands on the guidance for implementing fair value measurements, and increases the level of disclosure required for fair value measurements. Although SFAS No. 157 applies to and amends the provisions of existing FASB and American Institute of Certified Public Accountants (“AICPA”) pronouncements, it does not, of itself, require any new fair value measurements, nor does it establish valuation standards. SFAS No. 157 applies to all other accounting pronouncements requiring or permitting fair value measurements, except for: SFAS No. 123R, share-based payment and related pronouncements, the practicability exceptions to fair value determinations allowed by various other authoritative pronouncements, and AICPA Statements of Position 97-2 and 98-9 that deal with software revenue recognition. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The requirements of SFAS No. 157 does not apply to the Company as it is currently structured.

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Recent Accounting Pronouncements

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS No. 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. SFAS No. 159’s objective is to reduce both complexity in accounting for financial instruments and the volatility in earnings caused by measuring related assets and liabilities differently. Generally accepted account principles have required different measurement attributes for different assets and liabilities that can create artificial volatility in earnings. SFAS No. 159 helps to mitigate this type of accounting-induced volatility by enabling companies to report related assets and liabilities at fair value, which would likely reduce the need for companies to comply with detailed rules for hedge accounting. SFAS No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. SFAS No. 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. SFAS No. 159 also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. SFAS No. 159 does not eliminate disclosure requirements included in other accounting standards, including requirements for disclosures about fair value measurements included in SFAS No. 157 and SFAS No. 107. SFAS No. 159 is effective as of the beginning of a company’s first fiscal year beginning after November 15, 2007.

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”), which requires an acquirer to recognize in its financial statements as of the acquisition date (i) the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree, measured at their fair values on the acquisition date, and (ii) goodwill as the excess of the consideration transferred plus the fair value of any noncontrolling interest in the acquiree at the acquisition date over the fair values of the identifiable net assets acquired.  Acquisition-related costs, which are the costs an acquirer incurs to effect a business combination, will be accounted for as expenses in the periods in which the costs are incurred and the services are received, except that costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. SFAS No. 141(R) makes significant amendments to other Statements and other authoritative guidance to provide additional guidance or to conform the guidance in that literature to that provided in SFAS No. 141(R).  SFAS No. 141(R) also provides guidance as to what information is to be disclosed to enable users of financial statements to evaluate the nature and financial effects of a business combination.  SFAS No. 141(R) is effective for financial statements issued for fiscal years beginning on or after December 15, 2008, and early adoption is prohibited.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS No. 160”), which revises the relevance, comparability, and transparency of the financial information that a reporting entity provides in its consolidated financial statements by establishing accounting and reporting standards that require (i) the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated statement of financial position within equity, but separate from the parent’s equity, (ii) the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income, (iii) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently as equity transactions, (iv) when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value, with the gain or loss on the deconsolidation of the subsidiary being measured using the fair value of any noncontrolling equity investment rather than the carrying amount of that retained investment, and (v) entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 amends FASB No. 128 to provide that the calculation of earnings per share amounts in the consolidated financial statements will continue to be based on the amounts attributable to the parent. SFAS No. 160 is effective for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Early adoption is prohibited. SFAS No. 160 shall be applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements, which shall be applied retrospectively for all periods presented. The requirements of SFAS No. 160 does not apply to the Company as it is currently structured.

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On March 19, 2008—The Financial Accounting Standards Board (FASB) issued FASB Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard is intended to improve financial reporting about derivative instruments and hedging activities by requiring enhanced disclosures to enable investors to better understand their effects on an entity’s financial position, financial performance, and cash flows. It is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged.  The requirements of SFAS No. 160 do not apply to the Company as it is currently structured.

In June 2008, the FASB ratified Emerging Issues Task Force (“EITF”) Issue No. 07-05, “Determining Whether an Instrument (or Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-05”). EITF 07-05 mandates a two-step process for evaluating whether an equity-linked financial instrument or embedded feature is indexed to the entity’s own stock. Warrants that a company issues that contain a strike price adjustment feature, upon the adoption of EITF 07-05, results in the instruments no longer being considered indexed to the company’s own stock. Accordingly, adoption of EITF 07-05 will change the current classification (from equity to liability) and the related accounting for such warrants outstanding at that date. EITF 07-05 is effective for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. The Company does not currently anticipate that the adoption of EITF 07-05 on January 1, 2009 will have any impact on its consolidated financial statement presentation or disclosures.

3.  ACQUISITION OF MEDIADEFENDER, INC.

On July 28, 2005, the Company consummated the acquisition of MediaDefender, Inc., a privately-held Delaware corporation (“MediaDefender”), which is a leading provider of anti-piracy solutions in the Internet-piracy-protection (“IPP”) industry.  The stockholders of MediaDefender received aggregate consideration of $42,500,000 in cash, subject to certain holdbacks and adjustments described in the Merger Agreement.  In order to fund the acquisition of MediaDefender, the Company completed a $15,000,000 senior secured debt transaction and a $30,000,000 convertible subordinated debt transaction, as described at Note 4.

In accordance with the Merger Agreement, the Company acknowledged the terms of Employment Agreements entered into on July 28, 2005 by MediaDefender with each of Randy Saaf and Octavio Herrera, confirming the terms of their employment.  Mr. Saaf and Mr. Herrera each earn a base salary of no less than $350,000 per annum during the initial term of the agreements, which continue until December 31, 2008, and are also each entitled to receive performance bonuses of up to $350,000 if MediaDefender achieves operating earnings before interest, taxes, depreciation and amortization (calculated using the same accounting methods and policies as MediaDefender has historically used) exceeding $7,000,000 and $7,500,000 in fiscal 2007 and 2008, respectively.   No bonuses were earned during fiscal 2007 or 2008.

In conjunction with the acquisition of MediaDefender, effective July 28, 2005, the Company granted stock options to each of Mr. Saaf and Mr. Herrera to purchase 200,000 shares of common stock, exercisable for a period of five years at $3.00 per share, which was in excess of the fair value of the common stock issued in the MediaDefender transaction.  These options vest quarterly over three and one-half years.  The fair value of each of these options, calculated pursuant to the Black-Scholes option-pricing model, was determined to be $546,000, which is being recognized as stock-based compensation over the vesting period.

The Company also acknowledged the terms of Non-Competition Agreements entered into on July 28, 2005 by MediaDefender and Mr. Saaf and Mr. Herrera.  The Non-Competition Agreements prohibit Mr. Saaf and Mr. Herrera from (i) engaging in certain competitive business activities, (ii) soliciting customers of MediaDefender or the Company, (iii) soliciting existing employees of MediaDefender or the Company and (iv) disclosing any confidential information regarding MediaDefender or the Company.  Each agreement has a term of four years and shall continue to remain in force and effect in the event the above-referenced Employment Agreements are terminated prior to the end of the four-year term of the Non-Competition Agreements.

Mr. Saaf and Mr. Herrera each invested $2,250,000 in the convertible subordinated debt transaction entered into to fund the acquisition of MediaDefender on the same terms and conditions as the other investors in such financing (see Note 4).

In conjunction with the acquisition of MediaDefender, effective July 28, 2005, the Company granted stock options to Jonathan Diamond, its Chief Executive Officer, to purchase 1,708,098 shares of common stock, exercisable for a period of five years at $1.55 per share, which was in excess of the fair value of the common stock issued in the MediaDefender transaction.  The fair value of the time-vested options, calculated pursuant to the Black-Scholes option-pricing model, was determined to be $2,936,450, which was being recognized as stock-based compensation over the vesting period.   The terms of the time-vesting options were modified effective March 6, 2008 and the unrecognized balance was charged to expense during 2008 (see Note 16).

In conjunction with the acquisition of MediaDefender, effective July 28, 2005, the Company granted stock options to Robert Weingarten, its Chief Financial Officer, to purchase 275,000 shares of common stock, exercisable for a period of five years at $1.55 per share, which was in excess of the fair value of the common stock issued in the MediaDefender transaction.    The fair value of the time-vested options, calculated pursuant to the Black-Scholes option-pricing model, was determined to be $772,750, which was being recognized as stock-based compensation over the vesting period.  The terms of the time-vesting options were modified effective August 31, 2007 with all the time based options becoming fully vested as of August 31, 2008 (see Note 16).

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Upon the closing of the transaction, the Company issued 1,109,032 shares of common stock and a seven-year warrant to purchase 114,985 shares of common stock with an exercise price of $1.55 per share to WNT07 Holdings, LLC (“WNT07”).  The managers of WNT07 are Eric Pulier and Teymour Boutros-Ghali, both of whom were at the time of the issuance of the consideration and were members of the Company’s Board of Directors.  The shares and warrants were issued as consideration for services provided by Mr. Pulier and Mr. Boutros-Ghali as consultants to the Company with respect to the MediaDefender acquisition.  The consideration issued to WNT07 was approved by the disinterested members of the Company’s Board of Directors.  The shares and warrants were issued in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act and Rule 506 promulgated thereunder.  The shares of common stock were valued at $1,585,916 ($1.43 per share) and the warrants were valued at $83,939, based on a valuation report prepared by an independent valuation firm.  The aggregate value of $1,669,855 was allocated $333,971 (20%) to a covenant not to compete (as described below) and $1,335,884 (80%) to the costs that the Company incurred to acquire MediaDefender, based on management’s estimate of the relative values, as confirmed by the independent valuation firm.

On July 28, 2005, the Company entered into a Non-Competition Agreement with WNT07, Eric Pulier and Teymour Boutros-Ghali (collectively, the “Advisors”).  The Non-Competition Agreement prohibits any of the Advisors (i) from engaging in certain competitive business activities and (ii) from soliciting existing employees of the Company or its subsidiaries.  The covenants not to complete or solicit expired on the earlier of April 1, 2007 or the date of termination of Advisor’s services with the Company.  The amount allocated to the covenant not to compete was amortized through April 1, 2007.

4.  FINANCING TRANSACTIONS WITH RESPECT TO MEDIADEFENDER, INC. ACQUISITION

In conjunction with the acquisition of MediaDefender on July 28, 2005 (see Note 3), the Company completed a $15,000,000 senior secured debt transaction (the “Senior Financing”) and a $30,000,000 convertible subordinated debt transaction (the “Sub-Debt Financing”).

The Senior Financing was completed in accordance with the terms set forth in the Note and Warrant Purchase Agreement entered into on July 28, 2005 by the Company, each of the investors indicated on the schedule of buyers attached thereto and U.S. Bank National Association as Collateral Agent (the “Note Purchase Agreement”).  Pursuant to the terms of the Note Purchase Agreement, each investor received a note with a term of three years and eleven months that bears interest at the rate of 11.25% per annum (each a “Senior Note”), payable quarterly, with any unpaid principal and accrued interest due and payable at maturity.  Termination and payment of the Senior Notes by the Company prior to maturity does not result in a prepayment fee.  As collateral for the $15,000,000 Senior Financing, the investors received a first priority security interest in all existing and future assets of the Company and its subsidiaries, tangible and intangible, including, but not limited to, cash and cash equivalents, accounts receivable, inventories, other current assets, furniture, fixtures and equipment and intellectual property.

In addition, not later than ninety days after the close of each fiscal year, the Company is obligated to apply 60% of its excess cash flow, as defined in the Note Purchase Agreement (the “Annual Cash Sweep”), to prepay the principal amount of the Senior Notes.  At December 31, 2007, there was $313,000 payable for the 2007 Annual Cash Sweep, which is included in senior secured notes payable in the balance sheet at December 31, 2007 and was paid on March 28, 2008.

The Senior Financing investors also received five-year warrants to purchase an aggregate of 3,250,000 shares of the Company’s common stock at an exercise price of $2.00 per share (collectively, the “Senior Warrants”).  The Senior Warrants were valued at $1,982,500 based on a valuation report prepared by an independent valuation firm utilizing the Black-Scholes option-pricing model, and were recorded as a discount to the $15,000,000 of senior secured debt, and are being amortized to interest expense over the term of the debt.

The Senior Warrants were subject to certain anti-dilution and price reset provisions, as well certain registration rights obligations requiring the Company to file and maintain effective a registration statement with the SEC covering the shares of common stock underlying such warrants, which, if not complied with, subjects the Company to a cash penalty of 1.5% of the Senior Financing per thirty-day period.  Accordingly, in accordance with EITF 00-19, the fair value of the Senior Warrants was recorded as warrant liability in the Company’s balance sheet at July 28, 2005, and is being adjusted to reflect any material changes in such liability from the date of issuance to the end of each subsequent reporting period, with any such changes included in other income (expense) in the statement of operations.

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The Sub-Debt Financing was completed in accordance with the terms set forth in the Securities Purchase Agreement entered into on July 28, 2005 by the Company and each of the investors indicated on the schedule of buyers attached thereto (the “Securities Purchase Agreement”).  Pursuant to the terms of the Securities Purchase Agreement, each investor received a convertible subordinated note with a term of four years that bears interest at the rate of 4.0% per annum (each a “Sub-Debt Note”), with any unpaid principal and accrued interest due and payable at maturity.  The interest rate increases to 12.0% per annum during any period in which the Company is in default of its obligations under the Sub-Debt Note.  Commencing September 30, 2006, interest is payable quarterly in cash or shares of common stock, at the option of the Company.  Each Sub-Debt Note had an initial conversion price of $1.55 per share, was subject to certain anti-dilution, reset and change-of-control provisions and the Sub-Debt Notes contain specific provisions that expressly prohibit the Company from issuing shares to a Sub-Debt Note holder if, after the conversion, such Sub-Debt Note holder would exceed the respective limit called for in their Sub-Debt Note, either 4.99% or 9.99%, of the Company’s outstanding common shares.  In addition, each Sub-Debt Note is subject to mandatory conversion by the Company in the event certain trading price targets for the Company’s common stock are met.

On December 16, 2008, ARTISTdirect, Inc. entered into an amendment to the Sub-Debt Notes with Trilogy Capital Partners, Inc., Randy Saaf and Octavio Herrera, the holders of a majority of the aggregate principal amount outstanding of the subordinated convertible notes.  Pursuant to Section 17 of the Subordinated Notes the Majority Holders have the right to approve modifications to the Subordinated Notes.  The amendment decreases the conversion price of the Subordinated Notes from $1.55 to $1.00 per share and waives the requirement of certain holders to give 61 day written notice to increase or decrease the maximum limitation on such holders’ ability to convert the Subordinated Notes held by them.

The holders of the Sub-Debt Notes are entitled to receive any dividends paid or distributions made to the holders of common stock to the same extent as if such holders had converted their Sub-Debt Notes into common stock (without regard to any limitations on conversion) and had held such shares of common stock on the record date for such dividend or distribution, with such payment to be made concurrently with the payment of the dividend or distribution to the holders of common stock.

The Sub-Debt Financing investors also received five-year warrants to purchase an aggregate of 1,596,774 shares of common stock at an exercise price of $1.55 per share, subject to certain anti-dilution and price reset provisions (collectively, the “Sub-Debt Warrants”).  The Sub-Debt Warrants were valued at $1,133,710 based on a valuation report prepared by an independent valuation firm utilizing the Black-Scholes option-pricing model, and were recorded as a discount to the $30,000,000 of convertible subordinated debt, and are being amortized to interest expense over the term of the debt.

In conjunction with the aforementioned financing transactions, a Subordination Agreement dated July 28, 2005 was entered into between the Company, the Senior Financing investors, and the Sub-Debt Financing investors pursuant to which the Sub-Debt Financing investors agreed to subordinate their rights to the investors in the Senior Financing in the event of a default under the Senior Financing transaction documents and on certain other terms and conditions described therein.

If all of the securities issued in the Senior Financing and the Sub-Debt Financing are converted or exercised into shares of the Company’s common stock in accordance with their respective terms, it will result in significant dilution to the Company’s existing stockholders and a possible change in control of the Company.  If all of the Company’s outstanding equity-based instruments are converted or exercised into shares of the Company’s common stock in accordance with their respective terms, including those issued in conjunction with the acquisition of MediaDefender, there would be a total of approximately 38,000,000 shares of the Company’s common stock issued and outstanding.

The securities issued by the Company in the Senior Financing and the Sub-Debt Financing were offered and sold in reliance upon exemptions from registration pursuant to Section 4(2) under the Securities Act of 1933, as amended (the “Securities Act”), and Rule 506 promulgated thereunder.  Each of the investors qualified as an “accredited investor,” as specified in Rule 501 under the Securities Act.

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The Sub-Debt Notes contain reset, anti-dilution and change-in-control provisions that the Company has determined caused such debt instruments to be classified as “non-conventional” debt.  Upon evaluation of such debt instruments under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”), and EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”), it was determined that the Company was required to bifurcate and value certain rights embedded in the Sub-Debt Notes on the date of issuance (including, specifically, the initial $1.55 per share fixed conversion feature, which was in excess of the $1.43 per share fair market value of the Company’s common stock on the date of issuance) and to classify such rights as either assets or liabilities.  The fair value of these bifurcated derivatives as of July 28, 2005, as determined by an independent valuation firm, was calculated in accordance with SFAS No. 133 Implementation Issue No. B15, “Embedded Derivatives:  Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”, using a binomial lattice model utilizing highly subjective and theoretical assumptions that can materially affect fair values from period to period.  The recognition of these derivative amounts did not have any impact on the Company’s revenues, operating expenses or cash flows.  The Company recorded an initial embedded derivative liability of $10,534,000, which was recorded as a discount to the $31,460,500 of convertible subordinated notes, and is being amortized over the term of the debt.  The carrying value of the embedded derivative liability is being adjusted to reflect any material changes in such liability from the date of issuance to the end of each subsequent reporting period, with any such changes included in other income (expense) in the statement of operations

The Sub-Debt Notes contain several embedded derivative features (both assets and liabilities) that have been accounted for at fair value.  The various embedded derivative features of the Sub-Debt Notes have been valued at the date of inception of the Sub-Debt Financing and at the end of each reporting period thereafter.  The material derivative features include:  (1) the standard conversion feature of the debentures, (2) a limitation on the conversion by the holder, and (3) the Company’s right to force conversion.  An independent valuation firm valued the embedded derivative features and determined that, except for the above-noted features, the remaining derivative attributes (both assets and liabilities) were immaterial, both individually and in the aggregate, and effectively offset each other.  The value of the embedded derivatives was bifurcated from the Sub-Debt Notes and recorded as derivative liability, with the initial amount recorded as discount on the related Sub-Debt Notes.  This discount is being amortized to interest expense over the life of the Sub-Debt Notes.

The Company determined that the warrants issued in conjunction with the Senior Financing and the Sub-Debt Financing created derivative liabilities in accordance with EITF 00-19 because share settlement of these financial instruments was not within the control of the Company, since the Company could not conclude that it had sufficient authorized but unissued common shares available to satisfy its potential share obligations under the warrant agreements.  The Company reached this conclusion because:  (1) the Company has an obligation to file a registration statement with the SEC to register the common stock underlying warrants, and to have such registration statement declared effective, and to maintain effective such registration statement, or to pay penalties in the form of liquidated damages for each thirty-day period that such registration statement is not effective, (2) the warrants contained dilution protection features, with no limit or cap on the number of shares that could be issued by the Company pursuant to such provisions, and (3) the warrants contained certain price reset features.  Because the warrants contain certain anti-dilution and price reset provisions, as well as have registration rights, the fair value of the warrants was accounted for as a derivative and presented as warrant liability.

Pursuant to the Senior Financing and Sub-Debt Financing documents, the Company is required to comply on a quarterly basis with certain financial covenants, including minimum working capital, maximum capital expenditures, minimum leverage ratio, minimum EBITDA and minimum fixed charge coverage ratio.  These financial covenants are identical in the Senior Financing and the Sub-Debt Financing documents.

The financing documents governing the terms and conditions of the senior and subordinated indebtedness required the Company to maintain an effective registration statement covering the resale of shares of common stock underlying the various securities issued by the Company to each holder.  A resale registration statement on Form SB-2, as amended, was declared effective by the SEC on December 9, 2005.  The Company subsequently filed Post-Effective Amendment No. 1 to the registration statement on Form SB-2, which was declared effective by the SEC on May 1, 2006, and Post-Effective Amendment No. 2 to the registration statement on Form SB-2, which was declared effective by the SEC on July 6, 2007.  As a result of the determination to restate previously issued financial statements (see Note 1), the Form SB-2 was not available for use by the holders between December 21, 2006 and July 6, 2007.

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The financing documents specify that an event of default of the senior and subordinated indebtedness is triggered if a resale registration statement is unavailable for use by the holders for a period of more than ten consecutive trading days after the expiration of an allowable ten-day grace period.  The Company invoked its use of the ten-day allowable grace period on December 21, 2006, which expired on December 31, 2006.  The Company delivered notice to holders of its outstanding senior and subordinated indebtedness that, as of December 20, 2006, an event of default had been triggered under their respective senior and subordinated financing documents.

As of December 20, 2006, the Form SB-2 remained unavailable for use by the holders, and it continued to be unavailable for use until July 6, 2007, when Amendment No. 2 to the registration statement on Form SB-2 was declared effective by the SEC.  Accordingly, at December 30, 2006, the registration statement covering the resale of shares of common stock underlying the various securities issued by the Company to each holder of the senior and subordinated indebtedness was not effective.  As a result, an event of default, among others, with respect to the senior and subordinated indebtedness was triggered by the unavailability of the Form SB-2 to the holders between December 20, 2006 and July 6, 2007.  The financing documents provide that while the Form SB-2 remains unavailable for use, holders of senior indebtedness are entitled to a cash penalty equal to 1.5% of the original Senior Financing, on a pro rata basis, and the holders of subordinated indebtedness are entitled to a cash penalty equal to 1.0% of the original Sub-Debt Financing, on a pro rata basis.  These cash penalties are due and payable by the Company at the end of each thirty-day period while the Form SB-2 remains unavailable.  The first cash penalty payment was due on January 31, 2007 and monthly thereafter.

In accordance with EITF 00-19-2, which the Company adopted as of December 31, 2006, and SFAS No. 5, the Company accrued seven months liquidated damages (through mid-August 2007) under the registration rights agreements aggregating approximately $3,777,000 as a charge to operations at December 31, 2006, which was reduced by $395,000 as a result of the Company’s registration statement being declared effective on July 6, 2007, which was earlier than originally estimated, and by an aggregate of $1,000,000 of advance payments made to the holders of the Senior Financing during the year ended December 31, 2007 for liquidated damages under the registration rights agreement.  Accordingly, liquidated damages payable under registration rights agreements were $1,972,000 at December 31, 2008 and $2,382,000 at December 31, 2007, and were reflected as a current liability at such dates.  The Company believes that the amount of the liquidated damages accrued reflects the undiscounted maximum potential amount of liquidated damages payable to the holders of the Senior Financing and the Sub-Debt Financing since the underlying shares become generally available for resale under an effective registration statement on July 6, 2007.

A summary of the registration penalty accrual at December 31, 2008 and 2007 is presented below.

	December 31, 2008		December 31, 2007
Senior secured notes payable	$	—	$	410,000
Subordinated convertible notes payable	1,972 ,000		1,972,000
Total registration penalty accrual	$	1,972,000	$	2,382,000

As of December 31, 2008 and 2007, approximately $12,494,000 and $13,307,000 principal amount respectively was outstanding with respect to the Senior Financing, and approximately $27,658,000 principal amount was outstanding with respect to the Sub-Debt Financing.  In addition, at December 31, 2008, approximately $0 and $1,972,000 was outstanding with respect to accrued registration delay penalties to the holders of the Senior Financing and the Sub-Debt Financing, respectively, and approximately $113,000 and $6,805,000 was outstanding with respect to accrued interest payable to the holders of the Senior Financing and the Sub-Debt Financing, respectively.  Through December 31, 2008, the Company had not paid the registration delay penalties to the Sub-Debt Notes, although it had made payments to the holders of the Senior Notes aggregating $1,410,000.  As a result of the registration failure, the failure to pay the registration delay penalties and the various financial covenant and other breaches of the terms of the Senior Financing and the Sub-Debt Financing, multiple events of default exist under the Senior Financing and the Sub-Debt Financing.  The terms of the Subordination Agreement among the Company and the creditor parties thereto (the “Subordination Agreement”) prevent the Company from making any cash payments to the Sub-Debt Note holders until the events of default under the Senior Financing are either cured or waived.  Furthermore, upon the occurrence of an event of default, holders of at least 25% of the outstanding senior indebtedness may declare the outstanding principal and accrued interest on all senior notes immediately due and payable upon written notice to the Company, and each holder of outstanding subordinated indebtedness may only demand redemption of all or any portion of their respective notes under certain circumstances as described in the Subordination Agreement. See “Subsequent Events”  Footnote.

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All quarterly interest payments due on the outstanding senior and subordinated indebtedness were timely paid by the Company through December 2006.  In addition, the quarterly interest payments due on the outstanding senior indebtedness in 2008 were timely paid.  Pursuant to the terms of the Subordination Agreement, interest on the outstanding subordinated convertible notes payable cannot be paid as a result of the existence of the events of default described herein.

A summary of accrued interest payable at December 31, 2008 and 2007 is presented below.

	December 31, 2008		December 31, 2007
Senior secured notes payable	$	113,000	$	67,000
Subordinated convertible notes payable	6,362,000		3,034,000
Liquidated damages payable with respect to:
Senior secured notes payable	—		79,000
Subordinated convertible notes payable	443,000		172,000
Total accrued interest payable	$	6,918,000	$	3,352,000

Pursuant to a series of Forbearance and Consent Agreements with the investors in the Senior Financing, such investors agreed to forbear from the exercise of their rights and remedies under the Senior Financing documents as a result of the events of default with respect to the unavailability of the Company’s registration statement, as well as certain other events of default that existed or that could come into existence during the forbearance period, from April 17, 2007 through February 20, 2008, in exchange for aggregate cash payments of $1,000,000 in 2007 and $494,446 in February 2008.  The payments made by the Company under the Forbearance and Consent Agreements were credited against the registration delay cash penalties and interest on the penalties resulting from the Company’s default under the various agreements between the Company and the Senior Financing investors.  On March 17, 2008, the Company entered into a Forbearance and Consent Agreement with the investors in the Company’s Senior Debt Financing, which was effective as of February 20, 2008, whereby the investors  agreed to forbear from exercising any of their rights and remedies under the Senior Financing transaction documents through December 31, 2008 in exchange for an adjustment in the interest rate associated with the Senior Notes from 11.25% to 16%.

On August 3, 2007, the Company entered into a Waiver and Forbearance Agreement with the holders of the Sub-Debt Financing pursuant to which the holders agreed to waive their right to charge the 12.0% default interest rate triggered by the Company’s defaults under the Subordinated Financing transaction documents and instead charge the 4.0% standard interest rate on the Sub-Debt Notes for the period from July 16, 2007 through August 31, 2007 (the “Forbearance Period”).  The holders of the Sub-Debt Financing also agreed to forbear from exercising any of their other rights and remedies under the Sub-Debt Financing transaction documents during the Forbearance Period, upon the terms and conditions in the Waiver and Forbearance Agreement.  Effective September 1, 2007, the interest rate returned to the 12.0% default interest rate.

As a result of the requirement to restate previously issued financial statements, which resulted in the recording of an embedded derivative liability, the reclassification of the senior and subordinated indebtedness to current liabilities, and the recording of liquidated damages payable under registration rights agreements, the Company was not in compliance with certain of its financial covenants under both the Senior Financing and the Sub-Debt Financing at December 31, 2006.  Notwithstanding such developments, the Company would have been out of compliance with certain of its financial covenants at December 31, 2008 and 2007.

The registration delay penalties and ongoing default interest charges continued to have a significant and material negative impact on the Company’s operations and cash flows during fiscal years 2008 and 2007.

87

5.  DERIVATIVE FINANCIAL INSTRUMENTS

In conjunction with the financing for the acquisition of MediaDefender on July 28, 2005 (see Notes 3 and 4), the Company completed a $15,000,000 senior secured debt transaction (the “Senior Financing”) and a $30,000,000 convertible subordinated debt transaction (the “Sub-Debt Financing”).  The Company also issued various warrants in conjunction with such financings.

The Sub-Debt Notes contain multiple embedded derivative features (both assets and liabilities) that have been accounted for at fair value as a compound embedded derivative.  The compound embedded derivative associated with the Sub-Debt Notes has been valued at the date of inception of the Sub-Debt Financing and at the end of each reporting period thereafter.  The compound embedded derivative includes the following material features:  (1) the standard conversion feature of the debentures, (2) a limitation on the conversion by the holder, and (3) the Company’s right to force conversion.

An independent valuation firm assisted the Company in valuing the various derivative features in the compound embedded derivative and determined that, except for the above-noted features, the remaining derivative attributes (both assets and liabilities) were immaterial, both individually and in the aggregate, and they effectively offset one another.  The value of the compound embedded derivative that includes the above-noted features was bifurcated from the Sub-Debt Notes and recorded as derivative liability.  This initial amount was recorded as a discount on the related Sub-Debt Notes.  This discount is being amortized to interest expense over the life of the Sub-Debt Notes.

The Company, with the assistance of an independent valuation firm, calculated the fair value of the compound embedded derivative associated with the Sub-Debt Notes in accordance with SFAS No. 133 Implementation Issue No. B15, “Embedded Derivatives:  Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”, which requires that when multiple derivatives (both assets and liabilities) exist within a financial instrument, they are bundled together as a single hybrid compound instrument.  The calculation model utilized a complex, customized, binomial lattice model suitable for the valuation of path-dependent American options.  The model uses the risk neutral binomial methodology to simulate the scenarios and stock price paths.  The model also uses backward dynamic programming to value the payoffs at each node considering all the embedded options simultaneously.  The valuation model used the following assumptions for the original valuation and for each succeeding quarterly valuation:

	2005				2006		2007								2008
Embedded derivatives	28-Jul		31-Dec		31-Dec		31-Mar		30-Jun		30-Sep		31-Dec		31-Mar		30-Jun		30-Sep		31-Dec
Initial fair value of common stock ($)	1.43		—		—		—		—		—		—		—		—		—		—
Fair value of common stock at each reporting period end	—		3.3		2.35		1.9		2		1.8		0.38		0.38		0.27		0.03		0.01
Conversion price ($)	1.55		1.55		1.55		1.55		1.55		1.55		1.55		1.55		1.55		1.55		1.00
Terminal time period in months	48		43		31		28		25		22		19		16		13		10		7
Expected return	4.04	%	4.35	%	4.69	%	4.58	%	4.87	%	3.97	%	3.05	%	1.62	%	2.35	%	1.78	%	0.37	%
Initial volatility factor	55	%	—		—		—		—		—		—		—		—		—		—
Volatility factor for each subsequent reporting period	—		59	%	53	%	60	%	56	%	63	%	73	%	67	%	74	%	208.3	%	269.5	%
Triggering events to forced conversion:
Event 1 - stock price equal or above ($)	2.32		2.32		2.32		2.32		2.32		2.32		2.32		2.32		2.32		2.32		2.32
Event 2 - daily share trading volume equal or above (in thousands)	200		200		200		200		200		200		200		200		200		200		200
Lack of liquidity discount for the limitation on conversion	20	%	20	%	20	%	20	%	20	%	20	%	20	%	20	%	20	%	20	%	20	%

88

The Company determined that the warrants issued in conjunction with the Senior Financing and the Sub-Debt Financing created derivative liabilities in accordance with EITF 00-19 because share settlement of these financial instruments was not within the control of the Company, since the Company could not conclude that it had sufficient authorized but unissued common shares available to satisfy its potential share obligations under the warrant agreements.  The Company reached this conclusion because:  (1) the Company has an obligation to file a registration statement with the SEC to register the common stock underlying warrants, and to have such registration statement declared effective, and to maintain effective such registration statement, or to pay penalties in the form of liquidated damages for each thirty-day period that such registration statement is not effective, (2) the warrants contained dilution protection features, with no limit or cap on the number of shares that could be issued by the Company pursuant to such provisions, and (3) the warrants contained certain price reset features.  Because the warrants contain certain anti-dilution and price reset provisions, as well as have registration rights, the fair value of the warrants was accounted for as a derivative and presented as warrant liability.

The Company calculated the fair value of the various warrants using the Black-Scholes option-pricing model, using the volatility factor determined by the independent valuation firm.  The valuation model used the following assumptions for the original valuation and for each succeeding quarterly valuation.

	2005				2006		2007								2008
Warrant liability	28-Jul		31-Dec		31-Dec		31-Mar		30-Jun		30-Sep		31-Dec		31-Mar		30-Jun		30-Sep		31-Dec
Initial fair value of common stock ($)	1.43		—		—		—		—		—		—		—		—		—
Fair value of common stock at each subsequent reporting period end ($)	—		3.3		2.35		1.9		2.00		1.8		0.38		0.38		0.27		0.03		0.01
Exercise price:
Senior warrants ($)	2.00		2.00		2.00		2.00		2.00		2.00		2.00		2.00		2.00		2.00		2.00
Sub-debt warrants ($)	1.55		1.55		1.43		1.43		1.43		1.43		1.43		1.43		1.43		1.43		1.43
Libra warrant ($)	2.00		2.00		—		—		—		—		—		—		—		—		—
Time period in months:
Senior warrants	60		55		43		40		37		34		31		28		25		22		19
Sub-debt warrants	60		55		43		40		37		34		31		28		25		22		19
Libra warrant	84		79		—		—		—		—		—		—		—		—		—
Expected return %	4.04		4.35		4.69		4.58		4.89		4.03		3.45		1.62		2.35		2.28		0.76
Initial volatility factor	55	%	—		—		—		—		—		—		—		—		—		—
Volatility factor for each subsequent reporting period	—		59	%	53	%	60	%	56	%	63	%	73	%	67	%	74	%	208.3	%	269.5	%

89

The Company’s Sub-Debt Notes contain compound embedded derivatives (as described above) that required that they be bifurcated from the debt host instrument at the date of issuance and valued.  The calculation of the fair value of the compound embedded derivatives required the use of a more sophisticated valuation model than a Black-Scholes option-pricing model.  Accordingly, the Company retained an independent valuation firm to calculate the fair value of the compound embedded derivatives, and the changes in fair value at each subsequent period end.  The Company, with the assistance of the independent valuation firm, calculated the fair value of the compound embedded derivatives associated with the Sub-Debt Notes in accordance with SFAS No. 133 Implementation Issue No. B15, “Embedded Derivatives:  Separate Accounting for Multiple Derivative Features Embedded in a Single Hybrid Instrument”, by utilizing a complex, customized, binomial lattice model suitable in the valuation of path-dependent American options.  This model utilized subjective and theoretical assumptions that can materially affect fair values from period to period.

The independent valuation firm concluded that the Company’s historical pattern of stock prices as of July 28, 2005, and for some time thereafter, would not provide a sufficient indication of the long-term expected volatility of the Company’s stock going forward for purposes of the calculation of the fair value of the compound embedded derivatives, due to the significant changes in the business operations and capital structure of the Company on July 28, 2005 as a result of the acquisition of MediaDefender and the related financing transactions.  The resulting volatilities were then used to calculate the fair value, and the changes in fair value, of the Company’s compound embedded derivative liabilities at each period end.  The Company also utilized these volatilities to calculate the fair value, and the changes in fair value, of the Company’s warrant derivative liabilities at each period end.

Paragraph A32 of SFAS No. 123R lists factors to consider in estimating expected volatility.  The independent valuation firm retained by the Company to value the compound embedded derivatives contained in the Sub-Debt Notes determined that the appropriate methodology to calculate volatility with respect to the Company’s compound embedded derivatives was to consider the Company as similar to a newly public company without a trading history because of the significant transformative changes resulting from the acquisition and financing of the MediaDefender transaction on July 28, 2005.  With reference to newly public companies, section (c) of paragraph A32 of SFAS No. 123R suggests that the expected volatility of similar entities be considered.  The independent valuation firm arrived at this determination due to the Company’s acquisition of MediaDefender on July 28, 2005 and the related equity-based financing transactions that provided the capital to fund the acquisition.

90

6.  PROPERTY AND EQUIPMENT

	December 31,
Property and equipment are recorded at cost and consist of the following:	2008			2007
	(in thousands)
Computer equipment and software	$	4,237		$	3,973
Furniture and fixtures	194			194
Leasehold improvements	290			285
	4,721			4,452
Less accumulated depreciation and amortization	(3,519		)	(2,614		)
Property and equipment, net	$	1,202		$	1,838

During the year ended December 31, 2007, the Company recorded a charge to operations of $97,000 to write-off the net book value of obsolete computer equipment that it does not expect to utilize in future periods.

At June 30, 2007, the Company evaluated the useful life of certain of its computer equipment and determined to reduce the depreciation period from 7 years to 5 years.  The effect of this change in estimate was to increase depreciation expense by approximately $371,000 for the year ended December 31, 2007.  The Company estimates that this change in estimate will increase depreciation expense by a total of approximately $168,000 in 2008 in excess of the amounts that would have been recorded as depreciation expense originally.

7.  GOODWILL AND OTHER INTANGIBLE ASSETS

Identifiable Intangible Assets

Components of the Company’s identifiable intangible assets at December 31, 2008 and 2007, all of which were recorded in conjunction with the acquisition of MediaDefender in July 2005 (see Note 3), are as follows:

	Balance at Beginning of Year		Amortization Expense		Balance at End of Year
	(in thousands)
December 31, 2008
Customer relationships	$	440	$	440	$	—
Proprietary technology	1,478		1,478		—
Non-competition agreements	416		263		153
Total	$	2,334	$	2,181	$	153
December 31, 2007
Customer relationships	$	1,195	$	755	$	440
Proprietary technology	4,012		2,534		1,478
Non-competition agreements	728		312		416
Total	$	5,935	$	3,601	$	2,334

Amortization expense with respect to intangible assets for the years ended December 31, 2008 and 2007 was $2,181,000 and $3,601,000, respectively.  The $153,000 balance of scheduled amortization expense with respect to intangible assets will be charged to operations in the year ended December 31, 2009.

91

Goodwill

Goodwill at December 31, 2008 and 2007 was $0 and $31,085,000 respectively, which was recorded in conjunction with the acquisition of MediaDefender in July 2005 (see Note 3).  In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets”, an intangible asset that is not subject to amortization such as goodwill shall be tested for impairment at least on an annual basis, and more often under certain circumstances, and written down when impaired.  An interim impairment test is required if an event occurs or conditions change that would more likely than not reduce the fair value of the reporting unit below its carrying value.  The first step of the impairment test consists of a comparison of the total fair value of each reporting unit to the reporting unit’s net assets on the date of the test.  If the fair value is in excess of the net assets, there is no indication of impairment and thus no need to perform the second step of the impairment test.

During the year ended December 31, 2008, the Company recorded a non-cash charge to operations aggregating $31,085,000 with respect to the impairment of the goodwill recognized in conjunction with the acquisition of MediaDefender in July 2005.  This charge to operations was based on various factors and developments occurring in 2008, including continuing erosion in the demand for MediaDefender's core Internet anti-piracy services within the entertainment industry, the unexpected non-renewal by MediaDefender’s largest customer in mid-2008, continuing deterioration of operating margins and valuation metrics, and the inability to implement new advertising initiatives on a large-scale basis.

8.   DEFERRED FINANCING COSTS

Components of the Company’s deferred financing costs at December 31, 2008 and 2007 are as follows:

	Balance at Beginning of Year		Amortization Expense		Write-offs Resulting from Conversions and Repayments of Debt		Balance at End of Year
	(in thousands)
Year Ended December 31, 2008
Deferred financing costs related to:
Subordinated convertible notes payable	$	912	$	608	$	—	$	304
Senior secured notes payable	331		234		8		89
Total	$	1,243	$	842	$	8	$	393
Year Ended December 31, 2007
Deferred financing costs related to:
Subordinated convertible notes payable	$	1,519	$	607	$	—	$	912
Senior secured notes payable	565		234		—		331
Total	$	2,084	$	841	$	—	$	1,243

92

Amortization expense with respect to deferred financing costs for the years ended December 31, 2008 and 2007 was $842,000 and $841,000, respectively.  The $393,000 balance of deferred financing costs will be charged to operations in the year ended December 31, 2009.

9.  ALLOWANCE FOR DOUBTFUL ACCOUNTS

A summary of the activity with respect to the allowance for doubtful accounts is as follows:

	Years Ended December 31,
	2008			2007
	(in thousands)
Balance, beginning of year	$	418		$	421
Provision for doubtful accounts	(36		)	203
Amounts charged off	(153		)	(206		)
Balance, end of year	$	229		$	418

The provision for doubtful accounts for the years ended December 31, 2008 and 2007 by segment was as follows:

	Years Ended December 31,
	2008			2007
	(in thousands)
E-commerce	$	8		$	10
Media	(10		)	23
Anti-piracy and file-sharing marketing services	(34		)	170
Total	$	(36	)	$	203

10.  ACCRUED EXPENSES

Accrued expenses are comprised of the following:

	December 31,
	2008			2007
	(in thousands)
Accrued cost of sales	$	104		$	221
Accrued compensation and related costs	248			1,096
Accrued professional fees	2			133
Accrued business and property taxes	(2		)	51
Other accrued expenses	82			384
Total accrued expenses	$	434		$	1,885

93

11.  INCOME TAXES

The components of the provision for income taxes are as follows:

	Years Ended December 31,
	2008		2007
	(in thousands)
Current:
Federal	$	78	$	—
Federal – FIN 48	492		—
State	94		5
State – FIN 48	150		—
		814		5
Tax benefit of a net operating loss carry-back – federal (current)	—		(828		)
Deferred:
Federal		—		(170	)
State	—		(46		)
	—		(216		)
Total	$	814	$	(1,039	)

Income taxes differ from the amount computed using a tax rate of 34% as a result of the following:

	Years Ended December 31,
	2008			2007
	(in thousands)
Computed expected tax (tax benefit)	$	(16,032	)	$	3,563
Additional Federal Assessments	78			—
State and local income taxes, net of federal income tax benefit	63			3
Permanent adjustment at state rate, net of federal income tax benefit	2,391			—
Amortization of non-cash financing costs	460			470
Adjustments to deferred tax assets	(2,329		)	8
Stock-based compensation	10,880			630
Permanent adjustments caused by warrant and derivative liabilities	1,792			(6,878		)
Amortization of proprietary technology and customer list	652			—
Fin 48 tax reserves and related interest	592			—
Other	9			18
	(1,444		)	(2,186		)
Valuation allowance	2,258			1,147
Total income tax (benefit) expense	$	814		$	(1,039	)

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at December 31, 2008 and 2007 are as follows:

	December 31,
	2008				2007
	(in thousands)
Deferred tax liabilities:
State income taxes	$		3,843		$	3,644
Depreciation	(144			)	45
Total deferred tax liabilities	3,699				3,689
Deferred tax assets:
Net operating loss carryforwards	50,876				48,660
Non-deductible accrued expenses	1,400				1,282
Other	113				179
Total deferred tax assets	52,389				50,121
Valuation allowance	(48,690			)	(46,432		)
Net deferred assets	3,699				3,689
Net deferred tax liabilities	$	—			$	—

94

At December 31, 2008, the Company had net operating loss carryforwards of approximately $111,000,000 for Federal income tax purposes expiring beginning in 2019 and California state net operating loss carryforwards of approximately $114,000,000 expiring beginning in 2009.

In assessing the potential realization of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized.  The ultimate realization of deferred tax assets (primarily net operating loss carryforwards) is dependent upon the Company attaining future taxable income during the periods in which those temporary differences become deductible.  As of December 31, 2008 and 2007, management was unable to determine if it is more likely than not that the Company’s deferred tax assets will be realized, and has therefore recorded an appropriate valuation allowance against deferred tax assets at such dates.

Due to the restrictions imposed by Internal Revenue Code Section 382 regarding substantial changes in the stock ownership of companies with loss carryforwards, the utilization of the Company’s federal net operating loss carryforward was severely limited as a result of the change in the effective stock ownership of the Company resulting from the debt financings arranged in conjunction with the acquisition of MediaDefender.

As of December 31, 2008, the Company’s 2005 and 2006 U.S. federal income tax return was undergoing examination by the Internal Revenue Service.  The Internal Revenue Service has proposed various adjustments to the Company’s 2005 and 2006 taxable income.  Estimated taxes and interest relating to such adjustments have been accrued as income taxes payable in the accompanying financial statements at December 31, 2008.  The Internal Revenue Service has completed its field examination and has taken various positions as to the deductibility of interest accrued and paid relating to the subordinate notes.  The Company does not agree with the agents interpretations of the various treasury regulations in question and the company has responded to the agents’ initial findings.  In as much as the Company has a substantial NOL for federal purposes the Company does not expect that any of the IRS positions would have a material effect on the federal taxes which ultimately would be due to the Treasury.   However, the disallowance of the deductibility of interest accrued and paid to the subordinated note holders would result in an additional tax obligation to the state of California.  Although the final outcome of the federal income tax examination is uncertain, the company has accrued $814,000 for any additional tax expense which may become due in accordance with FIN 48. The Company recorded a benefit for income taxes of $1,039,000 for the year ended December 31, 2007, as a result of the carryback of 2007 tax losses to 2005 and 2006.

The Company adopted the provisions of FIN48 on January 1, 2007, and has identified unrecognized tax benefits related to the deductibility of certain interest expense on subordinated debt.  However, there would be no additional accrual required due to available net operating losses.  The following table provides a reconciliation of the Company’s unrecognized tax benefits at December 31, 2008:

Unrecognized tax benefits at January 1, 2007	$	0
Increase based upon tax positions taken prior to 2007	713,000
Increase based upon tax positions taken in 2007	1,209,000
Increase based upon tax positions taken in 2008	1,326,000
Decrease based upon net operating loss arising in 2007	(1,209,000		)
Decrease based upon 2007 net operating loss carryback to prior years	(69,000		)
Decrease based upon net operating loss arising in 2008	(1,326,000		)
Decrease based upon 2008 net operating loss carryback to prior years	(77,000		)
Unrecognized tax benefits at December 31, 2008	$	567,000

95

12.  RELATED PARTY TRANSACTIONS

Transactions Involving Officers and Directors

Effective as of January 1, 2006, the Company entered into a one-year consulting agreement with Eric Pulier, a director of the Company, through WNT Consulting Group, a California limited liability company wholly-owned by Mr. Pulier (“WNT”).  The consulting agreement was approved by the disinterested members of the Company’s Board of Directors.  Effective January 12, 2007, the parties mutually agreed to terminate this consulting agreement, which had automatically renewed for a second one-year term through December 31, 2007.  Under the terms of the original consulting agreement, Mr. Pulier received a base fee of $10,000 per month, certain other mandatory payments, and was also eligible to receive cash bonuses on the achievement of certain specified milestones.  Mr. Pulier had also agreed to waive all stock options and other stock-based compensation granted to outside members of the Company’s Board of Directors during the term of his original consulting agreement.  The termination agreement provided for a one-time cash payment to Mr. Pulier (through WNT) in the amount of $100,000, in consideration for the termination of the consulting agreement and an acknowledgement and complete release.  The termination agreement was approved by the Compensation Committee of the Company’s Board of Directors.  On January 12, 2007, the Company entered into a new consulting agreement with Mr. Pulier (through WNT).  The new consulting agreement which was at the Company’s discretion, provide that Mr. Pulier (through WNT) receive compensation at the rate of $500 per hour.  No consulting services were provided by Mr. Pulier under the new consulting agreement in either 2007 or 2008.  Mr. Pulier resigned as a member of the Company’s Board of Directors in August 12, 2008.

For the year ended December 31, 2008, each non-employee member of the Company’s Board of Directors received a cash retainer of $15,000.  In addition, each director that serves on a Committee of the Board of Directors received, for each committee served, an additional cash retainer of $10,000 annually, paid quarterly.  The Company did not grant any stock options during 2008.

For the year ended December 31, 2007, each non-employee member of the Company’s Board of Directors received a cash retainer of $15,000, and a grant of 10,000 stock options having a value (based upon the appropriate Black-Scholes option valuation methodology) equal to $16,200.  In addition, each director that serves on a Committee of the Board of Directors received, for each committee served, an additional cash retainer of $10,000, and a grant of 5,000 stock options having a value equal to $8,100, having the same terms and conditions as options granted to all non-employee members of the Board of Directors generally.  The effective date of the above stock options was June 29, 2007, a total of 80,000 shares were granted under the 2006 Equity plan, having an aggregate Black-Scholes value of $129,600.  The options are exercisable through June 29, 2012 at $2.00 per share, the fair market value on the date of grant.  The options vested 50% on June 30, 2007 and 25% each on September 30, 2007 and December 31, 2007.  In addition, to their normal board fees, two directors also served on the Special Committee related to restructuring matters and received additional cash compensation of $60,000 each during 2007.

During the years ended December 31, 2008 and 2007, the Company incurred legal fees of approximately $22,000 and $16,000, respectively, to Davis Shapiro Lewit & Hayes, LLP, a law firm in which Fred Davis, a director of the Company, is a partner.

See Notes 3, 13 and 16 for information with respect to additional related party transactions.

96

13.  STOCKHOLDERS’ EQUITY (DEFICIENCY)

Stock-Based Transactions - - Year Ended December 31, 2008

During the year ended December 31, 2008, the Company did not issue any common stock options or warrants to directors, employees or consultants.

Stock-Based Transactions - - Year Ended December 31, 2007

During the year ended December 31, 2007, the Company issued 23,076 shares of common stock, pursuant to a consulting agreement (see Note 16), and options to purchase 480,000 shares of common stock, including options to purchase 350,000 shares to management, as discussed below.

Effective February 2, 2007, the Company issued to Rene L. Rousselet, the Company’s Corporate Controller and Chief Accounting Officer, a stock option to purchase 50,000 shares of common stock exercisable through February 2, 2012 at $1.50 per share, the fair market value on the date of grant.  The stock option vests and becomes exercisable in equal installments on March 31, 2007, June 30, 2007, September 30, 2007 and December 31, 2007.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $60,000, which was charged to operations during the year ended December 31, 2007.

Effective February 2, 2007, the Company issued to its newly-appointed Vice President of Worldwide Sales, a stock option to purchase 300,000 shares of common stock exercisable through February 2, 2012 at $1.50 per share, the fair market value on the date of grant.  The option with respect to 175,000 shares vests in seven equal quarterly installments on June 30, 2007, September 30, 2007, December 31, 2007, March 31, 2008, June 30, 2008, September 30, 2008 and December 31, 2008, and the option with respect to 125,000 shares vests on the achievement of performance targets to be mutually determined by the parties.  The fair value of the time-vested portion of this stock option, determined pursuant to the Black-Scholes option-pricing model, was $208,000, of which $89,000 was charged to operations during the year ended December 31, 2008 and December 31, 2007.

Effective June 29, 2007, the Company issued to its six non-officer directors stock options to purchase an aggregate of 80,000 shares exercisable through June 29, 2012 at $2.00 per share, the fair market value on the date of grant.  The options vested 50% on June 30, 2007 and 25% each on September 30, 2007 and December 31, 2007.   The fair value of these stock options, determined pursuant to the Black-Scholes option-pricing model, was $129,600, which was charged to operations during the year ended December 31, 2007.

The assumptions used in the Black-Scholes option-pricing model to calculate the fair value of the aforementioned options were as follows:

Stock price on date of grant	$1.50 – $2.30
Risk-free interest rate	4.84 – 5.06	%
Volatility	1.065 – 1.116	%
Dividend yield	0	%
Weighted average expected life (years)	5
Weighted average fair value of option	$1.19 – $1.76

As a result of the resignation of the Company’s former Chief Financial Officer effective August 31, 2007 (see Note 16), the Company agreed to amend certain provisions of stock options previously granted to the former Chief Financial Officer, including the accelerated vesting of certain options.  The Company recorded the fair value of these grants, calculated pursuant to the Black-Scholes option-pricing model, of $215,000 as a charge to operations in 2007.  The assumptions used in the Black-Scholes option-pricing model to calculate the fair value of the amendments to the options were as follows:

Stock price on date of grant	$	3.00
Risk-free interest rate	5.0		%
Volatility	146.3		%
Dividend yield	0		%
Weighted average expected life (years)	5
Weighted average fair value of option	$	2.81

97

Sufficiency of Authorized but Unissued Shares

The Company has concluded, for the reasons described below, that it is highly probable that the Company will have sufficient shares available to satisfy its existing option and warrant obligations to officers, directors, employees, consultants, advisors and others for the foreseeable future (excluding the warrants issued in conjunction with the financing of the MediaDefender transaction described at Note 4, which are accounted for as a derivative liability).

Paragraphs 28 to 35 of SFAS No. 123R describe the types of equity awards that should be classified as a liability, including an option (or similar instrument) that could require the employer to pay an employee cash or other assets, unless cash settlement is based on a contingent event that is (a) not probable and (b) outside the control of the employee.  The Company has concluded that any cash settlement obligation represented by its outstanding options and warrants issued to employees, officers and directors would be triggered only by a contingent event that is both not probable and is outside the control of the equity holder.

Most of the Company’s outstanding options and warrants were issued to employees, officers and directors in compensatory transactions accounted for under SFAS No. 123R.  Of the 3,068,585 options and warrants outstanding at December 31, 2008, 2,886,085 were issued to employees, officers and directors.  The Company believes that potential impact pursuant to EITF 00-19-2 of the remaining 182,500 options and warrants issued to consultants, advisors and others is not material to the consolidated financial statements.  With respect to the 182,500 options and warrants, 20,000 are exercisable at $0.50 per share, 82,500 are exercisable at $1.00 per share and the remaining 80,000 are exercisable at prices ranging from $1.80 per share to $2.90 per share; all such exercise prices are in excess of the current market value of the Company’s common stock.

98

The Company currently has 60,000,000 shares of common stock authorized, of which 10,344,666 shares of common stock were issued at December 31, 2008, resulting in 49,655,334 unissued shares at such date.  If all of the Company’s equity-based instruments were converted or exercised into shares of common stock in accordance with the second amendment dated December 30, 2008, without regard to whether such instruments have vested or are in-the-money, approximately 28,000,000 additional shares would be issued, resulting in a total of approximately 38,000,000 shares of common stock issued and outstanding.  Accordingly, this calculation results in approximately 22,000,000 shares of common stock available for issuance, in excess of all equity commitments that the Company currently has outstanding as of December 31, 2008.  See Subsequent event.

On December 16, 2008, the Company entered into an amendment to the Sub-Debt Notes with Trilogy Capital Partners, Inc., Randy Saaf and Octavio Herrera, the holders of a majority of the aggregate principal amount outstanding of the subordinated convertible notes.  Pursuant to Section 17 of the Subordinated Notes the Majority Holders have the right to approve modifications to the Subordinated Notes.  The amendment decreases the conversion price of the Subordinated Notes from $1.55 to $1.00 per share and waives the requirement of certain holders to give 61 day written notice to increase or decrease the maximum limitation on such holders’ ability to convert the Subordinated Notes held by them.

The Company has approximately $27,658,000 of Sub-Debt Notes outstanding at December 31, 2008, which are convertible into common stock at $1.00 per share and which represent the single largest component of such potential dilution (approximately 27,658,000 shares).

Accordingly, based on the foregoing analysis and the Company’s current capital structure, the Company has concluded that it is highly probable that the Company will have sufficient shares available to satisfy its existing option and warrant obligations for the foreseeable future.  The Company will continue to evaluate this issue and if it becomes probable that there are insufficient authorized shares, the Company will consider alternative accounting treatment at that time.

14.  STOCK-BASED PLANS

2004 Consultant Stock Plan

Effective September 29, 2004, the Company’s Board of Directors adopted the ARTISTdirect, Inc. 2004 Consultant Stock Plan (the “Consultant Plan”) in order for the Company to be able to compensate consultants, at the option of the Company, who provide bona fide services to the Company not in connection with capital raising or promotion of the Company’s securities.  The Consultant Plan will expire on September 29, 2014, and provides for the issuance of up to 500,000 shares of common stock to consultants at fair market value.  On January 13, 2005, the Company filed a Registration Statement on Form S-8 with the Securities and Exchange Commission to register the 500,000 shares of common stock for future issuance under the Consultant Plan.  As of December 31, 2007, no shares had been issued under the Consultant Plan.

2006 Equity Incentive Plan

The Company’s stockholders approved the ARTISTdirect, Inc. 2006 Equity Incentive Plan (the “2006 Equity Plan”) at the Company’s Annual Meeting of Stockholders held on June 19, 2006 (the “Annual Meeting”).  The Board of Directors of the Company had previously approved the 2006 Equity Plan in April 2006.  A total of 1,500,000 new shares of the Company’s common stock have initially been reserved for issuance under the 2006 Equity Plan.  Awards under the 2006 Equity Plan may be granted to any of the Company’s employees, directors, officers, consultants or those of the Company’s affiliates.  Awards may consist of stock options (both incentive stock options and non-statutory stock options), stock awards, stock appreciation rights and cash awards.  An incentive stock option may be granted under the 2006 Equity Plan only to a person who, at the time of the grant, is an employee of the Company or a parent or subsidiary of the Company.  During the year ended December 31, 2006, the Company issued 34,615 shares of common stock pursuant to a consulting agreement (see Notes 13 and 16) and options to purchase 126,551 shares of common stock.  During the year ended December 31, 2007, the Company issued options to purchase 480,000 shares of common stock of which 5,000 were cancelled in 2007 and 150,000 were cancelled in 2008.  No shares of common stock were issued during 2008.  As of December 31, 2008, 1,013,834 shares remained available for future option grant.

99

A summary of stock option activity under the 2006 Equity Plan during the years ended December 31, 2007 and 2008 is as follows:

	Options Outstanding
	Number of Shares		Weighted Average Exercise Price
Options outstanding at December 31, 2006	126,551		$	3.20
Granted	480,000		1.63
Exercised	—		—
Cancelled/expired	(5,000	)	1.50
Options outstanding at December 31, 2007	601,551		1.96
Granted	—		—
Exercised	—		—
Cancelled/expired	(150,000	)	1.50
Options outstanding at December 31, 2008	451.551		$	2.12
Options exercisable at December 31, 2008	451,551		$	2.12

The following table summarizes information regarding options outstanding and options exercisable at December 31, 2008 under the 2006 Equity Plan:

			Options Outstanding				Options Exercisable
				Weighted
				Average	Weighted			Weighted
				Remaining	Average			Average
			Number	Contractual	Exercise		Number	Exercise
Exercise Prices			of Shares	Life	Price		of Shares	Price
	$	1.50	200,000	3.09	$	1.50	200,000	$	1.50
	$	1.55	5,000	2.91	$	1.55	5,000	$	1.55
	$	1.80	5,000	2.91	$	1.80	5,000	$	1.80
	$	1.90	5,000	2.91	$	1.90	5,000	$	1.90
	$	2.00	10,000	2.91	$	2.00	10,000	$	2.00
	$	2.00	80,000	3.49	$	2.00	80,000	$	2.00
	$	2.15	5,000	2.91	$	2.15	5,000	$	2.15
	$	2.20	5,000	2.91	$	2.20	5,000	$	2.20
	$	2.25	5,000	2.91	$	2.25	5,000	$	2.25
	$	2.30	5,000	2.91	$	2.30	5,000	$	2.30
	$	2.35	5,000	2.91	$	2.35	5,000	$	2.35
	$	2.90	30,000	2.91	$	2.90	30,000	$	2.90
	$	3.35	91,551	2.91	$	3.35	91.551	$	3.35
	$	1.50-$3.35	451,551	3.01	$	2.12	451,551	$	2.12

The weighted average grant date fair value of stock options issued during the year ended December 31, 2007 was $1.63 per share and no options were issued the year ended December 31, 2008.

The intrinsic value of exercisable but unexercised in-the-money options at December 31, 2008 was $0.

100

The following table summarizes information regarding the Company’s non-vested options under the 2006 Equity Plan as of December 31, 2007 and 2008, and the changes during such years:

	Number  of Shares
Options outstanding but unvested at December 31, 2006	—
Granted	480,000
Vested	(250,000	)
Forfeited	(5,000	)
Expired	—
Options outstanding but unvested at December 31, 2007	225,000
Granted	—
Vested	(75,000	)
Forfeited	(150,000	)
Expired	—
Options outstanding but unvested at December 31, 2008	—

As of December 31, 2008, unrecognized compensation cost related to unvested stock options under the 2006 Equity Plan will be 0.

1999 Employee Stock Option Plan

In October 1999, the Company implemented the 1999 Employee Stock Option Plan (the “Employee Plan”).  The Employee Plan was not approved by the public stockholders of the Company.  The Employee Plan has currently reserved 1,273,004 shares of the Company’s common stock for issuance to employees, non-employee members of the board of directors and consultants.  This share reserve automatically increases on the first trading day in January each calendar year by an amount equal to 2% of the total number of shares of the Company’s common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 87,500 shares.  No option may have a term in excess of ten years.  The options generally vest within three years.  As of December 31, 2008, 500,614 shares remained available for future option grant.

A summary of stock option activity under the Employee Plan during the years ended December 31, 2007 and 2008 is as follows:

	Options Outstanding
	Number of Shares		Weighted Average Exercise Price
Options outstanding at December 31, 2006	864,762		$	3.88
Granted	—		—
Exercised	(35,375	)	0.79
Cancelled/expired	(11,310	)	91.41
Options outstanding at December 31, 2007	818,077		2.81
Granted	—		—
Exercised	—		—
Cancelled/expired	(45,687	)	7.5
Options outstanding at December 31, 2008	772,390		$	2.53
Options exercisable at December 31, 2008	762,866		$	2.52

101

The following table summarizes information regarding options outstanding and options exercisable at December 31, 2008 under the Employee Plan:

			Options Outstanding				Options Exercisable
				Weighted
				Average	Weighted			Weighted
				Remaining	Average			Average
			Number	Contractual	Exercise		Number	Exercise
Exercise Prices			of Shares	Life	Price		of Shares	Price
	$	0.79	66,558	3.24	$	0.79	66,558	$	0.79
	$	1.00	82,500	1.35	$	1.00	82,500	$	1.00
	$	1.95	170,000	3.69	$	1.95	170,000	$	1.95
	$	3.00	400,000	1.57	$	3.00	390,476	$	3.00
	$	4.80	33,332	0.77	$	4.80	33,332	$	4.80
	$	5.10	10,000	0.77	$	5.10	10,000	$	5.10
	$	7.50	10,000	0.88	$	7.50	10,000	$	7.50
	$	0.79-$7.50	772,390	2.09	$	2.53	762,866	$	2.52

The intrinsic value of exercisable but unexercised in-the-money options at December 31, 2008 was $0. The intrinsic value of options exercised during the years ended December 31, 2008 and 2007 was $0 and $75,000, respectively.

The following table summarizes information regarding the Company’s non-vested options under the Employee Plan as of December 31, 2007 and 2008, and the changes during such years:

	Number of Shares
Options outstanding but unvested at December 31, 2006	238,095
Vested	(114,285	)
Forfeited	—
Expired	—
Options outstanding but unvested at December 31, 2007	123,810
Vested	(114,286	)
Forfeited	—
Expired	—
Options outstanding but unvested at December 31, 2008	9,524

As of December 31, 2008, unrecognized compensation costs of $26,000 related to unvested stock options under the Employee Plan will be charged to operations in the year ending December 31, 2009.

1999 Artist and Artist Advisor Option Plan

In June 1999, and as amended in October 1999 and March 2000, the Company adopted the 1999 Artist and Artist Advisor Stock Option Plan (the “Advisor Plan”).  The Advisor Plan was not approved by the public stockholders of the Company.  The Advisor Plan has currently reserved 477,159 shares of common stock for issuance to artists for whom the Company entered into agreements related to online and e-commerce activities and their agents, business managers, attorneys and other advisors.  This share reserve automatically increases on the first trading day in January each calendar year by an amount equal to 1% of the total number of shares of the Company’s common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 37,500 shares.  As of December 31, 2008, 477,159 shares remained available for future option grants.  The options expire seven years from the date of grant and vesting generally varies between one to three years.  No new option grants under this plan were made during 2007 or 2008.

102

A summary of stock option activity under the Advisor Plan during the years ended December 31, 2007 and 2008 is as follows:

	Options Outstanding
	Number of Shares		Weighted Average Exercise Price
Options outstanding at December 31, 2006	29,864		$	139.28
Granted	—		—
Exercised	—		—
Cancelled/expired	(29,864	)	139.28
Options outstanding at December 31, 2007	—		—
Granted	—		—
Exercised	—		—
Cancelled/expired	—		—
Options outstanding at December 31, 2008	—		$	—

1999 Artist Stock Plan

In June 1999, and as amended in October 1999, the Company adopted the 1999 Artist Stock Plan (the “Artist Plan”).  The Artist Plan was not approved by the public stockholders of the Company.  The Artist Plan currently has reserved 1,023,004 shares of common stock for issuance to artists for whom the Company entered into agreements related to their online and e-commerce activities.  This share reserve automatically increases on the first trading day in January each calendar year by an amount equal to 2% of the total number of shares of the Company’s common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 87,500 shares.  As of December 31, 2008, 1,023,004 shares remained available for future option grants.  The options expire seven years from the date of grant and vesting generally varies between one to three years.  No new option grants under this plan were made during 2007 or 2008.

A summary of stock option activity under the Artist Plan during the years ended December 31, 2007 and 2008 is as follows:

	Options Outstanding
	Number of Shares		Weighted Average Exercise Price
Options outstanding at December 31, 2006	10,375		$	139.28
Granted	—		—
Exercised	—		—
Cancelled/expired	(10,375	)	139.28
Options outstanding at December 31, 2007	—		—
Granted	—		—
Exercised	—		—
Cancelled/expired	—		—
Options outstanding at December 31, 2008	—		$	—

As of December 31, 2008, unrecognized compensation cost related to all unvested stock options (plan and non-plan) of $26,000 will be charged to operations in the year ending December 31, 2009.

103

1999 Employee Stock Purchase Plan

In October 1999, the Company adopted the 1999 Employee Stock Purchase Plan that initially reserved 50,000 shares of common stock for issuance under this plan.  As of December 31, 2008, this plan had 250,000 shares reserved for issuance, of which 237,831 shares remained available for future issuances.  This share reserve automatically increases on the first trading day in January each calendar year, by an amount equal to 1% of the total number of shares of the Company’s common stock outstanding on the last trading day of December in the prior calendar year, but in no event will this annual increase exceed 25,000 shares.  Terms of the plan permit eligible employees to purchase common stock through payroll deduction of up to 15% of each employee’s compensation.  The accumulated deductions are applied to the purchase of shares on each semi-annual purchase date at a purchase price per share equal to 85% of the fair market value per share on the participant’s entry date into the offering period or the semi-annual purchase date, whichever is lower.  During the years ended December 31, 2007 and 2008, no shares were issued under this plan.

Non-Plan Options Outstanding

Effective September 29, 2003, the Company issued to Jonathan V. Diamond, the Company’s Chief Executive Officer, a non-plan, non-qualified stock option to purchase 259,659 shares of common stock exercisable through August 15, 2010 at $0.85 per share, which was the approximate fair market value of the common stock on the date of grant.  The option vested over a period of three years from the date of grant, and was fully vested in 2006.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $221,000, of which $36,000 was charged to operations in 2006.

Effective March 29, 2004, the Company issued to Robert N. Weingarten, the Company’s Chief Financial Officer, a non-plan, non-qualified stock option to purchase 120,000 shares at $0.50 per share, which was not less than the fair market value on the date of grant, exercisable through March 29, 2011.  The option vested and became exercisable in a series of thirty-six successive equal monthly installments from March 29, 2004 through March 29, 2007.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $42,000, of which $0 and $3,500 was charged to operations in 2008 and 2007, respectively.

Effective May 31, 2001, the Company issued to Frederick W. (Ted) Field, the Company’s Chairman and former Chief Executive Officer, a non-qualified stock option to purchase 302,370 shares of common stock exercisable at $7.50 per share through May 30, 2008.  The option vested over a period of five years from June 29, 2001, and was fully vested in 2006.  The fair value of the stock option, determined pursuant to the Black-Scholes option-pricing model, was $2,006,000, of which $201,000 was charged to operations in 2006.

15.  401(K) PLAN

The Company has adopted the Cash or Deferred Profit Sharing Plan and Trust under Section 401(k) of the Internal Revenue Code (the “401(k) Plan”).  Under the 401(k) Plan, participating employees may defer a percentage (not to exceed 15%) of their eligible pretax earnings up to the Internal Revenue Service’s annual contribution limit.  All employees of the Company who are 21 years or older and who complete three months of service are eligible to participate in the 401(k) Plan.  The Company does not match contributions by participants to the 401(k) Plan.  Accordingly, there is no related expense for the years ended December 31, 2008 and 2007.

16.  COMMITMENTS AND CONTINGENCIES

Lease Commitments

On January 30, 2006, the Company entered into a sub-lease agreement for office facilities in Santa Monica, California, effective February 2, 2006 through November 30, 2011, to house the operations of ADI and MediaDefender.  In connection with the sub-lease agreement, the Company provided an irrevocable standby bank letter of credit for $180,000 as security for the Company’s obligations under the sub-lease agreement, which was secured by cash of $180,000, which was classified as restricted cash in the Company’s balance sheet.  Pursuant to the terms of the sub-lease agreement, the letter of credit was reduced to $90,000 during February 2007.

This lease contains predetermined fixed increases in the minimum rental rate during the initial lease term.  The Company began to recognize the related rent expense on a straight-line basis on the effective date of the lease.  The Company records the difference between the amount charged to expense and the rent paid as deferred rent on the Company’s balance sheet.

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Future cash payments under such operating lease are as follows (amounts are in thousands):

Years Ending December 31,
2009	485
2010	499
2011	471
	$	1,455

Rent expense under operating leases for the years ended December 31, 2008 and 2007 was $470,000 and $441,000.

Employment Agreements

On July 28, 2005, the Company entered into an Employment Agreement with Jonathan Diamond to serve as the Company’s Chief Executive Officer. During the term of the Employment Agreement through December 31, 2008, Mr. Diamond’s base salary would be no less than $350,000 per annum, plus certain specified perquisites that include a monthly car allowance. Mr. Diamond was also eligible to receive an annual discretionary bonus of up to 100% of base salary, as determined by the Compensation Committee of the Board of Directors or, if none, the Board of Directors, and an annual performance bonus of up to 100% of base salary if the Company achieved defined earnings before interest, taxes, depreciation and amortization in fiscal 2007 ($12,000,000 - $14,400,000) and fiscal 2008 ($15,000,000 - $18,000,000). Mr. Diamond was also entitled to receive stock options at the discretion of the Company’s Board of Directors. In the event Mr. Diamond was terminated “without cause,” he would be entitled to receive 12 months of severance pay at the rate of 100% of his monthly salary, any performance bonus due for the year in which termination occurs and all stock options subject to time vesting shall be deemed fully vested and exercisable.  On October 14, 2005, February 3, 2006, June 19, 2006 and July 31, 2006, the Company entered into agreements with Mr. Diamond to incorporate non-material modifications into the Employment Agreement.

Pursuant to an Amended and Restated Services Agreement dated as of March 6, 2008 (the “Services Agreement”) between the Company and Mr. Diamond, Mr. Diamond’s employment as Chief Executive Officer was ended and he was elected as the Company’s Chairman of the Board of Directors (the “Chairman”) effective March 6, 2008.  Under the Services Agreement, in consideration of Mr. Diamond’s waiver of his rights contained in the Employment Agreement dated as of July 28, 2005 (the “Prior Agreement”), the execution by Mr. Diamond of a general release in favor of the Company and its affiliates, and his agreement to serve as Chairman, the Company agreed to (a) pay Mr. Diamond a severance payment of $350,000 payable in semi-monthly installments for a period of six months, (b) accelerate the vesting of Mr. Diamond’s “Time Vesting” options, (c) accelerate the vesting of Mr. Diamond’s options granted in 2004 to purchase 259,659 shares (the “2004 Options”), (d) extend to February 5, 2011 the exercisability of the Time Vesting Options and to March 29, 2011 for the 2004 Options, and (e) pay Mr. Diamond his accrued base salary through February 29, 2008 and 40 days of accrued vacation time.

On July 28, 2005, the Company entered into an Employment Agreement with Robert Weingarten to serve as the Company’s Chief Financial Officer. During the term of the Employment Agreement through December 31, 2008, Mr. Weingarten’s base salary would be no less than $195,000 per annum, plus certain specified perquisites that include a monthly car allowance. Mr. Weingarten was also eligible to receive an annual discretionary bonus of up to 100% of base salary, as determined by the Compensation Committee of the Board of Directors or, if none, the Board of Directors, and an annual performance bonus of up to 100% of base salary if the Company achieved defined earnings before interest, taxes, depreciation and amortization in fiscal 2007 ($12,000,000 - $14,400,000) and fiscal 2008 ($15,000,000 - $18,000,000). Mr. Weingarten was also entitled to receive stock options at the discretion of the Company’s Board of Directors. In the event Mr. Weingarten was terminated “without cause,” he would be entitled to receive 12 months of severance pay at the rate of 100% of his monthly salary, any performance bonus due for the year in which termination occurs and all stock options subject to time vesting shall be deemed fully vested and exercisable.  On February 3, 2006, June 19, 2006 and July 31, 2006, the Company entered into agreements with Mr. Weingarten to incorporate non-material modifications into the Employment Agreement.

Effective August 31, 2007, Mr. Weingarten resigned from all positions he held with the Company.  The Company and Mr. Weingarten entered into a Separation Agreement and Release dated August 31, 2007, whereas the Company and Mr. Weingarten mutually agreed to terminate their employment relationship as of August 31, 2007 and the parties released each other from any and all claims.  As a result of this resignation, the Company and Mr. Weingarten entered into an Agreement for Consulting Services (the “Consulting Agreement”) dated August 31, 2007 whereas Mr. Weingarten would be retained as a consultant for a twelve-month period, unless sooner terminated pursuant to the terms of the Consulting Agreement, and shall be paid a base consulting fee of $16,250 per month.  Upon the expiration of the Consulting agreement the Company entered into an open consulting agreement within Mr. Weingarten would be paid and hourly fee for services rendered and would be reimbursed for expenses incurred on a monthly invoice.

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In addition, the Company and Mr. Weingarten entered into an Omnibus Stock Option Amendment Agreement (the “Option Agreement”) dated August 31, 2007 whereas the Company agreed to amend certain provisions of stock options previously granted to Mr. Weingarten (see Note 13).  Mr. Weingarten would be allowed to exercise the 120,000 stock options granted to him in 2004 until the original expiration date of March 29, 2011 without regard to his resignation from the Company.  Pursuant to the Option Agreement, the vesting of time-vesting options to acquire 275,000 shares will be accelerated provided he does not breach the Consulting Agreement such that the remaining unvested time-vesting options became fully vested and exercisable as of August 31, 2007.  The vesting of the performance-vesting options to acquire 275,000 shares will occur only upon the closing of a sale, merger or other “change of control” transaction at a price above $3.10 per share occurring prior to August 31, 2008 provided he does not breach the Consulting Agreement.  In addition, Mr. Weingarten will be able to exercise the time-vesting options and the performance-vesting options, if vested, until August 5, 2010, without regard to his resignation provided he does not breach the Consulting Agreement.

In accordance with the MediaDefender transaction, the Company acknowledged the terms of Employment Agreements entered into on July 28, 2005 by MediaDefender with each of Randy Saaf, who serves as Chief Executive Officer of MediaDefender, and Octavio Herrera, who serves as President of MediaDefender. Mr. Saaf and Mr. Herrera will each earn a base salary of no less than $350,000 per annum during the initial term of the agreements, which shall continue until December 31, 2008, and are also each entitled to receive performance bonuses of up to $350,000 if MediaDefender achieves defined operating earnings before interest, taxes, depreciation and amortization (calculated using the same accounting methods and policies as MediaDefender has historically used) exceeding $7,000,000 and $7,500,000 in fiscal 2007 and fiscal 2008, respectively.  The Company determined to pay the performance bonuses to Mr. Saaf and Mr. Herrera for 2007, however there were no bonuses due for the year ended December 31, 2008.

In addition, the Company granted stock options to purchase 200,000 shares of common stock to each of Mr. Saaf and Mr. Herrera, exercisable for a period of five years at $3.00 per share and vesting quarterly over a period of three and one-half years.  On July 28, 2006, the Company entered into agreements with Mr. Saaf and Mr. Herrera to incorporate non-material modifications into the Employment Agreements.

Consulting Agreements

On October 9, 2006, the Company entered into an eighteen-month non-exclusive consulting agreement with Wood River Ventures, LLC and Jonathan Dolgen for consulting and advisory services with respect to the business and operations of the Company.  The consulting agreement provided for an aggregate cash fee of $187,500, payable quarterly in six installments of $31,250, and a stock award valued at $112,500, consisting of 34,615 shares of common stock based on the Company’s closing stock price on October 10, 2006 of $3.25 per share to be issued under the Company’s 2006 Equity Incentive Plan.  The shares vest pro rata over the eighteen-month period of the consulting agreement, beginning on October 10, 2006 and thereafter monthly on the first day of each month of the term of the consulting agreement through March 2008.  Accordingly, during the years ended December 31, 2007 and 2006, the Company issued 23,076 shares and 5,769 shares of common stock under this consulting agreement with a fair value of $75,000 and $19,000, which was charged to operations (see Note 13).

On October 1, 2006, the Company entered into a one-year non-exclusive consulting agreement with an entity for business development consulting services.  The consulting agreement provides for an aggregate cash fee of $108,000, consisting of an initial payment of $18,000 and a base fee payable monthly in twelve installments of $7,500, and stock options, consisting of an initial award of options to acquire 25,000 shares of common stock, and subsequent awards of options to acquire 5,000 shares of common stock on the last day of each month of the term of the consulting agreement through September 30, 2007.

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The stock options are fully vested when issued.  Accordingly, during the years ended December 31, 2008 and 2007, the Company issued options to acquire 0 shares and 45,000 shares of common stock under this consulting agreement pursuant to the Company’s 2006 Equity Incentive Plan, exercisable through November 30, 2011, at prices ranging from $1.55 to $2.30 per share, the market price on the date of grant.  The aggregate fair value of the options, calculated pursuant to the Black-Scholes option-pricing model was $0 and $71,000, respectively, which was charged to operations (see Note 13).

Legal Matters

The Company is periodically subject to various pending and threatened legal actions that arise in the normal course of business.  The Company’s management believes that the impact of any such litigation will not have a material adverse impact on the Company’s financial position or results of operations.

As a result of the restatement of our financial statements and the other events described elsewhere in this Annual Report on Form 10-K, the Company has triggered various events of default under our senior debt and subordinated debt financing documents.  We could be subject to future claims under our financing documents (see Note 18).

17.  REPORTABLE SEGMENTS

Information with respect to the Company’s operating segments for the years ended December 31, 2008 and 2007 is presented below.  During the years ended December 31, 2008 and 2007, the Company’s operations consisted of three reportable segments:  e-commerce, media and anti-piracy and file-sharing marketing services.

The factors for determining reportable segments were based on services and products.  Each segment is responsible for executing a unique marketing and business strategy.  The accounting policies of the segments are as described in the summary of significant accounting policies.  The Company evaluates performance based on, among other factors, earnings or loss before interest, taxes, depreciation and amortization (“Adjusted EBITDA”).  Adjusted EBITDA also excludes stock-based compensation, changes in the fair value of warrant liability and derivative liability, and other non-cash write-offs and charges.  Included in Adjusted EBITDA are direct operating expenses for each segment.

The table shown below summarizes net revenue and Adjusted EBITDA by operating segment for the years ended December 31, 2008 and 2007.  Corporate expenses consist of general operating expenses that are not directly related to the operations of the segments.  A reconciliation of Net Income (Loss) to Adjusted EBITDA is also provided.

	Years Ended December 31,
	2008			2007
	(in thousands)
Net Revenue:
E-commerce	$	336		$	1,497
Media	3,995			7,500
Anti-piracy and file-sharing marketing services	7,810			15,174
	$	12,141		$	24,171
Adjusted EBITDA:
E-commerce	$	(88	)	$	(218	)
Media	264			2,604
Anti-piracy and file-sharing marketing services	264			5,304
	440			7,690
Corporate:
General and administrative expenses	(3,635		)	(4,824		)
Liquidated damages under registration rights agreements	—			395
	$	(3,195	)	$	3,261

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	Years Ended December 31,
	2008			2007
	(in thousands)
Reconciliation of Adjusted EBITDA to Net Income (Loss):
Adjusted EBITDA per segments	$	(3,195	)	$	3,261
Stock-based compensation	(991		)	(2,110		)
Depreciation and amortization	(906		)	(1,015		)
Amortization of intangible assets	(2,181		)	(3,602		)
Amortization of deferred financing costs	(842		)	(841		)
Goodwill Impairment	(31,085		)	—
Write-off of unamortized discount on debt and deferred financing costs resulting from principal payments on senior secured notes payable	(25		)	—
Interest income	51			211
Other income	340			—
Write-off of fixed assets	—			(97		)
Interest expense, including amortization of discount on debt of $3,088 and $3,081 in 2008 and 2007, respectively	(8,740		)	(7,923		)
Change in fair value of warrant liability	130			4,551
Change in fair value of derivative liability	302			18,043
Provision (benefit) for income tax	(814		)	1,039
Net income (loss)	$	(47,956	)	$	11,517

The following table summarizes assets as of December 31, 2008 and 2007.  Assets by segment are those assets used in or employed by the operations of each segment.  Corporate assets are principally made up of cash and cash equivalents, prepaid expenses, computer equipment, leasehold improvements and other assets.

	December 31,
	2008		2007
	(in thousands)
Assets:
Corporate	$	1,437	$	3,144
E-commerce	241		248
Media	1,441		2,149
Anti-piracy and file-sharing marketing services	4,370		44,923
	$	7,489	$	50,734

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18.  SUBSEQUENT EVENTS (UNAUDITED)

Debt Restructuring

Senior Debt Restructuring

Effective January 30, 2009, ARTISTdirect, Inc. (the “Company”) entered into a First Amendment to Note and Warrant Purchase Agreement dated as of December 31, 2008 (the “Senior Amendment”) with the holders of the Company’s senior secured debt (the “Senior Note Holders”).  Pursuant to the Senior Amendment, the Senior Note Holders agreed to extinguish all obligations by the Company under the Note and Warrant Purchase Agreement, dated July 28, 2005, and other documents entered into in connection with the senior secured debt transaction (the “Senior Debt Restructuring”), upon completion of the following: (1) $3,500,000 cash payment to the Senior Note Holders; (2) issuance of new subordinated notes, in the aggregate principal amount of $1,000,000, to the Senior Note Holders (the “New Notes”); (3) issuance of 9,000,000 restricted shares of the Company’s common stock to the Senior Note Holders, which are subject to a lock-up period of 12 months; and (4) the conversion of all of the previously issued Subordinated Notes.

The New Notes are unsecured and bear interest at 6.0% per annum, beginning January 30, 2009. The principal and the interest accrued thereon are payable on the maturity date, January 30, 2014, and are subordinated to the senior indebtedness of the Company.

Additionally, in connection with the Senior Debt Restructuring, Trilogy Capital Partners, Inc. agreed to deliver to the Company for cancellation a warrant to purchase up to 433,333 shares of the Company’s capital stock at an exercise price of $2.00 per share.  Fifty percent of such warrant was beneficially owned by Dimitri Villard, the Company’s Chief Executive Officer, who had acquired such warrants as part of the acquisition of 6,190,000 shares from Trilogy Capital Partners, Inc., which occurred on January 15, 2009.

Conversion of Subordinated Notes

In connection with the Senior Debt Restructuring, effective January 30, 2009, the Company entered into a Second Amendment to the Convertible Subordinated Note with holders of the Subordinated Notes representing no less than the majority of the current outstanding aggregate principal amount to provide for the immediate conversion of the Subordinated Notes (the “Subordinated Amendment”). The Subordinated Amendment also provides for the extinguishment of all obligations of the Company under the Subordinated Notes and related documents, including the Registration Rights Agreement among the Company and the holders.  Such obligations included the outstanding principal amount and accrued and unpaid interest on the Subordinated Notes, accrued and unpaid late charges and amounts owed under the Registration Rights Agreement.

Financing by Factoring Accounts Receivables

On January 30, 2009, the Company’s two wholly-owned subsidiaries, ARTISTdirect Internet Group, Inc. (“ADIG”) and MediaDefender, Inc. each entered into an Accounts Receivable Purchase & Security Agreement (the “A/R Agreement”) with Pacific Business Capital Corporation (“PBCC”), pursuant to which ADIG and Mediadefender agreed to sell and PBCC agreed to purchase qualified accounts receivable on a recourse basis. On January 30, 2009, PBCC purchased an aggregate of approximately $1,600,000 of unpaid receivables to be acquired by PBCC pursuant to the A/R Agreement, subject to a maximum aggregate amount of $3,000,000. The A/R Agreement is effective for twelve-months and automatically renews for successive 12-month periods unless terminated by written notice by either party 30 days prior to such successive period.

As collateral for the financing, PBCC received a first priority interest in all existing and future assets of the Company, ADIG and Mediadefender, tangible and intangible, including but not limited to, cash and cash equivalents, accounts receivable, inventories, other current assets, furniture, fixtures and equipment and intellectual property. In addition to the foregoing, the Company, ADIG and Mediadefender entered into cross guarantees of their respective obligations under the A/R Agreement.

The following table is a proforma presentation of the Consolidated Balance Sheet reflecting the above described Debt Restructuring as if it had occurred as of December 31, 2008.

	December 31, 2008
	Audited			Proforma
Assets:
Cash	$	2,262,000		$	12,000
Other current assets, net	3,480,000			3,480,000
Property and equipment, net	1,201,000			1,201,000
Other non-current assets, net	546,000			153,000
	$	7,489,000		$	4,846,000
Liabilities and Stockholders’ Equity (Deficiency)
Accounts payable and accrued expenses	$	921,000		$	971,000
Accrued interest and liquidated damages	8,890,000			—
New credit facility	—			1,250,000
Senior secured notes, net	12,817,000			—
Subordinated convertible notes, net	26,397,000			—
Other current liabilities	1,228,000			1,183,000
	50,253,000			3,404,000
New subordinated notes, net of discount	—			270,000
Other long-term liabilities	159,000			159,000
	159,000			429,000
Net Stockholders’ Equity (Deficiency), net	(42,923,000		)	1,013,000
	$	7,489,000		$	4,846,000

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Convertible short-term note to Director

On March 3, 2009, the Company issued a convertible note (the “Note”) to Frederick W. Field, a director of the Company.  The Note is in the principal amount of $200,000 with the principal amount and accrued interest at the rate of 5% per annum due on July 31, 2009.  The Note is automatically convertible into shares of the Company’s Common Stock at a price of $0.03 per share at such time as the Company has sufficient authorized shares.

Management and Director Changes

Effective January 13, 2009, each of Randy Saaf and Octavio Herrera (each, an “Executive”) entered into separate amendments (collectively, the “Amendments”) to their respective Employment, Confidentiality and Noncompetition Agreements (collectively, the “Employment Agreements”) dated as of July 28, 2005 with MediaDefender, Inc., the Company’s wholly owned subsidiary (the “Subsidiary”).  Under each of the Amendments, commencing January 1, 2009 the term of employment between each Executive and the Subsidiary were at-will, and either the Subsidiary or the Executive may terminate the applicable Employment Agreement upon five days’ written notice, in which case such Executive shall have a period of 60 days from the effective date of termination to exercise all vested stock options. Effective February 15, 2009, MediaDefender, Inc., a wholly-owned subsidiary of ARTISTdirect, Inc., terminated the employment of Randy Saaf, Chief Executive Officer of MediaDefender, and Octavio Herrera, President of MediaDefender.

Effective February 1, 2009, Dimitri Villard, the Chairman of the Board of Directors, was appointed to serve as the Company’s Chief Executive Officer. Prior to that date, Mr. Villard was the Company’s interim Chief Executive Officer.

Pursuant to a 3-year employment agreement, effective February 1, 2009, Mr. Villard will receive base compensation equal to $25,000 per month.  Mr. Villard will also be entitled to participate in the Company’s stock compensation plan that may exist from time to time and will receive a bonus based on the Company’s EBITDA if the Company’s EBITDA exceeds a certain threshold amount as determined by the Company’s Compensation Committee for such fiscal year.

Effective February 1, 2009, the Company and Rene Rousselet (“Executive”) entered into an Employment Agreement pursuant to which Mr. Rousselet was employed to continue as the Company’s Corporate Controller and Principal Accounting Officer.  The employment is on an “at will basis.”  Mr. Rousselet will receive a salary of $14,583 per month subject to increases and a bonus as determined by the Board of Directors, in its sole discretion.  Mr. Rousselet was granted options to purchase 560,000 shares of the Common Stock of the Company at $0.03 per share vesting monthly over 36 months commencing February 1, 2009.  If Mr. Rousselet’s employment is terminated without cause, Mr. Rousselet will receive his salary and vesting of options for an additional period of three months from the date of termination.

Acquisition of MediaSentry

The Company and its wholly owned subsidiary, MediaDefender entered into an Asset Purchase Agreement dated as of March 30, 2009 (the “Purchase Agreement”) pursuant to which the Company through MediaDefender agreed to purchase from SafeNet, Inc. and MediaSentry, Inc. (collectively the “Sellers”), substantially all the assets of the MediaSentry operating unit (the “Acquired Assets”).  In connection with the acquisition, MediaDefender acquired the receivables, equipment and intellectual property of MediaSentry as well as assumed substantially all the employees, offices and client contracts relating to MediaSentry.  The purchase price of the Acquired Assets was $936,000 consisting of $136,000 in cash and a $800,000 one-year promissory note of the Company.  The acquisition was consummated on March 30, 2009.  The MediaSentry operating unit provides (a) comprehensive business and marketing intelligence services for digital media measurement and (b) services to globally detect, track and deter the unauthorized distribution of digital content.

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INDEX TO EXHIBITS

EXHIBIT NUMBER	DESCRIPTION
2.1	Agreement and Plan of Merger, dated July 28, 2005, by and among ARTISTdirect, Inc., ARTISTdirect Merger Sub, Inc. and MediaDefender, Inc. (incorporated by reference to current report on Form 8-K filed on August 5, 2005).
3.1	Fourth Amended and Restated Certificate of Incorporation of ARTISTdirect, Inc. (incorporated by reference to Exhibit 3.1 to current report on Form 8-K filed on June 22, 2006).
3.2	Amended and Restated Bylaws of ARTISTdirect, Inc. (incorporated by reference to current report on Form 8-K filed on April 18, 2006).
4.1	Form of 11.25% Senior Note Due July 28, 2009 issued to each of the Senior Financing investors dated July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.2	Form of Warrant to Purchase Common Stock issued to each of the Senior Financing investors dated July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.3	Registration Rights Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and each of the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.4	Form of Convertible Subordinated Note issued to each of the Sub-debt investors dated July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.5	Form of Sub-Debt Financing Warrant issued July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.6	Registration Rights Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and each of the Sub-Debt Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.7	Warrant issued to Libra FE, LP on July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.8	Registration Rights Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and Libra FE, LP. (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.9	Warrant issued to WNT07, LLC on July 28, 2005 (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
4.10	Waiver of Registration Rights Agreement, dated November 25, 2005, by and among ARTISTdirect, Inc. and certain of the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on November 30, 2005).
4.11	Waiver of Registration Rights Agreement, dated November 25, 2005, by and among ARTISTdirect, Inc. and certain of the Sub-Debt Financing investors (incorporated by reference to current report on Form 8-K filed on November 30, 2005).
4.12	Omnibus Amendment to Note and Warrant Purchase Agreement and Warrants to Purchase Common Stock by and between ARTISTdirect, Inc. and the Senior Financing investors dated April 7, 2006 (incorporated by reference to current report on Form 8-K filed on April 10, 2006).
4.13	Amendment No.1 to Registration Rights Agreement by and between ARTISTdirect, Inc. and the Senior Financing investors dated April 7, 2006 (incorporated by reference to current report on Form 8-K filed on April 10, 2006).

E-1

4.14	Omnibus Amendment and Waiver to Notes and Warrants Issued Pursuant to Securities Purchase Agreement by and between ARTISTdirect, Inc. and the Senior Financing investors dated April 7, 2006 (incorporated by reference to current report on Form 8-K filed on April 10, 2006).
4.15	Amendment No.1 to Registration Rights Agreement executed by ARTISTdirect, Inc. and CCM Master Qualified Fund dated April 7, 2006 (incorporated by reference to current report on Form 8-K filed on April 10, 2006).
4.16	Amendment No.1 to Registration Rights Agreement executed by ARTISTdirect, Inc. and DKR SoundShore Oasis Holding Funding, Ltd. dated April 7, 2006 (incorporated by reference to current report on Form 8-K filed on April 10, 2006).
4.17	First Amendment to Convertible Subordinated Note, dated December 16, 2008, by and among ARTISTdirect, Inc., Trilogy Capital Partners, Inc., Randy Saaf and Octavio Herrera (incorporated by reference to Exhibit 4.1 to current report on Form 8-K filed on December 19, 2008).
4.18	Second Amendment to Subordinated Convertible Subordinated Note, dated as of December 31, 2008, by and among ARTISTdirect, Inc., DKR Soundshore Oasis Holding Fund Ltd., Trilogy Capital Partners, Inc., Michael Rapp, Broadband Capital Management, LLC, Philip Wagenheim, Karl Brenza, Jeffrey Meshel and Cliff Chapman (incorporated by reference to Exhibit 4.1 to current report on Form 8-K filed on February 4, 2009).
4.19	Form of Subordinated Note, dated as of January 30, 2009, issued to each of the Senior Lenders (incorporated by reference to Exhibit 4.2 to current report on Form 8-K filed on February 4, 2009).
10.1	Notice of Grant of Stock Option dated as of September 29, 2003 by and between ARTISTdirect, Inc. and Jon Diamond (incorporated by reference to quarterly report on Form 10-Q filed on November 14, 2003).
10.2	Settlement, Release and Termination of Lease Agreement dated as of September 8, 2003, by and between 5670 Wilshire L.P. and ARTISTdirect, Inc. (incorporated by reference to quarterly report on Form 10-Q filed on November 14, 2003).
10.3	Form of Director Indemnification Agreement (incorporated by reference to registration statement on Form S-1/A filed on January 27, 2000).
10.4	Form of Officer Indemnification Agreement (incorporated by reference to registration statement on Form S-1/A filed on January 27, 2000).
10.5	ARTISTdirect, Inc. 1999 Employee Stock Option Plan (incorporated by reference to registration statement on Form S-1/A filed on January 27, 2000).
10.6	ARTISTdirect, Inc. Artist Plan (incorporated by reference to registration statement on Form S-1/A filed on January 27, 2000).
10.7	ARTISTdirect, Inc. Artist and Artist Advisor Plan (incorporated by reference to registration statement on Form S-1/A filed on January 27, 2000).
10.8	ARTISTdirect, Inc. 2004 Consultant Stock Plan (incorporated by reference to registration statement on Form S-8 filed on January 13, 2005).
10.9	Notice of Grant of Stock Option dated as of March 29, 2004 by and between ARTISTdirect, Inc. and Robert N. Weingarten (incorporated by reference to quarterly report on Form 10-Q filed on August 20, 2004).
10.10	ARTISTdirect, Inc. 2006 Equity Incentive Plan (incorporated by reference to definitive proxy statement on Schedule 14A filed on May 8, 2006).

E-2

10.11	Employment, Confidentiality and Noncompetition Agreement, dated July 28, 2005, by and between MediaDefender, Inc. and Randy Saaf (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.12	Employment, Confidentiality and Noncompetition Agreement, dated July 28, 2005, by and between MediaDefender, Inc. and Octavio Herrera (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.13	Non-Competition Agreement, dated July 28, 2005, entered into between MediaDefender, Inc. and Randy Saaf (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.14	Non-Competition Agreement, dated July 28, 2005, entered into between MediaDefender, Inc. and Octavio Herrera (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.15	Note and Warrant Purchase Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc., the investors indicated on the schedule of buyers thereto and U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.16	Security Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and its subsidiaries and U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005)
10.17	Pledge Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.18	Form of Copyright Security Agreement (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.19	Patent Security Agreement, dated July 28, 2005, by and among MediaDefender, Inc. and U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.20	Trademark Security Agreement, dated July 28, 2005, by and among ARTISTdirect, Inc. and U.S. Bank National Association, as Collateral Agent for the benefit of the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.21	Subsidiary Guaranty, dated July 28, 2005, made by ARTISTdirect, Inc. and its subsidiaries in favor of U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.22	Securities Purchase Agreement, dated July 28, 2005, entered into by and among ARTISTdirect, Inc. and the Sub-debt Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.23	Subordination Agreement, dated July 28, 2005, among ARTISTdirect, Inc., and certain of its subsidiaries, the Sub-debt Financing investors and U.S. Bank National Association, as Collateral Agent for the Senior Financing investors (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.24	Non-Competition Agreement, dated July 28, 2005, entered into between ARTISTdirect, Inc. and WNT07, LLC (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.25	Employment Agreement, dated July 28, 2005, entered into between ARTISTdirect, Inc. and Jon Diamond (incorporated by reference to current report on Form 8-K filed on August 3, 2005).

E-3

10.26	Employment Agreement, dated July 28, 2005, entered into between ARTISTdirect, Inc. and Robert Weingarten (incorporated by reference to current report on Form 8-K filed on August 3, 2005).
10.27	Amendment No. 1 to Employment Agreement, dated October 11, 2005), entered into between ARTISTdirect, Inc. and Jon Diamond (incorporated by reference to current report on Form 8-K filed on October 14, 2005).
10.28	Acknowledgement and Amendment regarding Employment Agreement by and between ARTISTdirect, Inc. and Jon Diamond dated February 3, 2006 (incorporated by reference to current report on Form 8-K filed on February 3, 2006).
10.29	Acknowledgement and Amendment regarding Employment Agreement by and between ARTISTdirect, Inc. and Robert Weingarten dated February 3, 2006 (incorporated by reference to current report on Form 8-K filed on February 3, 2006).
10.30	Sublease by and between Sapient Corporation and ARTISTdirect, Inc. dated January 26, 2006 (incorporated by reference to current report on Form 8-K filed on February 3, 2006).
10.31	Amendment, dated July 28, 2006, to Employment, Confidentiality and Non-Competition Agreement by and between ARTISTdirect, Inc. and Randy Saaf (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on August 1, 2006).
10.32	Amendment, dated July 28, 2006, to Employment, Confidentiality and Non-Competition Agreement by and between ARTISTdirect, Inc. and Randy Saaf (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on August 1, 2006).
10.33	Offer of Employment between ARTISTdirect, Inc. and Rene Rousselet approved as of February 2, 2007 (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on February 6, 2007).
10.34	Omnibus Stock Option Amendment Agreement dated August 31, 2007, between the Registrant and Robert N. Weingarten (incorporated by reference to Exhibit 10.69 to quarterly report on Form 10-QSB filed on November 14, 2007).
10.35	Separation Agreement and Release dated August 31, 2007, between the Registrant and Robert N. Weingarten (incorporated by reference to Exhibit 10.70 to quarterly report on Form 10-QSB filed November 14, 2007).
10.36	Engagement Letter, dated as of February 7, 2008, by and between the Registrant and Salem Partners LLC (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on February 14, 2008).
10.37	Amended and Restated Services Agreement dated as of March 6, 2008 between the Company and Jon Diamond (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed March 12, 2008).
10.38	Amendment No. 1 to Employment, Confidentiality and Noncompetition Agreement dated as of December 23, 2008 between the Company and Randy Saaf (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on January 13, 2009).
10.39	Amendment No. 1 to Employment, Confidentiality and Noncompetition Agreement dated as of December 23, 2008 between the Company and Octavio Herrera (incorporated by reference to Exhibit 10.2 to current report on Form 8-K filed on January 13, 2009).
10.40	First Amendment to Note and Warrant Purchase Agreement, dated as of December 31, 2008, by and among ARTISTdirect, Inc., U.S. Bank National Association, JMB Capital Partners, L.P., JMG Capital Partners, L.P., CCM Master Qualified Fund, Ltd., JMG Triton Offshore Fund, Ltd., and with respect to Section 3 only, Trilogy Capital Partners, Inc.  (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on February 4, 2009).

E-4

10.41	Form of Accounts Receivable Purchase & Security Agreement with Pacific Business Capital Corporation, dated as of January 27, 2009  (incorporated by reference to Exhibit 10.2 to current report on Form 8-K filed on February 4, 2009).
10.42	Employment Agreement dated as of February 1, 2009 between Rene Rousselet and the Company (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on March 11, 2009).
10.43	Employment Agreement dated as of February 1, 2009 between Dimitri Villard and the Company (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on March 23, 2009).

10.44	Asset Purchase Agreement dated as of March 30, 2009 among the Company, MediaDefender, SafeNet, Inc. and MediaSentry, Inc. (incorporated by reference to Exhibit 10.1 to current report on Form 8-K filed on April 2, 2009).
10.45	Promissory Note dated March 30, 2009 of the Company (incorporated by reference to Exhibit 10.2 to current report on Form 8-K filed on April 2, 2009).
14.1	Code of Business Conduct and Ethics (incorporated by reference to current report on Form 8-K filed on June 22, 2006).
14.2	ARTISTdirect, Inc. Audit Committee Charter (incorporated by reference to definitive proxy statement on Schedule 14A filed on May 8, 2006).
21.1	Subsidiaries of ARTISTdirect, Inc. (incorporated by reference to registration statement on Form SB-2 filed on November 10, 2005).
23.1	Consent of Gumbiner Savett Inc., independent registered public accounting firm, with respect to ARTISTdirect, Inc. and subsidiaries.
31.1	Certifications of the Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act.
31.2	Certifications of the Principal Accounting Officer under Section 302 of the Sarbanes-Oxley Act.
32.1	Certifications of the Chief Executive Officer under Section 906 of the Sarbanes-Oxley Act.
32.2	Certifications of the Principal Accounting Officer under Section 906 of the Sarbanes-Oxley Act.

E-5

EX-23.1

Exhibit 23.1

Consent of Independent Registered Public Accounting Firm

The Board of Directors

ARTISTdirect, Inc.

We consent to the incorporation by reference in the registration statements (No. 333-122027, No. 333-53208, No. 333-38104, No. 333-63572 and No. 333-68396) on Forms S-8 of ARTISTdirect, Inc., of our report dated  April 14, 2009, with respect to the consolidated balance sheets of ARTISTdirect, Inc. and subsidiaries (the “Company”) as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ deficiency and cash flows for the years then ended, which report appears in the Annual Report on Form 10-K for the fiscal year ended December 31, 2008 of ARTISTdirect, Inc.

/s/	Gumbiner Savett Inc.
GUMBINER SAVETT INC.
Santa Monica, California
April 14, 2009

EX-31.1

Exhibit 31.1

CERTIFICATIONS

I, Dimitri Villard, certify that:

1.I have reviewed this annual report on Form 10-K for the fiscal year ended December 31, 2008 of ARTISTdirect, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)) and 15d-15(f) for the registrant and we have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:   April 15, 2009	By:	/s/ DIMITRI VILLARD
		Dimitri Villard
		Chief Executive Officer
		(Principal Executive Officer)

EX-31.2

Exhibit 31.2

CERTIFICATIONS

I, Rene Rousselet, certify that:

1.I have reviewed this annual report on Form 10-K for the fiscal year ended December 31, 2008 of ARTISTdirect, Inc.;

2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f)) and 15d-15(f) for the registrant and we have:

(a)Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5.The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant ability to record, process, summarize and report financial information; and

(b)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: April 15, 2009	By:	/s/ RENE ROUSSELET
		Rene Rousselet
		Corporate Controller
		(Principal Accounting Officer)

EX-32.1

Exhibit 32.1

CERTIFICATIONS OF THE CHIEF EXECUTIVE OFFICER
UNDER SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the filing by ARTISTdirect, Inc. (the “Registrant”) of its Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the “Annual Report”) with the Securities and Exchange Commission, I, Dimitri Villard, Chief Executive Officer of the Registrant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)The Annual Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

A signed original of this written statement required by Section 906 has been provided to the Registrant and will be retained by the Registrant and furnished to the Securities and Exchange Commission or its staff upon request.

Date:     April 15, 2009	By:	/s/ DIMITRI VILLARD
		Dimitri Villard
		Chief Executive Officer
		(Principal Executive Officer)

EX-32.2

Exhibit 32.2

CERTIFICATIONS OF THE CHIEF FINANCIAL OFFICER
UNDER SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the filing by ARTISTdirect, Inc. (the “Registrant”) of its Annual Report on Form 10-K for the fiscal year ended December 31, 2008 (the “Annual Report”) with the Securities and Exchange Commission, I, Neil McCarthy, Interim Chief Financial Officer of the Registrant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)           The Annual Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2)           The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Registrant.

A signed original of this written statement required by Section 906 has been provided to the Registrant and will be retained by the Registrant and furnished to the Securities and Exchange Commission or its staff upon request.

Date:     April 15, 2009	By:	/s/ RENE ROUSSELET
		Rene Rousselet
		Corporate Controller
		(Principal Accounting Officer)