AUDIO HIGHWAY-COM, 10KSB, 1999-04-15

AUDIO HIGHWAY-COM
10KSB, 1999-04-15
COMPUTER PROCESSING & DATA PREPARATION

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U.S. SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-KSB

(MARK ONE)

/X/ ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998

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

FOR THE TRANSITION PERIOD FROM ______________ TO ______________

COMMISSION FILE NUMBER: 1-14697
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AUDIOHIGHWAY.COM
(Name of small business issuer in its charter)

<TABLE>
<S> <C>
CALIFORNIA 77-0377306
(State or other jurisdiction of incorporation (I.R.S. Employer Identification Number)
or organization)

20600 MARIANI AVENUE
CUPERTINO, CA 95014
(Address of principal executive offices) (Zip Code)

Issuer's Telephone Number: (408) 255-5301

Securities registered under Section 12(b) of Name of each exchange on which listed:
the Act:
TITLE OF CLASS BOSTON STOCK EXCHANGE
COMMON STOCK, NO PAR VALUE
</TABLE>

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Securities registered under Section 12(g) of the Act: None

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

Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be contained,
to the best of the registrant's knowledge, in definitive proxy information
statements incorporated by reference in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB. / /

Revenues for the most recent fiscal year were: $139,000

The aggregate market value of the voting and non-voting common stock held by
non-affiliates computed by reference to the closing sale price on April 8, 1999,
was $150,189,243*.

The number of shares outstanding of the issuer's Common Stock as of March
31, 1999 was 4,835,191.*

Documents incorporated by reference: None

Transitional Small Business Disclosure Format. Yes / / No /X/

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* Based on a closing price of $34.125 per share on April 8, 1999. Excludes
434,041 shares of the Registrant's Common Stock held by executive officers,
directors and stockholders whose ownership exceeds 5% of the Common Stock
outstanding. Exclusion of such shares should not be construed to indicate that
any such person possesses the power, direct or indirect, to direct or cause the
direction of the management or policies of the Registrant or that such person is
controlled by or under common control with the Registrant.

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This Form 10-KSB contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange Act of 1934, as amended. These forward-looking statements
represent the Company's judgment on future events. Because the Company has only
been engaged in revenue-producing activities since November 1997 when it began
operating its audiohighway.com Web site, the Company is subject to risks and
uncertainties that could cause the Company's actual performance and results to
differ materially from those projected or discussed herein. These risks and
uncertainties are discussed in "Business Risks" in Item 1 below and in "Risk
Factors" in the Company's Prospectus dated December 17, 1998. All
forward-looking statements included in this document are based upon information
available to the Company as of the date hereof, and the Company assumes no
obligation to update any such forward-looking statements. It is important to
note that the Company's actual results may differ materially from the results
projected in the forward-looking statements.

PART I

ITEM 1. BUSINESS

The Company is an Internet-based information and entertainment company
which, through its AudioCast System, uses the capabilities of the World Wide Web
(the "Web") to deliver audio content. By entering into licensing agreements with
audio content providers such as National Public Radio ("NPR"), Penguin Books USA
and Newsweek on Air, the Company has assembled a continually expanding digital
library of over 3,500 titles, including timely news programs that are updated
frequently, audio books, music and other forms of information and entertainment.
Once a consumer has selected audio programming, he or she can either listen in
real time to "streaming" audio (in the case of certain content) or download and
store the program in digital form so it can be retrieved and enjoyed at any time
or location the user finds convenient. This digital library can be accessed over
the Internet at the Company's Web site.

To access the Company's digital library, a user simply visits the Company's
Web site located at HTTP:\\WWW.AUDIOHIGHWAY.COM, registers using his or her name
and e-mail address, then downloads and installs the Company's proprietary
AudioWiz software. Once on-line, the user may select any audio content of his or
her choice from the Company's audio content library. Certain of the user's
selections can be streamed in "real time" over the Internet, using Microsoft
Windows Media Player, which is available for free download on the Company's Web
site. Even more content selections are available for download to the user's
personal computer ("PC").

Substantially all of the audio content provided by the Company is available
to users from other sources. Recorded music and audio books are available
through many retail outlets. Current audio programming, such as news and market
data, are available on radio and from a variety of data sources. The advantage
of the Company's AudioCast System is that it allows the user to select precisely
the content he or she wishes to hear, to download it directly from the Internet
to a home or office computer at any time and to play it back at any convenient
time. For example, a user can download market or other business information at
any time and can play it back during a commute to work or other automobile
travel when it would be impractical to view a video presentation of the same
information.

Listeners can visit the Company's Web site as often as they like and
download free audio content supported by the sponsorship of the Company's
advertisers. Because of the increasing acceptance of Internet commerce, the
Company believes that many consumers will be willing to purchase training
seminars or other premium audio content that is not offered on the
advertising-supported portion of the Web site and that still others will be
willing to pay to receive non-premium audio content on an advertising-free
basis. To accommodate this market, the Company currently plans to begin selling
audio content to consumers on its Web site during the second quarter of 1999.
This will be accomplished by delivering either a physical copy of the content,
such as a CD, to the customer or by delivering the content digitally, over the
Internet, directly to the listener's computer. However, there is no assurance
that the timing of the

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availability of premium content and advertisement-free content on the Company's
Web site will not be delayed for business or other reasons.

INDUSTRY BACKGROUND

GROWTH OF THE INTERNET. The Internet has grown rapidly in recent years,
spurred by developments such as easy-to-use Web browsers, the availability of
multimedia PCs, the adoption of more robust network architectures and the
emergence of quality Web-based content and commercial applications. The broad
acceptance of the Internet Protocol ("IP") standard has also led to the
emergence of intranets and the development of a wide range of non-PC devices
that allow users to access the Internet and intranets.

Much of the Internet's rapid evolution towards becoming a mass medium can be
attributed to the accelerated pace of technological innovation, which has
expanded the Web's capabilities and qualitatively improved users' on-line
experiences. Most notably, the Internet has evolved from a mass of static, text-
oriented Web pages and e-mail services to a much richer environment, capable of
delivering graphical, interactive and multimedia content. Prior to the
development of streaming media technologies, users could not play back audio and
video clips until the content was downloaded in its entirety. As a result, live
Internet broadcasts were not possible. The development of streaming media
products from companies such as Microsoft and RealNetworks enables the
simultaneous transmission and playback of continuous "streams" of audio and
video content over the Internet and intranets. These technologies have evolved
to deliver audio and video over widely used 28.8 kbps narrow bandwidth modems,
yet can scale in quality to take advantage of higher speed access that is
expected to be provided by xDSL, cable modems and other emerging broadband
technologies.

THE INTERNET AS A NEW MEDIUM FOR ADVERTISING. The rapidly increasing number
of Web users and ubiquitous access to the Internet, both in the United States
and internationally, have resulted in the emergence of the Web as new mass
medium for advertising.

The proliferation of workstations and personal computers served by local
area networks has also resulted in the rapid increase in the number of potential
recipients for electronically distributed information.

The Web is an attractive medium for advertising because of its
interactivity, flexibility, targetability and measurability. Advertisers can
reach broad audiences and target advertisements to users with similar
demographic characteristics, specific regional populations, affinity groups or
selected individuals. The interactive nature of the Web enables advertisers to
determine customer preferences, using these to initiate ongoing commercial
relationships with potential customers. Advertisers can easily change their
advertising messages frequently. The Web is a measurable medium because
impression levels and demographic information concerning users can be tracked
and reported to advertisers.

INTERNET COMMERCE. The Web is also emerging as a new medium for global
commerce. A rapidly increasing number of consumers have begun transacting
business over the Web, such as paying bills, buying airline tickets, trading
securities and purchasing books and other consumer merchandise. Moreover, online
transactions can be faster, less expensive and more convenient than transactions
conducted via human interaction. Internet retailers can offer convenience and
value to their customers and simultaneously display in-depth information
concerning products or services selected by users according to their preferences
using a combination of text, video and sound.

DEMAND FOR AUDIO CONTENT. The total market for audio content is substantial
and includes such diverse types of content as audio books, broadcast radio,
recorded and live music, business news, education and training. An increasing
number of commuters and other mobile listeners demand quality audio content.
This demand has not only fueled growth in the number of types of audio content,
but has also generated the development of new entertaining, useful and/or
educational forms of content. For example, in 1996, there were over $1.6 billion
in sales of audio books, a relatively recent product that was not widely

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available until the late 1980's. The Company believes that, increasingly,
consumers will look to the Internet as a source for audio content.

THE AUDIOHIGHWAY.COM OPPORTUNITY: BUSINESS STRATEGY

Although several alternative means of providing audio content have achieved
acceptance by the general public, the Company believes that Internet
distribution of audio content can have cost or convenience advantages for the
consumer over both radio and physical merchandise, such as compact disks or
audio tapes. For example, a consumer can listen to broadcast radio but only to
whatever happens to be on the air at the time. The radio listener has limited
control over the selection of broadcast content (I.E., he or she can change the
channel) and has no control over the time at which specific programs can be
heard. The purchaser of CDs or audio tapes can make selections and determine
when to listen to the content but must pay for the entire recording even if only
selected portions are desired. In addition, the Company believes that
distribution over the Internet can provide significant price and convenience
advantages to users of its Web site by eliminating the need to physically visit
a retail store and to purchase hard copy out of the store's inventory.

The Company believes broadcasting audio content over the Internet offers
advantages over traditional media. The Company intends to exploit the advantages
of the Internet in capitalizing on the worldwide popularity of various kinds of
audio programming, including audio books, musical and comedy programs, and
timely news programs such as those provided by NPR and Newsweek. By offering
quality audio programming and by using the Web's graphical and interactive
capabilities to add value to its content, the Company hopes to increase brand
recognition for the audiohighway.com name. The Company believes that it can
build upon its brand recognition, its digital library of audio content and its
proprietary technology to pursue multiple revenue opportunities, including,
among others, advertising, e-commerce, technology licensing and intranet
programs.

THE AUDIOHIGHWAY.COM WEB SITE: CONTENT AND TECHNOLOGY

After logging onto the Company's Web site at http://www.audiohighway.com,
the customer can browse the Web site to learn more about the Company's digital
library. When a new customer decides to download or "AudioCast," he or she first
must register with audiohighway.com by providing limited personal information
such as name and e-mail address. The registration page permits the entry of
additional data, including personal listening category preferences, but the
system does not require this information nor does it require confidential
information that other sites require, such as home address and telephone number.
The data entered on the registration page is used by the AudioCast System to
route appropriate advertising targeted to the user's preferences.

The Company has designed its Web site to offer a large and comprehensive
selection of audio programming and has the capability to "stream" audio content
on a real time basis or transfer it over the Internet to the user's PC for
storage and playback. The Company has actively sought out sources of audio
programming to add to the library of material stored electronically on the
Company's Web site. On the News Channel, for example, a consumer can download
news stories and audio programs on a current basis from a list of programs
including National Public Radio, Associated Press, Newsweek and Dow Jones. The
user can assemble a personalized news broadcast from his or her personal
selection of sources chosen from the Company's audio content library and play it
back at a convenient place and time. The Company is actively engaged in
negotiations with numerous other providers of audio content and plans to
continue to expand its digital library.

All of the audio content currently available on the Company's Web site is
available to the user free of charge. However, the Company believes that the
delivery of user-selectable audio content over the Internet for a fee, as well
as advertising-free audio content, represents a significantly under-exploited
market

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segment. The Company intends to offer audio content and merchandise through
electronic commerce
("e-commerce") and revenue sharing arrangements with existing and future content
providers. ']

The Company believes that active usage of the Web site has meaningfully
accelerated development by identifying problem areas and promoting the testing
of refinements. Based upon extensive marketing and technical evaluation, the
Company has initiated a commercial strategy that contains the following
elements: advertising, electronic commerce, category channel sponsor fees,
partnership sales and licensing.

AUDIOWIZ. The Company's proprietary AudioWiz software, which is downloaded
by the user free of charge, allows users to select, download from the Company's
Web site and play back content on his or her computer or compatible portable
listening device. The AudioWiz user interface consists of an onscreen player
that acts as a control panel, allowing the user to control the computer audio.
Using AudioWiz, the user can navigate through stored items of audio content that
have been downloaded using control functions much the same as those found on a
standard CD player. AudioWiz displays a description of each downloaded item. The
user can play back audio selections on his or her computer while simultaneously
using another application such as a word processor or spreadsheet.

PORTABILITY. The Company believes that the ability to move the audio
content from a PC to a portable listening device will be important or desirable
for many listeners on its Web site. Portable audio players capable of storing
and playing back MP3 audio files downloaded from the Company's web site have
recently been introduced by Diamond Multimedia Systems, Inc. and Creative
Technologies, Ltd. The Company believes several additional manufacturers of
consumer electronic hardware will introduce portable audio players capable of
storing and playing back audio content downloaded from its Web site. The Company
has decided to cease manufacturing its ListenUp Player and to instead support
players made by others.

The Company's technology can be adapted to allow owners of palmtop
computers, personal digital assistants ("PDAs") and other compatible hand-held
computing devices with speakers to be loaded with digital audio material
obtained by the user from the Company's Web site. The Company expects that in
the future there will be a number of portable listening devices with the
capability of receiving audio content downloaded from the Company's Web site.

ADVERTISING. The Company currently derives the majority of its revenue from
advertising on its Web site. It uses three methods of advertising: "banner" ads,
audio ads and channel sponsorships. The Company's audio ads are included as part
of the downloaded and streaming audio content. Audio channel sponsorships enable
the Company to charge for focused advertising related to a specific content
channel. Banner advertisements can allow interested readers to link directly to
the advertisers' own Web sites. The Company targets traditional advertisers,
such as consumer product and service companies and manufacturers as advertisers
on its Web site. Advertising revenue has been derived principally from
short-term advertising contracts on a per impression basis or for a fixed fee
based on a minimum number of impressions.

The Company's audio material is divided by subject matter into category
channels. The Web site presently organizes the content into eight channels. The
channels include News, Business, Audio Books, Music, Comedy, Sports,
Entertainment and Technology. For each of the category channels on the Company's
Web site, the Company offers a premier content sponsorship to a content provider
who prefers to be prominently displayed on the Web site.

To enable advertisers to verify the number of ad playbacks or visual
impressions made by their advertisements and monitor their advertisements'
effectiveness, the Company provides its advertisers with reports showing data on
impressions, click through and downloads applicable to their advertisements.

SECURE TRANSACTION ELECTRONIC COMMERCE. The Company implemented electronic
merchandising
("e-commerce") during the first quarter of 1999, thereby addressing the
purchasing interests of an

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increasing number of consumers who are buying products over the Internet. The
Company negotiated a link to an established provider of secure financial
communications software so that it can offer users a safe means to purchase
products over the Internet. Initially, the Company is selling products
complementary to Internet-based audio, such as speakers, multimedia computers
and multimedia upgrade kits. During the second quarter of 1999, the Company
plans to sell music CD's, certain downloaded audio content and various other
products complementary to the Internet audio market. Customers will pay by
credit card for merchandise or downloading at the time of ordering directly over
the Internet, using the Company's financial communications software. ']

DISTRIBUTION PARTNERSHIPS. The Company intends to develop partnerships with
strategic Internet sites to increase the traffic to its Web site category
channels. The Company offers audio technology, audio content and audio
advertising capable of delivering audio to other companies' Web sites in order
to develop additional streams of revenue from audio advertising. These
partnerships can be easily implemented by putting a button on the partner's Web
site that will link the user to the audio content being made available by the
Company's server. Incremental increases in traffic generated from partnership
sites will increase the frequency of advertisement impressions on the Company's
Web site. The Company believes it can significantly increase total advertising
revenue from the increased traffic generated by partnered sites.

AUDIO CONTENT. The Company seeks to enter into licensing agreements with a
wide variety of content providers in an effort to appeal to the broadest
possible market. Current categories include children's programming, commercial
programming and academic programming. Content providers currently include audio
recordings of popular and classical books, comedy, self-improvement courses,
information and news services, magazines, music and sports updates, as well as
various entertainment products such as audio movie reviews and product
information from a variety of product areas.

The Company believes that the audiohighway.com concept has been well
received by content providers because it (i) represents a display shelf of
infinite length not limited by physical space such as in retail stores, and (ii)
provides them with additional distribution for their programming as well as the
incremental revenue stream that accompanies it.

Different types of content typically have different types of licensing
terms. For the most part, the Company only pays for the content on a "per
download" basis, so the Company is not charged simply for having the content
available on its Web site. Exceptions to this include the Brite Voice content
(E.G., stock market updates, sport scores, etc.), which is updated via satellite
feed many times per day for a flat fee.

Each item of audio content is digitized and added to the Company's content
library. This digital library is stored electronically and is located at the
Company's office. When a customer's content selection is received by the system,
the Company's proprietary routing, scheduling and queuing system will initiate
the AudioCast and storage of the user-selected content on the user's PC, which
may then be uploaded to a compatible portable listening device.

AUDIOHIGHWAY.COM'S EXISTING LIBRARY. Since launching its Web site in
November 1997, the Company has collected a library of over 3,500 titles and
segments covering a broad range of subject categories, and continues to rapidly
increase the size of its audio library. Current audio content providers include,
among others, ABC Tonight, Associated Press, National Public Radio, CBS Tonight,
Compact Classics, Dateline, NBC Tonight, Newsweek, Penguin Books USA and PR
Newswire. The Web site content is currently organized into the following eight
channels: News, Business, Audio Books, Music, Comedy, Sports, Entertainment and
Technology.

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THE AUDIOHIGHWAY.COM WEB SITE ARCHITECTURE

The Company has developed a proprietary information publishing system
capable of disseminating a wide variety of audio content to a large population
of consumers using the Internet. The system is organized into a number of
software modules summarized below.

CONTENT MANAGEMENT MODULE. The Content Management Module is a
client/server-based software module that enables the system to add new files to
the Audio Content Database ("ACD"). In addition, it provides audio compression
of the digitized content file. This allows for rapid uploading from the user's
personal computer to a compatible portable playback device.

CATALOG SERVER. The Catalog Server is a Web Server-based software module
that provides a catalog interface into the ACD. This module allows end users to
browse the content library and select content for downloading. This module also
provides the user with a search engine for finding information quickly and
easily and includes secured identifiers for AudioWiz.

ADVERTISING SERVER. The Advertising Server consists of a database system
that provides advertising segments to logged-on users. This server identifies
certain advertisements based on its content and then matches them to recorded
user preferences or interest profiles. This technology allows users to receive
advertisements that correspond to their interests whether explicitly disclosed
in the user profile or based on content selections over time.

MERCHANT SYSTEM. The Merchant System is responsible for tracking and
managing all transactions. This is used for billing and system auditing.

CUSTOMIZATION MODULE. The Customization Module allows the end-user to
customize the content delivery system to his or her specific needs. It further
allows for scheduled downloads and automated e-mail notification of updates. In
addition, it handles the end user's requests and preferences for content and is
the server interface to AudioWiz.

ADS AND CONTENT SERVER. The Audio Digitizing System ("ADS") is a hardware
and software-based system that provides the tools to digitize audio content from
DAT, audio cassette or broadcast sources and processes the content for loading
onto the Content Server. The Content Server is then responsible for distributing
the audio content to the end user.

AUDIOWIZ SOFTWARE. This software is a client application used to manage the
audio files on the end user's computer. Tasks such as uploading to a compatible
listening device and simple file management are performed using this utility. It
is also used for configuring automated tasks, such as pre-scheduled or automatic
nightly downloads. The AudioWiz interfaces to the end user's Windows 95 or newer
version of Windows, as well as to a compatible portable listening device.

MARKETING AND SALES

The Company attracts users to its Web site, primarily through Web-based
promotions. These can take the form of either advertisements on other targeted
Web sites or e-mail directed at selected Internet users. This use of e-mail is
the Internet version of direct marketing, and the Company feels it will prove to
be an important method by which it can continue to promote its Web site to an
increasing number of registered users. To a lesser extent, the Company plans to
attract new users through more traditional media, such as print ads and audio
spots on drive time radio.

The Company has gained significant recognition within the industry by its
participation in various tradeshows and through its public relations efforts.
The Company's AudioCast System won the "INNOVATIONS '97 DESIGN & ENGINEERING
SHOWCASE AWARD" at the 1997 Consumer Electronics Show, the "PEOPLE'S CHOICE
AWARD" at the 1998 UpSide Magazine Internet Showcase and, in June 1998,
CommerceNet's "NEW INNOVATOR AWARD."

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The Company's in-house sales force develops and implements its advertising
strategies, including identifying strategic accounts and developing
presentations and promotional material. As of March 31, 1999, the Company
employs 11 persons to carry out its sales and marketing activities. Each sales
person has been assigned an industry segment and solicits advertising contracts
from companies in those industries and their agencies.

The Company also enters into cross-marketing relationships with other Web
sites, including NPR, Weather Underground and MSN Web Events. This is primarily
implemented through putting click-through banners on each other's Web sites so
that traffic generated on one Web site has the ability to move easily to the
cross-marketing partner's Web site by simply clicking on the banner.

RESEARCH AND DEVELOPMENT

Since inception, the Company has devoted significant time and financial
resources to research and development activities to develop its current
technology, products and services. The Company anticipates that a portion of its
ongoing operations will continue to include research and development activities
due to the rapid technological evolution of Internet-based commerce. Research
and development expenditures were $677,000 and $1,073,000 in 1997 and 1998,
respectively.

PATENTS, TRADEMARKS AND PROPRIETARY RIGHTS

The Company has filed several patent applications with respect to certain
aspects of the AudioCast System, and two patents have been issued. Although the
Company does not believe that its existing patents provide a competitive
advantage, there is no assurance that in the future, patent protection will not
be of substantial importance to the Company's business and future prospects.

There is no assurance that patents will be issued pursuant to the pending
applications or that the patents that are issued or may be issued in the future
will not be held invalid or unenforceable by a court having jurisdiction over a
dispute challenging their validity. Even if patents are upheld and are not
challenged, third parties might be able to develop equivalent technologies or
products without infringing such patents or the Company could be required to
expend substantial funds in order to defend its patents.

The Company regards its copyrights, trademarks, trade secrets and similar
intellectual property as critical to its success and relies on a combination of
copyright and trademark laws, trade secret protection, confidentiality and
non-disclosure agreements and contractual provisions with its employees and with
third parties to establish and protect its proprietary rights. There is no
assurance that these steps will be adequate, that the Company will be able to
secure trademark registrations for all of its marks in the United States or
other countries or that third parties will not infringe upon or misappropriate
the Company's copyrights, trademarks, service marks and similar proprietary
rights. The Company does not own any registered copyrights protecting its
products but claims common law copyrights in its software. There is no assurance
that common law copyright will provide adequate protection for the Company's
related intellectual property. In addition, effective copyright and trademark
protection may be unenforceable or limited in certain countries, and the global
nature of the Internet makes it impossible to control the ultimate destination
of the content downloaded from the Company's Web site. In the future, litigation
may be necessary to enforce and protect the Company's trade secrets, copyrights
and other intellectual property rights.

The Company has filed trademark claims for "Audio Highway," "AudioWiz" and
"AudioCast." The "ListenUp" trademark is licensed from ListenUp, Inc. The
Company intends to pursue the registration of its trademarks based upon
anticipated use internationally. There is no assurance that the Company will be
able to secure adequate protection for these trademarks in foreign countries. In
addition, there could be potential trademark or trademark infringement claims
brought by owners of other registered trademarks or trademarks.

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There is no assurance that any particular aspect of the Company's technology
will not be found to infringe the rights of other companies. Other companies may
hold or obtain patents on inventions or may otherwise claim proprietary rights
to technology useful or necessary to the Company's business. The extent to which
the Company may be required to seek licenses under such proprietary rights of
third parties, and the cost or availability of such license, cannot be
predicted. While it may be necessary or desirable in the future to obtain
licenses relating to one or more of its proposed products or relating to current
or future technologies, there is no assurance that the Company will be able to
do so on commercially reasonable terms, if at all.

There is no assurance that the measures taken by the Company will adequately
protect the confidentiality of the Company's proprietary information or that
others will not independently develop products or technology that are equivalent
or superior to those of the Company. Moreover, the Company may also be subject
to litigation to defend against claims of infringement of the rights of others
or to determine the scope and validity of the intellectual property rights of
others. If competitors of the Company prepare and file applications in the
United States that claim trademarks used or registered by the Company, the
Company may oppose those applications and be required to participate in
proceedings before the United States Patent and Trademark Office to determine
priority of rights to the trademark, which could result in substantial costs to
the Company. Similarly, actions could be brought by third parties claiming that
the Company's products infringe patents owned by others. An adverse outcome
could require the Company license disputed rights from third parties or to cease
using such trademark or infringing product. Any litigation regarding the
Company's proprietary rights could be costly and divert management's attention,
result in the loss of certain of the Company's proprietary rights, require the
Company to seek licenses from third parties and prevent the Company from selling
its products and services, any one of which could have a material adverse effect
on the Company's business, results of operations and financial condition. In
addition, inasmuch as the Company licenses a substantial portion of its content
from third parties, its exposure to copyright infringement actions may increase
because the Company must rely upon such third parties for information as to the
origin and ownership of such licensed content. The Company generally obtains
representations as to the origins and ownership of such licensed content and
generally obtains indemnification to cover any breach of any such
representations; however, there can be no assurance that such representations
will be accurate or that such indemnification will adequately protect the
Company.

COMPETITION

The Company faces intense competition in every aspect of its business,
including competition for consumers of audio materials, advertisers, providers
of audio materials and vendors of products. The business of providing data and
other products using the Internet as a medium is currently experiencing
explosive growth and is characterized by extremely rapid technological
development, rapid changes in consumer habits and preferences, massive infusions
of capital and the emergence of a large number of new and established companies
with aspirations to control as much of the distribution process as possible. A
relatively small number of these companies, including America On Line and
Yahoo!, currently control primary or secondary access of significant percentages
of all Internet users and therefore have a competitive advantage in marketing to
those users. Other large and established companies, such as local and long
distance telephone companies, cable companies, satellite programming providers
and others have established relationships with large customer bases and are
rapidly expanding into the provision of Internet services. Although the Company
does not believe that any of these companies currently are direct competitors
and believes that it provides services and has technology that could be
attractive to such companies as customers, substantially all of these companies
have financial, technological, promotional and other resources that are much
greater than those available to the Company. Most, if not substantially all, of
such providers could use or adapt their current technology, or could purchase
technology, to provide a service directly competitive with the Company's
AudioCast System.

9
<PAGE>
The Company competes with (i) other Web sites and Internet broadcasters to
acquire and provide content to attract users, (ii) online services, other Web
site operators and advertising networks, as well as traditional media such as
television, radio and print, for a share of advertisers' total advertising
budgets, (iii) local radio and television stations and national radio and
television networks for sales of advertising spots and (iv) other Web site
operators engaged in e-commerce.

Competition among Web sites that provide content such as news, financial
information, music and audio books is intense and is expected to increase
significantly in the future. The Company competes against a variety of
businesses that provide content through one or more media, such as print, radio,
television, cable television and the Internet. Traditional media companies that
have not established a significant presence on the Internet may expend resources
to establish such a presence in the future. The Company competes generally with
other content providers for the time and attention of users and for advertising
revenues. To compete successfully, the Company must license and then provide
sufficiently compelling and popular content to generate users and support
advertising intended to reach such users. The Company believes that the
principal competitive factors in attracting Internet users include the quality
of service and the relevance, timeliness, depth and breadth of content and
services offered. The Company also competes for the time and attention of
Internet users with thousands of Web sites operated by businesses and other
organizations, individuals, governmental agencies and educational institutions.
The Company expects competition to intensify and the number of competitors to
increase significantly in the future. In addition, as the Company expands the
scope of its content and services, it will compete with a greater number of Web
sites and other media companies. Because the operations and strategic plans of
existing and future competitors are undergoing rapid change, it is extremely
difficult for the Company to anticipate which companies are likely to offer
competitive services in the future.

The Company also competes with online services, other Web site operators and
advertising networks, as well as traditional media such as television, radio and
print for a share of advertisers' total advertising budgets. The Company
believes that the principal competitive factors for attracting advertisers
include the number of users accessing the Company's Web site, the demographics
of the Company's users, the Company's ability to deliver focused advertising and
interactivity through its Web site and the overall cost-effectiveness and value
of advertising offered by the Company. There is intense competition for the sale
of advertising on high-traffic Web sites, which has resulted in a wide range of
rates quoted by different vendors for a variety of advertising services, making
it difficult to project levels of Internet advertising that will be realized
generally or by any specific company. Any competition for advertisers among
present and future Web sites, as well as competition with other traditional
media for advertising placements, could result in significant price competition.
The Company believes that the number of companies selling Web-based advertising
and the available inventory of advertising space have recently increased
substantially. Accordingly, the Company may face increased pricing pressure for
the sale of advertisements. Reduction in the Company's Web advertising revenues
would have a material adverse effect on the Company's business, results of
operations and financial condition. There is no assurance that the Company will
be able to compete in its chosen market.

GOVERNMENT REGULATION

Although there are currently few laws and regulations directly applicable to
the Internet, it is likely that new laws and regulations will be adopted in the
United States and elsewhere covering issues such as music licensing, broadcast
license fees, copyrights, privacy, pricing, sales taxes and characteristics and
quality of Internet services. It is possible that governments will enact
legislation that may be applicable to the Company in areas such as content,
network security, encryption and the use of key escrow, data and privacy
protection, electronic authentication or "digital" signatures, illegal and
harmful content, access charges and retransmission activities. Moreover, the
applicability to the Internet of existing laws governing issues such as property
ownership, content, taxation, defamation and personal privacy is uncertain. The
majority of such laws were adopted before the widespread use and
commercialization of the Internet and,

10
<PAGE>
as a result, do not contemplate or address the unique issues of the Internet and
related technologies. Any such export or import restrictions, new legislation or
regulation or governmental enforcement of existing regulations may limit the
growth of the Internet, increase the Company's cost of doing business or
increase the Company's legal exposure, which could have a material adverse
effect on the Company's business, financial condition and results of operations.

By distributing content over the Internet, the Company faces potential
liability for claims based on the nature and content of the materials that it
distributes, including claims for defamation, negligence or copyright, patent or
trademark infringement, which claims have been brought, and sometimes
successfully litigated, against Internet companies. The Company's general
liability insurance may not cover potential claims of this type or may not be
adequate to indemnify the Company for any liability that may be imposed. Any
liability not covered by insurance or in excess of insurance coverage could have
a material adverse effect on the Company's business, results of operations and
financial condition.

EMPLOYEES

As of March 31, 1999, the Company has 24 full time employees, 11 in
marketing and sales, 11 in research and development and 2 in finance and
administration. In addition, 7 consultants devote substantially all of their
time to the Company in the areas of system design and engineering. The Company
makes use of additional outside consultants and independent contractors to
perform various functions such as programming, engineering, development, and
accounting. The Company believes this approach not only allows it to limit
expenses, but also provides maximum flexibility to react to a rapidly changing
environment. None of the Company's employees is represented by a labor union.
The Company believes that its employee relations are good.

BUSINESS RISKS

The future operating results of the Company are highly uncertain, and the
following factors should be carefully reviewed in addition to the other
information contained in this annual report on Form 10-KSB and in other public
disclosures of the Company.

HISTORY OF LOSSES AND ANTICIPATION OF FUTURE LOSSES. The Company was
incorporated in June 1994 to deliver free, personalized audio via the Internet
and was in the development stage until the fourth quarter of 1997. The Company
first recognized revenues in November 1997 and has recorded net losses each year
since its inception. At December 31, 1998 the Company had an accumulated a
deficit of approximately $12,517,000. Accordingly, the Company has a limited
operating history on which to base an evaluation of its business and prospects.
The Company and its prospects must be considered in light of the early stage of
development, particularly companies in new and rapidly evolving markets such as
the market for Internet content, electronic commerce ("e-commerce") and
advertising. To achieve and sustain profitability, the Company must, among other
things, (i) provide diverse content of interest to Internet users, (ii)
effectively develop new and maintain existing relationships with advertisers,
advertising agencies and content providers, (iii) continue to develop and
upgrade its technology and network infrastructure; (iv) respond to competitive
developments, (v) successfully introduce enhancements to its existing products
and services to address new technology standards and developments on the
Internet, and (vi) attract, retain and motivate qualified personnel. The
Company's operating results are also dependent on factors outside the control of
the Company, such as the availability of desirable content. There can be no
assurance that the Company will be successful in addressing these risks and the
failure to do so would have a material adverse effect on the Company's business,
results of operations and financial condition. Additionally, the limited
operating history of the Company makes the prediction of future operating
results difficult or impossible, and there can be no assurance that the
Company's revenues will increase or even continue at their current level or
generate sufficient cash from operations in future periods. The Company expects
to continue to incur significant losses on a quarterly and annual basis for the
foreseeable future. For these and other reasons,

11
<PAGE>
there is no assurance that the Company will ever achieve profitability or, if
profitability is achieved, that it can be sustained.

LIMITED OPERATING HISTORY; UNPREDICTABILITY OF FUTURE REVENUES; POTENTIAL
FLUCTUATIONS IN QUARTERLY RESULTS. The Company has been out of the development
stage only since the fourth quarter of 1997. Because of the Company's limited
operating history and the emerging nature of the markets in which it competes,
the Company is unable to forecast accurately its revenues. Additionally, the
long-term acceptance of Web-based advertising is as yet uncertain. The Company
currently intends to increase substantially its operating expenses in order to,
among other things, (i) expand its distribution network capacity, (ii) fund
increased sales and marketing activities, (iii) acquire additional content, (iv)
develop and upgrade technology and (v) purchase equipment for its operations.
The Company's expense levels are based, in part, on its expectations with regard
to future revenues, and to a large extent such expenses are fixed, particularly
in the short term. To the extent the Company is unsuccessful in increasing its
revenues, the Company may be unable to appropriately adjust spending in a timely
manner to compensate for any unexpected revenue shortfall or will have to reduce
its operating expenses, causing it to forego potential revenue generating
activities, either of which could cause a material adverse effect in the
Company's business, results of operations and financial condition.

The Company's quarterly operating results may fluctuate significantly in the
future as a result of a variety of factors, many of which are outside the
Company's control. Factors that may affect the Company's quarterly operating
results include (i) the cost of acquiring and the availability of content, (ii)
demand for Internet advertising, (iii) seasonal trends in advertising
placements, (iv) the advertising cycles for, or the addition or loss of,
individual advertisers, (v) the level of traffic on the Company's Web site, (vi)
the amount and timing of capital expenditures and other costs relating to the
expansion of the Company's operations, (vii) price competition or pricing
changes in Internet advertising, (viii) the level of and seasonal trends in the
use of the Internet, (ix) technical difficulties or system downtime, (x) the
introduction of new products or services by the Company or its competitors and
(xi) general economic conditions and economic conditions specific to the
Internet, such as electronic commerce and online media. Any one of these factors
could cause the Company's revenues and operating results to vary significantly
in the future. In addition, as a strategic response to changes in the
competitive environment, the Company may from time to time make certain pricing,
service or marketing decisions or acquisitions that could cause significant
declines in the Company's quarterly operating results.

DEPENDENCE ON CONTENT PROVIDERS; LICENSE FEES PAYABLE TO CONTENT
PROVIDERS. The Company's future success depends in large part upon its ability
to obtain rights to and deliver content of sufficient interest to end users over
the Internet. The Company does not create its own content. Rather, the Company
relies on third party content providers, such as book publishers, news and
financial information services and music publishers for the content it makes
available to its users. The Company's ability to maintain its existing
relationships with such content providers and to build new relationships with
additional content providers is critical to the success of its business.
Although many of the Company's agreements with third party content providers are
for an initial term of one year, with automatic renewal unless cancelled, the
content providers may choose to terminate such agreements prior to the
expiration of their terms. The Company's inability to secure licenses from
content providers or the termination of a significant number of content provider
agreements would decrease the availability of content that the Company can offer
users. This may result in decreased traffic on the Company's Web site and, as a
result, decreased advertising revenue, which could have a material adverse
effect on the Company's business, results of operations and financial condition.

The Company's agreements with most of its content providers are
nonexclusive, and many of the Company's competitors offer, or could offer,
content that is similar to or the same as that obtained by the Company from such
nonexclusive content providers. Such direct competition could have a material
adverse effect on the Company's business, results of operations and financial
condition.

12
<PAGE>
License fees payable to content providers and other licensing agencies may
increase as the Company continues to accumulate content and as competition for
such content increases. There is no assurance that the Company's content
providers and other licensing agencies will enter into prospective agreements
with the Company on the same or similar terms as those currently in effect or on
terms acceptable to the Company if no agreement is in effect. If the Company is
required to pay increased licensing fees, such increased payments could have a
material adverse effect on the Company's business, results of operations and
financial condition.

UNCERTAIN ACCEPTANCE OF THE INTERNET AS AN ADVERTISING MEDIUM. The market
for Internet advertising has only recently begun to develop, is rapidly evolving
and is characterized by an increasing number of market entrants. As is typical
in the case of a new and rapidly evolving industry, demand and market acceptance
for recently introduced products and services are subject to a high level of
uncertainty. The Company's ability to generate advertising revenue will depend
on, among other factors, (i) the continued development of the Internet as an
advertising medium, (ii) pricing of advertising on other Web sites, (iii) the
amount of traffic on the Company's Web site, (iv) the Company's ability to
achieve and demonstrate user demographic characteristics that are attractive to
advertisers, (v) the development and expansion of the Company's advertising
sales force and (vi) the establishment and maintenance of desirable advertising
sales agency relationships. Most potential advertisers and their advertising
agencies have only limited experience with the Internet as an advertising medium
and have not historically devoted a significant portion of their advertising
expenditures to Web-based advertising. There is no assurance that advertisers or
advertising agencies will be persuaded to allocate or continue to allocate
portions of their budgets to Web-based advertising or, if so persuaded, that
they will find such advertising to be effective for promoting their products and
services relative to traditional print and broadcast media. No standards have
yet been widely accepted for the measurement of the effectiveness of Web-based
advertising, and there can be no assurance that such standards will develop
sufficiently to enable Web-based advertising to become a significant advertising
medium. Acceptance of the Internet among advertisers and advertising agencies
will also depend, to a large extent, on the level of use of the Internet by
consumers and upon growth in the commercial use of the Internet. If widespread
commercial use of the Internet does not develop, or if the Internet does not
develop as an effective and measurable medium for advertising, the Company's
business, results of operations and financial condition could be materially
adversely affected.

MANAGEMENT OF GROWTH. The Company anticipates that significant expansion of
its operations will be required in order to address potential market
opportunities. The Company expects that it will need to increase its personnel
significantly in the near future. The anticipated substantial growth is expected
to place a significant strain on its managerial, operational and financial
resources and systems. To manage its growth, the Company must implement, improve
and effectively use its operational, management, marketing and financial systems
and train and manage its employees. There can be no assurance that the Company
will be able to manage effectively the expansion of its operations or that the
Company's current personnel, systems, procedures and controls will be adequate
to support the Company's operations. Any failure of management to manage
effectively the Company's growth could have a material adverse effect on the
Company's business, results of operations and financial condition.

RISK OF SYSTEM FAILURE, DELAYS AND INADEQUACY; SINGLE SITE. The
performance, reliability and availability of the Company's Web site and network
infrastructure are critical to its reputation and ability to attract and retain
users, advertisers and content providers. The Company's network infrastructure
is located at a single, leased facility in Cupertino, California. The Company's
systems and operations are vulnerable to damage or interruption from fire,
flood, earthquakes, power loss, telecommunications failure, Internet breakdowns,
break-ins and similar events. The Company does not presently have redundant
facilities or systems or a formal disaster recovery plan and does not carry
sufficient business interruption insurance to compensate it for losses that may
occur. Services based on sophisticated software and computer systems often
encounter development delays and the underlying software may contain undetected
errors that could cause system failures when introduced. Any system error or
failure that causes interruption in availability

13
<PAGE>
of content or an increase in response time could result in a loss of potential
or existing business services customers, users, advertisers or content providers
and, if sustained or repeated, could reduce the attractiveness of the Company's
Web site to such entities or individuals. In addition, because the Company's Web
advertising revenues are directly related to the number of advertisements
delivered by the Company to users, system interruptions that result in the
unavailability of the Company's Web site or slower response times for users
would reduce the number of advertisements delivered and reduce revenues.

A sudden and significant increase in traffic on the Company's Web site could
strain the capacity of the software, hardware and telecommunications systems
deployed or used by the Company, which could lead to slower response times or
system failures. The Company's operations also are, in part, dependent upon
receipt of timely feeds from certain of its content providers, and any failure
or delay in the transmission or receipt of such feeds, whether due to system
failure of the Company, its content providers, satellites or otherwise, could
disrupt the Company's operations. The Company is also dependent upon Web
browsers, Internet Service Providers ("ISPs") and online service providers
("OSPs") to provide Internet users access to the Company's Web site. Users may
experience difficulties accessing or using the Company's Web site due to system
failures or delays unrelated to the Company's systems. These difficulties may
result in intermittent interruption in programming. Any sustained failure or
delay could reduce the attractiveness of the Company's Web site to users,
advertisers and content providers. The occurrence of any of the foregoing events
could have a material adverse effect on the Company's business, results of
operations and financial condition.

SECURITY RISKS. Despite the implementation of security measures, the
Company's networks may be vulnerable to unauthorized access, computer viruses
and other disruptive problems. A party who is able to circumvent security
measures could misappropriate proprietary information or cause interruptions in
the Company's Internet operations. ISPs and OSPs have in the past experienced,
and may in the future experience, interruptions in service as a result of the
accidental or intentional actions of Internet users, current and former
employees or others. The Company may be required to expend significant capital
or other resources to protect against the threat of security breaches or to
alleviate problems caused by such breaches. Although the Company intends to
continue to implement industry-standard security measures, there can be no
assurance that measures implemented by the Company will not be circumvented in
the future. Eliminating computer viruses and alleviating other security problems
may require interruptions, delays or cessation of service to users accessing the
Company's Web sites, which could have a material adverse effect on the Company's
business, results of operations and financial condition.

DEPENDENCE ON SHORT-TERM ADVERTISING CONTRACTS. A substantial portion of
the Company's Web advertising revenues are derived from short-term contracts.
Consequently, many of the Company's advertising customers can cease advertising
on the Company's Web site quickly and without penalty, thereby increasing the
Company's exposure to competitive pressures. There is no assurance that the
Company's current advertisers will continue to purchase advertisements or that
the Company will be able to secure new advertising contracts from existing or
future customers at attractive rates or at all. Any failure of the Company to
achieve sufficient advertising revenue could have a material adverse effect on
the Company's business, results of operations and financial condition.

COMPETITION. The market for information services and entertainment on the
Internet and otherwise is highly competitive, and the Company expects that
competition will continue to intensify. The Company competes with (i) other Web
sites and Internet broadcasters to acquire and provide content to attract users,
(ii) online services, other Web site operators and advertising networks, as well
as traditional media such as television, radio and print, for a share of
advertisers' total advertising budgets and (iii) local radio and television
stations and national radio and television networks for sales of advertising
spots. There is no assurance that the Company will be able to compete
successfully or that the competitive pressures faced by

14
<PAGE>
the Company, including those described below, will not have a material adverse
effect on the Company's business, results of operations and financial condition.

Many of the Company's competitors and potential competitors have greater
financial, sales and other resources than the Company. There is no assurance
that the Company's business strategy will be successful, or that the Company
will gain a market share or customer base that will be sufficient to justify
continued operations.

PRODUCT DEVELOPMENT AND TECHNOLOGICAL OBSOLESCENCE. The market for Internet
information delivery is characterized by extensive research and development and
rapid technological change, frequent new product introductions and technological
innovation, resulting in short product life cycles, and evolving industry
standards. Development by others of new or improved products, processes or
technology may render the Company's products and services less competitive or
obsolete. The emerging character of these products and services and their rapid
evolution will require the Company to effectively use leading technologies,
continue to develop its technological expertise, enhance its current services
and continue to improve the performance, features and reliability of its network
infrastructure. Changes in network infrastructure, transmission and content
delivery methods and underlying software platforms and the emergence of new
technologies could dramatically change the structure and competitive dynamic of
the market for the Company's products and services. There is no assurance that
the Company will be successful in responding quickly, cost effectively and
sufficiently to these or other such developments. In addition, the widespread
adoption of new Internet technologies or standards could require substantial
expenditures by the Company to modify or adapt its Web site and services. A
failure by the Company to rapidly respond to technological developments could
have a material adverse effect on the Company's business, results of operations
and financial condition.

DEPENDENCE ON CONTINUED GROWTH IN USE OF THE INTERNET. Rapid growth in the
use of and interest in the Internet is a recent phenomenon and there can be no
assurance that acceptance and use of the Internet will continue to develop or
that a sufficient base of users will emerge to support the Company's business.
Because global commerce and on-line exchange of information on the Internet is
new and evolving, it is difficult to predict with any assurance whether the
Internet will prove to be a viable commercial marketplace. Future revenues of
the Company will depend largely on the widespread acceptance and use of the
Internet as a source of multimedia information and entertainment and as a
vehicle for commerce in goods and services. The Internet may not be accepted as
a viable commercial medium for broadcasting multimedia content, if at all, for a
number of reasons, including (i) potentially inadequate development of the
necessary infrastructure, (ii) inadequate development of enabling technologies,
(iii) lack of acceptance of the Internet as a medium for distributing content
and (iv) inadequate commercial support for Web-based advertising. To the extent
that the Internet continues to experience an increase in users, an increase

15
<PAGE>
in frequency of use or an increase in the bandwidth requirements of users, there
can be no assurance that the Internet infrastructure will be able to support the
demands placed upon it, specifically the demands of delivering high-quality
audio content. Furthermore, user experiences on the Internet are affected by
access speed. There is no assurance that broadband access technologies and cable
modems will become widely adopted. In addition, the Internet could lose its
viability as a commercial medium due to delays in the development or adoption of
new standards and protocols required to handle increased levels of Internet
activity, or due to increased government regulation. Changes in or insufficient
availability of telecommunications services to support the Internet also could
result in unacceptable response times and could adversely affect use of the
Internet generally and of the Company's Web site in particular. If use of the
Internet does not continue to grow or grows more slowly than expected, or if the
Internet infrastructure does not effectively support the growth that may occur,
the Company's business, results of operations and financial condition could be
materially adversely affected.

DEPENDENCE UPON KEY PERSONNEL. The Company's success depends, to a
significant extent, upon a number of key employees and consultants. The loss of
the services of one or more of these employees or consultants could have a
material adverse effect on the business of the Company.

GOVERNMENT REGULATION AND LEGAL UNCERTAINTY. Although there are currently
few laws and regulations directly applicable to the Internet, it is likely that
new laws and regulations will be adopted in the United States and elsewhere
covering issues such as music licensing, broadcast license fees, copyrights,
privacy, pricing, sales taxes and characteristics and quality of Internet
services. The adoption of restrictive laws or regulations could slow Internet
growth or expose the Company to significant liabilities associated with content
available on its Web site. The application of existing laws and regulations
governing Internet issues such as property ownership, libel and personal privacy
is also subject to substantial uncertainty. There can be no assurance that
current or new laws and regulations, or the application of existing laws and
regulations (including laws and regulations governing issues such as property
ownership, content, taxation, defamation and personal injury), will not expose
the Company to significant liabilities, significantly slow Internet growth or
otherwise cause a material adverse effect on the Company's business, results of
operations or financial condition.

The Company currently does not collect sales or other taxes with respect to
the sale of services or products in states and countries where the Company
believes it is not required to do so. Some states and countries have sought to
impose sales or other tax obligations on companies that engage in online
commerce within their jurisdictions. A successful assertion by one or more
states or countries that the Company should collect sales or other taxes on
products and services, or remit payment of sales or other taxes for prior
periods, could have a material adverse effect on the Company's business, results
of operations and financial condition.

The Communications Decency Act of 1996 (the "CDA") was enacted in 1996.
Although those sections of the CDA that, among other things, proposed to impose
criminal penalties on anyone distributing "indecent" material to minors over the
Internet were held to be unconstitutional by the U.S. Supreme Court, there can
be no assurance that similar laws will not be proposed and adopted. Although the
Company does not currently distribute the types of materials that the CDA may
have deemed illegal, the nature of such similar legislation and the manner in
which it may be interpreted and enforced cannot be fully determined, and
legislation similar to the CDA could subject the Company to potential liability,
which in turn could have an adverse effect on the Company's business, financial
condition and results of operations. Such laws could also damage the growth of
the Internet generally and decrease the demand for the Company's products and
services, which could adversely affect the Company's business, results of
operations and financial condition.

POTENTIAL LIABILITY FOR INTERNET CONTENT. As a distributor of Internet
content, the Company faces potential liability for negligence, copyright,
patent, trademark, defamation, indecency and other claims based on the nature
and content of the materials that it makes available to Internet users. Such
claims have

16
<PAGE>
been brought, and sometimes successfully litigated, against Internet content
distributors. In addition, the Company could be exposed to liability with
respect to the content or unauthorized duplication or broadcast of content.
Although the Company maintains general liability insurance, the Company's
insurance may not cover potential claims of this type or may not be adequate to
indemnify the Company for all liability that may be imposed. In addition,
although the Company generally requires its content providers to indemnify the
Company for such liability, such indemnification may be inadequate. Any
imposition of liability that is not covered by insurance, is in excess of
insurance coverage or is not covered by an indemnification by a content provider
could have a material adverse effect on the Company's business, results of
operations and financial condition.

ITEM 2. PROPERTY

The Company's executive offices are located in an approximately 9,600 square
foot facility located in Cupertino, California. This space, which houses the
Company's current operations in two neighboring buildings, is subject to
separate leases that expire in December 1999. The monthly base rental under the
combined leases (not including insurance) is approximately $28,800 per month.

ITEM 3. LEGAL PROCEEDINGS

The Company is not presently a party to any material litigation.

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

As of November 22, 1998, the Company had obtained the approval by written
consent of more than a majority of the then-outstanding shares to approve
amendments to the Articles of Incorporation to change the name of the
corporation to audiohighway.com, add limitation of director liability and
indemnification provisions to the Articles of Incorporation. Shareholders
holding an aggregate of 538,460 shares signed the action by written consent. The
amendments were effective December 3, 1998.

As of December 10, 1998, the Company had obtained the approval by written
consent of more than a majority of the then-outstanding shares to approve an
amendment to the Articles of Incorporation to effect a 1-for-3.837 reverse stock
split of the then outstanding shares. Shareholders holding an aggregate of
538,460 shares signed the action by written consent. The reverse stock split
became effective December 11, 1998.

17
<PAGE>
PART II

ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION

Since December 18, 1998, the Company's Common Stock has been traded in the
over-the-counter market and is quoted on the Nasdaq SmallCap Market under the
symbol "AHWY." The Common Stock also trades on the Boston Stock Exchange under
the symbol "AHY." The following table sets forth the high and low closing sale
prices for the Common Stock as reported on the Nasdaq SmallCap Market for the
period indicated. These prices represent prices among dealers, do not include
retail markups, markdowns or commissions, and may not represent actual
transactions:

<TABLE>
<CAPTION>
FISCAL YEAR ENDED DECEMBER 31, 1998 HIGH LOW
- ------------------------------------------------------------------------ --------- ---------
<S> <C> <C>

Fourth Quarter (commencing December 18, 1998)........................... $14 13/16 $ 6 17/32
</TABLE>

On April 8 1999, the last reported sale price for the Common Stock was
$34 1/8 per share.

As of March 31, 1999, there were approximately 202 record holders of the
Company Common Stock. This number does not reflect the number of beneficial
holders of the Common Stock, which the Company believes is approximately 1,500
holders.

The Company has never paid cash dividends on its Common Stock. At present,
the Company intends to retain any earnings for use in its business and does not
anticipate paying cash dividends in the foreseeable future.

USE OF PROCEEDS

On December 17, 1998, the Securities and Exchange Commission declared the
Company's Registration Statement on Form SB-2 (File No. 333-59823) effective.
The net proceeds of this offering, including the exercise of the underwriters'
over-allotment option, were approximately $14,052,000. Because of the timing of
the initial public offering, as of December 31, 1998, the Company had most of
the net proceeds of the offering invested in money market accounts, debt
instruments having an original maturity of three months or less and other highly
liquid investments. However, approximately $628,000 of the net proceeds were
used to pay outstanding debt owed to unaffiliated third parties and an
additional $172,000 was paid to an executive officer and director of the Company
for previously unpaid salary accrued from prior years.

RECENT SALES OF UNREGISTERED SECURITIES

Not Applicable

ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion and analysis provides information that the
Company's management believes is relevant to an assessment and understanding of
the Company's results of operations and financial condition for the two fiscal
years ended December 31, 1997 and 1998. The following discussion should be read
in conjunction with the Financial Statements and Notes thereto appearing
elsewhere in this Annual Report on Form 10-KSB. The following discussion
contains forward-looking statements. Please see the discussion of certain
factors that may impact future results in "Business--Business Risks," contained
in Item 1 of this Report.

GENERAL

The Company offers a proprietary information and entertainment service that
enables its users to download and play back selected audio content from the
Internet (the "AudioCast System"). The

18
<PAGE>
AudioCast System consists of (i) proprietary client/server software developed by
the Company that is specifically adapted to transmit audio data over the
Internet, (ii) proprietary application software, known as AudioWiz, which is
provided free of charge to the customer and which allows him or her to download
and play back audio selections and (iii) a growing library of audio content that
ranges from audio books to sports updates and music.

The Company believes that what differentiates the AudioCast System from
other Internet-based information services is its focus on audio content versus
text, the downloading of audio content as digital files available for later use
and its emphasis on portability. The Company's system provides users with a
simple, easy to use method of selecting a diverse range of audio content from a
single Web site and the ability to listen to such programming in almost any
environment.

During the period from the Company's inception in June 1994 through December
31, 1996, the Company had no revenues and its operating activities related
primarily to the research and development efforts and initial planning and
development of the Company's Web site and operations. During 1997, the Company
generated minimal revenues from Web-based advertising, and the Company's
operating activities related to the continued development of its proprietary
software, building market awareness and the launch and continued enhancement of
its Web site. Throughout the Company's existence, it has expended significant
resources in the research and development of its technology and the aggregation
of content by obtaining Internet broadcasting rights to audio programming.

The Company's revenues are derived principally from the sale of audio
commercials included in its downloaded or streamed audio programming, channel
sponsorships and banner advertisements, all on short-term contracts. Advertising
revenues are recognized in the period in which the advertisement is delivered,
provided that collection of the resulting receivable is probable. For each hour
of downloaded content, the Company can distribute up to six minutes of audio
commercials. The audio selections, which include audio advertisements, are free
of charge to the user. In the first quarter of 1999, the Company began
generating nominal revenues from e-commerce. In the future, the Company
anticipates that it may generate additional revenue streams through ad-free
program charges and charges for premium content and e-commerce. However, the
extent and timing of developing such additional revenue sources is not currently
known, and there is no assurance that the Company will in fact generate revenues
from all or any of these potential sources at any time in the future.

The amount of revenue that the Company can generate is directly related to a
number of factors, including the volume of advertisers, the rates charged for
the various types of advertising, the number of users who visit the Company's
Web site and the amount of audio content downloaded or streamed. To date, the
Company has generated a minimal amount of advertising revenue, in part due to
excess advertisement "inventory" resulting from the fact the Company has
attracted more customers than advertisements to match with its audio content.
The Company expects to use a significant portion of the net proceeds of its
December 1998 initial public offering ("IPO") for sales and marketing and
thereby expects to rapidly expand its advertising inventory. There is no
assurance, however, that the Company will successfully increase revenues or
achieve profitability.

The Company has signed agreements with major media companies to provide a
wide selection of audio content such as news, books, self improvement programs,
magazine articles, radio and television programs and movie reviews. The Company
stores audio content on its Web site and is continually adding content to its
audio library. The cost of this content to the Company is, for the most part,
directly proportional to the duration of downloaded content. Certain of the
content is purchased on a flat fee basis.

The Company has incurred significant losses since its inception. As of
December 31, 1998, the Company had an accumulated deficit of approximately
$12,517,000 and is continuing to operate at a loss. The Company believes that
its success will depend largely on its ability to attract users to its Web site,
obtain advertising contracts and secure additional audio content of interest to
users. Accordingly, the

19
<PAGE>
Company intends to invest heavily in sales and marketing, content acquisition
and continued research and development efforts.

In view of the rapidly evolving nature of the Company's business and its
limited operating history, the Company believes that period-to-period
comparisons of its revenues and operating results, including its gross profit
margin and operating expenses as a percentage of total net revenues, are not
necessarily meaningful and should not be relied upon as indications of future
performance.

PLAN OF OPERATIONS

The Company intends to use the net proceeds of its IPO to expand and improve
its AudioCast System. The Company expects expenditures to increase very
substantially across all expense categories as it seeks to increase its
advertising inventory, expand its digital audio content library and upgrade its
Web site. The Company expects the most significant expense increases will occur
in sales and marketing and research and development.

RESULTS OF OPERATIONS

YEAR ENDED DECEMBER 31, 1998 COMPARED TO DECEMBER 31, 1997

Net revenues were $139,000 for the year ended December 31, 1998 compared to
$4,000 for the same period in 1997. The Company launched its Web site and began
generating revenues in November 1997.

Operating and development expenses were $1,287,000 for the year ended
December 31, 1998, up 81% from $712,000 for the same period in 1997. This
increase was primarily the result of increased staffing, data communications
expenses, costs to produce and maintain the Company's Web site and use of
consulting engineers. The Company employs outside consulting engineers to
facilitate a portion of its development effort.

Selling and marketing expenses were $1,832,000 for the year ended December
31, 1998, up 12% from selling and marketing expenses of $1,634,000 for the same
period in 1997. The Company expects selling and marketing expenses to continue
to increase substantially in future periods as the Company continues to promotes
its Web site.

General and administrative expenses ("G&A") were $631,000 for the year ended
December 31, 1998, compared to G&A expenses of $157,000 for the same period in
1997. This 302% increase was primarily the result of increased costs in rent,
legal fees and consulting fees.

The operating loss was $3,611,000 for the year ended December 31, 1998
compared to an operating loss for 1997 of $2,499,000, an increase of
approximately 44%. As noted above, the increased loss was primarily the result
of increased expenses for rent, legal fees, advertising, marketing, engineering
and product development.

Interest expense increased approximately 43% to $1,845,000 during the year
ended December 31, 1998 from $1,292,000 in the same period in 1997. This was
primarily the result of amortizing the fair value attributed to warrants issued
in connection with outstanding debt over the life of the related debt equal to
$913,000 in 1998 compared to $1,009,000 in 1997 and the amortization of
beneficial conversion features of certain convertible debt over the expected
conversion period of $609,000 in 1998 and $0 in 1997. In connection with the its
initial public offering, the Company recorded an extraordinary charge to
operations equal to $425,000 related to the unamortized fair value of warrants
issued in connection with certain debt converted in the IPO.

As a result of the factors described above, for the year ended December 31,
1998, the Company incurred a net loss of $5,867,000 compared to a net loss from
continuing operations of $3,791,000 for the same period in 1997.

20
<PAGE>
The Company has no current tax liability and management has determined that
the realization of its deferred tax assets is not probable. As such, the Company
has provided a full valuation allowance against its deferred tax assets.

LIQUIDITY AND CAPITAL RESOURCES

The Company has financed its operations since inception almost entirely from
the sale of equity and debt securities, supplemented with a bank line of credit.
In December 1998, it completed its initial public offering of securities, in
which it sold an aggregate of 2,530,000 units consisting of Common Stock and
redeemable Common Stock Purchase Warrants (the "Units"), at an initial public
offering price of $6.50 per Unit. The offering netted the Company approximately
$14,052,000 after deducting expenses related to the offering. As of December 31,
1998, the Company had cash and cash equivalents of $13,007,000 and working
capital of $10,850,000. In January 1999, the conditions for redemption set forth
in the Common Stock Purchase Warrants were satisfied and the Company noticed the
redemption of its outstanding public warrants. As a result, a total of
approximately 1,250,000 warrants were exercised, which resulted in gross
proceeds to the Company of approximately $12,000,000. The Company paid
approximately $300,000 to holders of Warrants who chose not to redeem during the
30-day redemption period. The Company currently is financing its daily
operations primarily through the application of the net proceeds from the IPO
and its subsequent warrant call.

The Company has issued subordinated convertible promissory notes which bear
interest at 8% to 10%, are convertible into Common Stock at rates ranging from
$3.00 to $14.39 per share and other non-convertible debt at rates from 8% to
15%. During 1998, the Company converted $2,466,000 of debt and accrued interest
of $264,000, including debt converted at the close of the Company's IPO, into
626,384 shares of Common Stock. The remaining debt is all due on or before June
30, 2000. As of December 31, 1997, officers and directors of the Company
purchased $130,000 of the debt, all of which were converted as described above
prior to December 31, 1998.

The Company believes that its current financial resources will be sufficient
to fund its operations for at least the next 12 months and that, during that
period, it will not be necessary for the Company to raise additional funds to
meet the expenditures required for operating its business.

The Company will make significant ongoing investments in research and
development for future generation products and services. It also expects to have
significant expenditures in sales and marketing and further content acquisition
in order to attract customers to its Web site. There is no assurance that the
Company's analysis of its capital requirements will be accurate, particularly in
light of the fact that it is entering a new business in a new market.

The Company's future expenditures and capital requirements will depend on a
number of factors including the development and implementation of next
generation technologies, technological developments on the Internet and the
regulatory and competitive environment for Internet based products and services.

NET OPERATING LOSS CARRYFORWARDS

At December 31, 1998, the Company fully provided against its deferred tax
assets. The Company believes sufficient uncertainty exists regarding the
realizability of the deferred tax assets such that a full valuation allowance is
required. At December 31, 1998, the Company had approximately $10,150,000 of
federal net operating loss carryforwards for tax reporting purposes available to
offset future taxable income; such carryforwards will expire beginning in 2009.
Additionally, the Company has approximately $5,075,000 of California net
operating loss carryforwards for tax reporting purposes which will expire
beginning in 1999.

21
<PAGE>
The Tax Reform Act of 1986 imposes limitations on the use of net operating
loss carryforwards if certain stock ownership changes have occurred or could
occur in the future. The sale of the Units sold in the Company's December 1998
IPO constituted such a change in ownership and utilization of the Company's net
operating loss carryforwards may be limited.

YEAR 2000 COMPLIANCE

There are issues associated with the programming code in existing computer
systems as the Year 2000 approaches. The "Year 2000 problem" is pervasive and
complex, as virtually every computer operation will be affected in some way by
the rollover of the two digit year value to 00. Systems that do not properly
recognize such information could generate erroneous data or fail. The Company
has evaluated its current systems, purchased necessary upgrades and believes
that its current hardware and software is Year 2000 compliant. Similarly, the
Company believes that the products and services it offers to its customers are
not affected by the Year 2000 problem. The Company has evaluated the potential
impact on it of a Year 2000 problem on the part of its important third party
vendors and has found none. The Company plans to continue to evaluate its
systems and those of its important vendors in an effort to minimize the effects
of a Year 2000 problem. The Company does not anticipate that the Year 2000
problem will have a material impact on its business or operations.

ITEM 7. FINANCIAL STATEMENTS

The Balance Sheet of the Company at December 31, 1998 and the related
Statements of Operations, Shareholders' Equity and Cash Flows for the years
ended December 31, 1997 and 1998, and the Notes to Financial Statements are
located on pages 24 through 34 of this Report.

22
<PAGE>
INDEX TO FINANCIAL STATEMENTS

<TABLE>
<CAPTION>
FORM 10-KSB
PAGE NUMBER
-----------------
<S> <C>
Report of Independent Certified Public Accountants.................................................. 24

Balance Sheet at December 31, 1998.................................................................. 25

Statements of Operations for the years ended December 31, 1998 and 1997............................. 26

Statement of Shareholders' Equity for the years Ended December 31, 1998 and 1997.................... 27

Statements of Cash Flows for the years ended December 31, 1998 and 1997............................. 28

Notes to Financial Statements....................................................................... 29
</TABLE>

23
<PAGE>
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors and Stockholders
audiohighway.com

We have audited the accompanying balance sheet of audiohighway.com (the
"Company"), as of December 31, 1998, and the related statements of operations,
stockholders' equity, and cash flows for each of the two years then ended. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of the Company as of December
31, 1998, and the results of its operations and its cash flows for each of the
two years then ended, in conformity with generally accepted accounting
principles.

Grant Thornton LLP

San Jose, California
April 14, 1999

24
<PAGE>
AUDIOHIGHWAY.COM

BALANCE SHEET

(IN THOUSANDS, EXCEPT SHARE AMOUNTS)

<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
ASSETS
Current assets
Cash and cash equivalents......................................................................... $ 13,007
Accounts receivable............................................................................... 80
Prepaid expenses.................................................................................. 47
------------
Total current assets............................................................................ 13,134

Property and equipment, net......................................................................... 333
------------
$ 13,467
------------
------------

LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Current maturities of long term debt.............................................................. $ 952
Accounts payable.................................................................................. 1,128
Accrued expenses and other current liabilities.................................................... 204
------------
Total current liabilities....................................................................... 2,284

Long term debt...................................................................................... 376

Stockholders' equity:
Preferred Stock, no par value; 5,000,000 shares authorized; none issued........................... --
Common Stock, no par value; 50,000,000 shares authorized; 4,103,000 issued and outstanding........ 19,130
Additional paid-in capital........................................................................ 4,194
Accumulated deficit............................................................................... (12,517)
------------
Total stockholders' equity...................................................................... 10,807
------------
$ 13,467
------------
------------
</TABLE>

The accompanying notes are an integral part of these statements.

25
<PAGE>
AUDIOHIGHWAY.COM

STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Net revenues................................................................................. $ 4 $ 139

Costs and expenses:
Operating and development.................................................................. 712 1,287
Sales and marketing........................................................................ 1,634 1,832
General and administrative................................................................. 157 631
--------- ---------
Total costs and expenses................................................................. 2,503 3,750

Loss from operations......................................................................... (2,499) (3,611)

Other income (expense):
Interest expense........................................................................... (1,292) (1,845)
Other...................................................................................... -- 14
--------- ---------
Net loss before extraordinary item....................................................... $ (3,791) $ (5,442)

Extraordinary loss on conversion of subordinated debt........................................ -- 425
--------- ---------
Net loss................................................................................. $ (3,791) $ (5,867)
--------- ---------
--------- ---------

Basic and diluted net loss per share from continuing operations.............................. $ (4.11) $ (4.75)
Basic and diluted net loss per share from extraordinary item................................. -- (0.37)
--------- ---------

Basic and diluted net loss per share......................................................... $ (4.11) $ (5.12)
--------- ---------
--------- ---------
Shares used in computing basic and diluted net loss per share................................ 923 1,146
--------- ---------
--------- ---------
</TABLE>

The accompanying notes are an integral part of these statements.

26
<PAGE>
AUDIOHIGHWAY.COM

STATEMENT OF STOCKHOLDERS' EQUITY

(IN THOUSANDS)

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL
---------------------- PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
----------- --------- ----------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1997............................... 832 $ 2,049 $ 1,071 $ (2,859) $ 261

Sales of Common Stock.................................. 12 184 -- -- 184
Issuance of Common Stock from exercise of options and
warrants............................................. 93 10 -- -- 10
Issuance of Common Stock for services.................. 7 78 -- -- 78
Issuance of warrants with debt......................... -- -- 813 -- 813
Net loss............................................... -- -- -- (3,791) (3,791)
----- --------- ----------- ------------ ---------

Balance at December 31, 1997............................. 944 2,321 1,884 (6,650) (2,445)

Public offering of Common Stock, net of issuance costs
of $2,343............................................ 2,530 14,052 -- -- 14,052
Conversion of subordinated notes and accrued interest
to Common Stock...................................... 626 2,730 -- -- 2,730
Issuance of Common Stock from exercise of options and
warrants............................................. 3 18 -- -- 18
Issuance of Common Stock for services.................. 1 9 -- -- 9
Beneficial conversion feature on convertible notes..... -- -- 609 -- 609
Issuance of warrants with debt......................... -- -- 1,701 -- 1,701
Net loss............................................... -- -- -- (5,867) (5,867)
----- --------- ----------- ------------ ---------

Balance at December 31, 1998............................. 4,104 $ 19,130 $ 4,194 $ (12,517) $ 10,807
----- --------- ----------- ------------ ---------
----- --------- ----------- ------------ ---------
</TABLE>

The accompanying notes are an integral part of these statements.

27
<PAGE>
AUDIOHIGHWAY.COM

STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss................................................................................... $ (3,791) $ (5,867)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization............................................................ 86 100
Common Stock issued for services......................................................... 78 9
Amortization of debt discounts and conversion features................................... 1,154 1,948
Changes in operating assets and liabilities:
Accounts receivable.................................................................... (2) (78)
Prepaid expenses....................................................................... (31) (5)
Accounts payable....................................................................... 546 305
Accrued expenses and other current liabilities......................................... 163 110
--------- ---------
Net cash used in operating activities................................................ (1,797) (3,478)

Cash flows from investing activities:
Acquisition of property and equipment...................................................... (159) (55)

Cash flows from financing activities:
Proceeds from issuance of Common Stock..................................................... 194 14,070
Proceeds from issuance of long term debt................................................... 1,376 2,613
Repayment of long term debt................................................................ -- (148)
--------- ---------
Net cash provided by financing activities............................................ 1,570 16,535
--------- ---------

Net change in cash and cash equivalents.............................................. (386) 13,002

Cash and cash equivalents at beginning of year............................................... 391 5
--------- ---------

Cash and cash equivalents at end of year..................................................... $ 5 $ 13,007
--------- ---------
--------- ---------

Cash paid during the period for:

Interest................................................................................... $ 23 $ 87
Income taxes............................................................................... $ -- $ --
</TABLE>

The accompanying notes are an integral part of these statements.

28
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 1--THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES

audiohighway.com (the "Company") is a global Internet media company that
offers a library of pre-recorded audio content via the World Wide Web (the
"Web"). The Company was incorporated in California in 1994 and, prior to October
1997, was in the development stage. The Company conducts its business within one
industry segment.

REVENUE RECOGNITION

The Company's revenues are derived principally from the sale of audio
commercials included in its downloaded programming ("deliveries") and from the
sale of banner advertisements, both on short-term contracts. Advertising
revenues on both banner advertisements and deliveries are recognized in the
period in which the advertisement is delivered, provided that collection of the
resulting receivable is probable. Advertisers are charged on a per impression or
delivery basis up to a maximum as specified in the contract. Standard rates for
advertising generally do not exceed thirty cents per impression or delivery. To
date, the duration of the Company's advertising commitments has not exceeded one
year and the Company does not guarantee a minimum number of impressions or
deliveries. Revenue sharing agreements with advertisers may provide that the
Company receive revenues from electronic commerce transactions. These revenues
are recognized by the Company upon notification from the advertiser of revenues
earned and, to date, have not been significant.

OPERATING AND DEVELOPMENT

Operating and development expenses consist primarily of Web site maintenance
costs, data communications expenses, content and software licensing fees,
operating supplies and related overhead.

ADVERTISING COSTS

Advertising costs are expensed as incurred. The Company does not incur any
direct-response advertising costs. Advertising expense totaled $367 for 1997 and
$343 for 1998.

CASH, CASH EQUIVALENTS AND SHORT TERM INVESTMENTS

All highly liquid instruments with an original maturity of three months or
less are considered cash equivalents. Cash equivalents include short term
investments in low risk investment grade securities with maturities of less than
three months.

CONCENTRATION OF CREDIT RISK

Financial instruments that potentially subject the Company to significant
concentration of credit risk consist primarily of cash, cash equivalents, and
accounts receivable. Substantially all of the Company's cash and cash
equivalents are managed by three financial institutions. Accounts receivable are
typically unsecured and are derived from revenues earned from customers
primarily located in the United States. The Company performs ongoing credit
evaluations of its customers and maintains reserves for potential credit losses.

29
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 1--THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT

Property and equipment, including leasehold improvements, are stated at
cost. Depreciation is computed using the straight-line method over the estimated
useful lives of the assets, generally two to five years. For leasehold
improvements, depreciation is computed over the shorter of the lease term or the
estimated useful life of the improvements.

INCOME TAXES

Income taxes are computed using an asset and liability method. Under the
asset and liability method, deferred income tax assets and liabilities are
determined based on the differences between the financial reporting and tax
bases of assets and liabilities and are measured using the currently enacted tax
rates and laws.

STOCK-BASED COMPENSATION

The Company accounts for stock-based employee compensation arrangements in
accordance with the provisions of Accounting Principles Board Opinion ("APB")
No. 25, "ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES," and complies with the
disclosure provisions of SFAS No. 123, "ACCOUNTING FOR STOCK-BASED
COMPENSATION." Under APB No. 25, compensation cost is recognized over the
vesting period based on the difference, if any, on the date of grant between the
fair value of the Company's stock and the amount an employee must pay to acquire
the stock.

USE OF ESTIMATES

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

BASIC AND DILUTED NET LOSS PER SHARE

Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earnings per share is
computed using the weighted average number of common and common equivalent
shares outstanding during the period. Common equivalent shares consist of the
incremental common shares issuable upon conversion of convertible securities
(using the if-converted method) and shares issuable upon the exercise of stock
options and warrants (using the treasury stock method). Common equivalent shares
are excluded from the computation if their effect is anti-dilutive.

FAIR VALUE OF FINANCIAL INSTRUMENTS

The fair value of cash and cash equivalents, accounts receivable and trade
payables approximates carrying value due to the short term nature of such
instruments. The fair value of long term obligations including subordinated debt
cannot be determined as there is no market for these instruments.

30
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 1--THE COMPANY AND SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECLASSIFICATIONS

Certain reclassifications have been made to prior year data to conform to
the 1998 presentation.

NOTE 2--BALANCE SHEET COMPONENTS

<TABLE>
<CAPTION>
DECEMBER 31,
1998
-------------
<S> <C>
Property and equipment:
Computers and equipment....................................................... $ 505
Furniture and fixtures........................................................ 10
Leasehold improvements........................................................ 23
-----
538
Less: accumulated depreciation................................................ (205)
-----
$ 333
-----
-----

Accrued expenses and other current liabilities:
Employee compensation costs................................................... $ 54
Interest...................................................................... 140
Other......................................................................... 10
-----
$ 204
-----
-----
</TABLE>

NOTE 3--LONG TERM DEBT

The Company has issued subordinated convertible promissory notes bearing
interest at rates from 8% to 10%, that are convertible into Common Stock at
rates ranging from $3.25 to $14.39 per share and other non-convertible debt
bearing interest at 8% to 15%. During 1998, the Company converted $2,466 of debt
and accrued interest of $264 into Common Stock, including $1,738 that
immediately converted upon closing of the Company's initial public offering in
December 1998. The remaining debt is due by June 30, 2000. Officers and
directors of the Company had purchased $130 of debt, of which none remains
outstanding at December 31, 1998.

Contractual maturities of long term debt are as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31:
- -------------------------------------------------------------------------------------
<S> <C>
1999................................................................................. $ 1,054
2000................................................................................. 1,264
---------
$ 2,318
---------
---------
</TABLE>

The Company has issued 604,973 warrants to purchase shares of Common Stock
in connection with the issuance of debt and for guarantees provided by
shareholders. The Company calculated the fair value of the warrants at the date
of issuance and is amortizing this amount as interest expense over the life of
the related debt.

31
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 3--LONG TERM DEBT (CONTINUED)
The carrying value of the debt is as follows:

<TABLE>
<CAPTION>
DECEMBER 31,
1998
------------
<S> <C>
Debt principal.................................................................. $ 2,358
Unamortized discount............................................................ (1,030)
------------
Carrying value.................................................................. $ 1,328
------------
------------
</TABLE>

NOTE 4--STOCKHOLDERS' EQUITY

INITIAL PUBLIC OFFERING

In December 1998, the Company completed an initial public offering whereby
2,530,000 units were sold at a price of $6.50 each. Each unit consisted of one
share of Common Stock and one warrant to purchase one share of Common Stock at
$9.75 (the "Unit Warrants", collectively the "Units"). The Unit Warrants
contained a call provision which was exercised by the Company in January 1999
(the "Warrant Call"). The Warrant Call resulted in net proceeds to the Company
of approximately $12,000. As a result of the Warrant Call, no Unit Warrants are
outstanding.

The underwriter of the initial public offering was granted a warrant to
acquire 220,000 Units, exercisable at $7.80 per Unit (the "Representative's
Warrants"). The Representative's Warrants expire in December 2003 and are all
outstanding as of December 31, 1998.

The Board of Directors and the shareholders approved a 1 for 3.837 reverse
split of the Common Stock that was effected on December 11, 1998. All references
to the number of shares of Common Stock, weighted average common shares, and per
share amounts in the accompanying financial statements and notes reflect this
reverse split.

STOCK OPTIONS AND WARRANTS

The 1996 Stock Option Plan (the "Plan") allows for the issuance of incentive
stock options, non-qualified stock options and stock purchase rights to purchase
shares of the Company's Common Stock. The Plan has authorized 364,869 shares of
which 99,431 remain available for granting at December 31, 1998. Under the Plan,
incentive stock options may be granted to employees, directors, and officers of
the Company and non-qualified stock options and stock purchase rights may be
granted to consultants, employees, directors, and officers of the Company.
Options granted under the Plan are for periods not to exceed ten years, and must
be issued at prices not less than 100% and 85%, for incentive and nonqualified
stock options, respectively, of the fair market value of the stock on the date
of grant. Options granted to shareholders who own greater than 10% of the
outstanding stock are for periods not to exceed five years and must be issued at
prices not less than 110% of the fair market value of the stock on the date of
grant. Options granted under the Plan generally vest within 3 to 5 years.

The Company has also granted options and warrants to purchase Common Stock
outside of the Plan to employees, directors and consultants. These instruments
generally vest within 3 to 5 years.

32
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
Stock option and warrant activity, excluding warrants issued in connection
with long term debt, the Unit Warrants, and the Representative's Warrants, is
summarized as follows:

<TABLE>
<CAPTION>
WEIGHTED AVERAGE
SHARES EXERCISE PRICE
--------- -----------------
<S> <C> <C>
Balance at January 1, 1997....................................... 300,756 $ 3.07
Granted........................................................ 78,186 13.16
Exercised...................................................... (93,823) 0.12
Cancelled...................................................... (13,031) 3.84
--------- ------

Balance at December 31, 1997..................................... 272,088 6.98
Granted........................................................ 163,700 6.50
Exercised...................................................... -- --
Cancelled...................................................... (31,274) 13.19
--------- ------

Balance at December 31, 1998..................................... 404,514 $ 6.29
--------- ------
--------- ------
</TABLE>

The following table summarizes information about stock options and warrants
outstanding as of December 31, 1998:

<TABLE>
<CAPTION>
WEIGHTED AVERAGE
RANGE OF NUMBER WEIGHTED AVERAGE REMAINING CONTRACTUAL NUMBER WEIGHTED AVERAGE
EXERCISE PRICE OUTSTANDING EXERCISE PRICE TERM (YEARS) EXERCISABLE EXERCISE PRICE
- ----------------- ----------- ----------------- --------------------- ----------- -----------------
<S> <C> <C> <C> <C> <C>
$ 1.92 - $ 5.76 193,902 $ 4.47 5.1 185,214 $ 4.41
$ 5.77 - $11.50 163,700 $ 6.50 3.0 63,850 $ 6.50
$ 11.51 - $14.39 46,912 $ 13.11 6.3 27,675 $ 12.87
----------- -----------
404,514 276,739
----------- -----------
----------- -----------
</TABLE>

The following table depicts the pro forma results of operations had
compensation expense been determined based on the fair value at the grant dates,
as prescribed in SFAS No. 123.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER
31,
--------------------
1997 1998
--------- ---------
<S> <C> <C>
Net loss
As reported............................................................ $ (3,791) $ (5,867)
Pro forma.............................................................. (3,876) (6,305)

Basic and diluted net loss per share
As reported............................................................ $ (4.11) $ (5.12)
Pro forma.............................................................. (4.20) (5.50)
</TABLE>

Prior to the Company's initial public offering, the fair value of each
option grant has been determined on the date of grant using the minimum value
method. After the Company's initial public offering, the fair value of option
grants has been determined using the Black-Scholes option pricing model. The
weighted

33
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 4--STOCKHOLDERS' EQUITY (CONTINUED)
average fair value of options and warrants granted to employees was $0.75 and
$5.84 for 1997 and 1998. The following weighted average assumptions were used to
perform the calculations: expected life of 4 years in 1997 and 2.8 years in
1998; interest rate of 6% in 1997 and 5.5% in 1998, volatility of 200% (for
grants after the initial public offering) and no dividend yield. The pro forma
disclosures may not be representative of pro forma effects on reported financial
results for future years as the above information does not include the effects
of grants made prior to 1995.

NOTE 5--INCOME TAXES

No provision for federal and state income taxes has been recorded as the
Company has incurred net operating losses through December 31, 1998. The
following table sets forth the primary components of deferred tax assets at
December 31, 1998:

<TABLE>
<S> <C>
Net operating loss and credit carryforwards........................ $ 3,906
Nondeductible reserves and expenses................................ 18
---------

Gross deferred tax assets.......................................... 3,924
Valuation allowance................................................ (3,924)
---------
$ --
---------
---------
</TABLE>

The Company believes sufficient uncertainty exists regarding the
realizability of the deferred tax assets such that a full valuation allowance is
required. At December 31, 1998, the Company had approximately $10,150 of federal
net operating loss carryforwards for tax reporting purposes available to offset
future taxable income; such carryforwards will expire beginning in 2009.
Additionally, the Company has approximately $5,075 of California net operating
loss carryforwards for tax reporting purposes which will expire beginning in
1999.

Federal and state laws impose restrictions on the utilization of net
operating loss carryforwards in the event of an "ownership change" as defined in
Section 382 of the Internal Revenue Code. As a result of the initial public
offering, the Company believes an ownership change has occurred and utilization
of the net operating losses may be limited.

NOTE 6--COMMITMENTS AND CONTINGENCIES

ROYALTY AGREEMENT

The Company has entered into an agreement whereby a vendor is to receive a
royalty up to a maximum of 8% of the revenue generated by deliveries made
directly to the Company's ListenUp Players. No royalties had been incurred as of
December 31, 1998.

OPERATING LEASES

The Company leases its operating facilities under operating leases that
expire in 1999. Future minimum lease payments are $310 in 1999. Rent expense
under operating leases totaled $100 in 1997 and $429 in 1998.

34
<PAGE>
AUDIOHIGHWAY.COM

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

DECEMBER 31, 1997 AND 1998
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)

NOTE 7--RELATED PARTY TRANSACTIONS

During 1998, the Company incurred $265 in expenses to TDP, Inc., for
software consulting and systems development expenses. Mr. Rehki, a member of the
Board of Directors of the Company, is the President of TDP, Inc. As of December
31, 1998, $142 of this amount was unpaid.

On February 23, 1999, the Company made an unsecured loan to Mr. Rehki in the
amount of $107 bearing interest at the rate of 10% per annum due February 23,
2000.

35
<PAGE>
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

There were no disagreements on accounting and financial disclosure.

PART III

ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS;
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT

The executive officers and directors of the Company as of March 31, 1999 are
as follows:

<TABLE>
<CAPTION>
NAME AGE POSITIONS
- ------------------------------------ --- ---------------------------------------------------------------------
<S> <C> <C>
Nathan M. Schulhof.................. 49 President, Chief Executive Officer and Director
Grant Jasmin(1)..................... 47 Executive Vice President, Chief Operating Officer, Vice President
Finance, Secretary and Director
Robert S. Leff...................... 52 Director
Lee M. Gammill(2)................... 62 Director
Muninderpal Rehki(1)(2)............. 49 Director
Marvin M. Reiss..................... 54 Director
Gregory Sutyak...................... 42 Chief Financial Officer
Marc Baum........................... 36 Vice President Product Development
Theodore Richards................... 52 Vice President and Creative Director
</TABLE>

- ------------------------

(1) Member of the Compensation Committee

(2) Member of the Audit Committee

Mr. Schulhof is one of the founders of the Company and has served as Chief
Executive Officer, President and a Director since the Company's inception in
June 1994. From January 1993 to May 1994, Mr. Schulhof was President and Chief
Executive Officer of TestDrive Corporation, a pioneer in the distribution of
computer software on CD-ROM ("TestDrive"), which he founded and sold to RR
Donnelley & Sons Co. For more than four years prior to forming TestDrive, Mr.
Schulhof worked as an independent management consultant to the computer
industry. Mr. Schulhof received a Bachelor of Arts degree in English from the
University of Wisconsin.

Mr. Jasmin is one of the founders of the Company and has served as Executive
Vice President, Chief Operating Officer, Secretary and a Director since the
Company's inception in June 1994. From June 1994 until January 1998, Mr. Jasmin
also served as the Company's Vice President, Finance. He again was appointed
Vice President, Finance in December 1998. For more than five years prior to
joining the Company, Mr. Jasmin was engaged in the practice of law specializing
in corporate and securities law. Mr. Jasmin received the degree of Juris Doctor
from the University of California Hastings College of the Law, Master of
Business Administration from the University of Santa Clara and a Bachelor of
Arts degree in Economics from San Jose State University.

Mr. Leff has served as a Director of the Company since February 1995. Mr.
Leff has served as an independent financial consultant since December 1994.
Prior thereto, Mr. Leff was a founder of Softsel, Inc., the predecessor to
Merisel, Inc., a publicly-held company, where he served as Co-Chairman of the
Board for more than five years until December 1994. Merisel is one of the
world's largest distributor of microcomputer hardware and software and
associated products. Mr. Leff holds both a Master of Science degree and a
Bachelor of Science degree from the State University of New York at Albany.

Mr. Gammill has served as a Director of the Company since November 1997.
Since May 1997, Mr. Gammill has served as Chief Executive Officer of The Gammill
Group, a consultant to the insurance and financial industry. In May 1997, Mr.
Gammill retired from 40 year career with New York Life Insurance Company where
he served as Vice Chairman of the Board of Directors. Mr. Gammill also serves

36
<PAGE>
on the Board of Directors of Guarantee Life Insurance Company, Omaha Nebraska,
and is a Trustee of the American College, Bryn Mawr, Pennsylvania. Mr. Gammill
received a Bachelor of Arts degree in Business Administration from Dartmouth
College.

Mr. Rehki has served as a Director of the Company since April 1998. Mr.
Rehki has been Chief Executive Officer of TDP, Inc., a high technology software
consulting firm, since January 1998. From October 1997 to January 1998, he was
Chief Executive Officer of TransWeb, a software consulting firm to the medical
industry. TransWeb is a wholly-owned subsidiary of CyberPlus, an Internet-based
software medical support company in which Mr. Rehki served as Chief Executive
Officer and Director from February 1996 to October 1997. From December 1993 to
January 1996, Mr. Rehki was Vice President of Operations for Intellimatch, Inc.,
an Internet-based human resources company. Mr. Rehki received a Bachelor of Arts
degree in Economics and a Master of Arts degree in Economics from Christ Church
College, India.

Mr. Reiss has served as a Director of the Company since October 1998. For
more than the past five years, Mr. Reiss has been Chairman and Chief Executive
Officer of The Rebot Corporation, a record company that produces, manufactures
and distributes recorded music under various labels including Arabesque
Recordings. Mr. Reiss received the degrees of Master of Business Administration,
Master of International Affairs and Master of Arts in Sociology from Columbia
University, Bachelor of Law degree from Brooklyn Law School, Master of Science
degree in Physiology from the Fairleigh Dickenson Dental School, Master of
Science degree in Microbiology from Marquette University School of Medicine and
Bachelor of Arts degree in Biology from Yeshiva University.

Mr. Sutyak has served as Chief Financial Officer since January 1998. From
January 1995 through December 1997, Mr. Sutyak served as a consultant to the
Company performing financial services. From March 1996 through December 1997,
Mr. Sutyak was an independent consultant. From May 1993 through February 1996,
Mr. Sutyak was Chief Financial Officer for TestDrive. Mr. Sutyak received a
Bachelor of Arts degree in Economics from the University of Pittsburgh and a
Masters of Business Administration degree from the University of San Francisco.

Mr. Baum has served as Vice President, Product Development since April 1998.
From May 1996 through March 1998, Mr. Baum was Vice President of Paragon
Technology Corporation, a network company providing software and consulting
services to the financial, insurance and retail industries. From March 1992
through April 1996, Mr. Baum was Director of Network Systems Products for U.S.
Robotics, a leading manufacturer of network and Internet connectivity products.
Mr. Baum received a Bachelor of Science degree in Computer Engineer from the
University of Illinois.

Mr. Richards has served as Vice President and Creative Director since July
1996. From November 1994 to July 1996, Mr. Richards was Vice President of User
Interface Design and Creative Director for SoftAd, a firm specializing in the
design and implementation of sales force automation and integrated
client-server-based Web sites. From January 1993 to July 1994, Mr. Richards was
Executive Creative Director and Vice President of TestDrive. Mr. Richards
received a Bachelor of Arts degree in Creative Writing from San Francisco State
University.

All members of the Board of Directors hold office until the next annual
meeting of shareholders and the election and qualification of their successors,
or until death, resignation, or removal. Officers serve at the discretion of the
Board of Directors. There are no family relationships among any of the directors
and executive officers of the Company.

INDEMNIFICATION OF DIRECTORS AND OFFICERS

As permitted by the General Corporation Law of California (the "Corporations
Code"), the Company's Articles of Incorporation eliminate, to the fullest extent
permitted under California law, the personal liability of a director to the
Company for monetary damages in an action brought by or in the

37
<PAGE>
right of the Company for breach of a director's duties to the Company and its
shareholders. Under current California law, liability is not eliminated for (i)
acts or omissions that involve intentional misconduct or a knowing and culpable
violation of law; (ii) acts or omissions that a director believed to be contrary
to the best interests of the corporation or its shareholders or that involve the
absence of good faith on the part of the director; (iii) any transaction from
which a director derived an improper personal benefit; (iv) acts or omissions
that show a reckless disregard for the director's duty to the corporation or its
shareholders in circumstances in which the director was aware, or should have
been aware, in the ordinary course of performing a director's duties, of a risk
of serious injury to the corporation or its shareholders; (v) acts or omissions
that constitute an unexcused pattern of inattention that amounts to an
abdication of the director's duty to the corporation or its shareholders; (vi)
contracts or other transactions between corporations and directors having
interrelated directors in violation of Section 310 of the Corporations Code; and
(vii) distributions, loans or guarantees made in violation of Section 316 of the
Corporations Code. In addition, the Company's Articles of Incorporation and
bylaws provide for indemnification, to the fullest extent permitted under the
Corporations Code, of directors, officers and agents of the Company and persons
who serve at the request of the Company as a director, officer, employee,
trustee or agent of another corporation, partnership, joint venture, trust or
other enterprise.

The Company has also entered into indemnification agreements with its
directors and executive officers, as permitted under the bylaws. The
indemnification agreements provide that the directors and executive officers
will be indemnified to the fullest extent permitted by applicable law against
all expenses (including attorneys' fees), judgments, fines and amounts
reasonably paid or incurred by them for settlement in any threatened, pending or
completed action, suit or proceeding, including any derivative action, on
account of their services as a director or executive officer of the Company or
of any subsidiary of the Company or of any other company or enterprise in which
they are serving at the request of the Company. No indemnification will be
provided under the indemnification agreements, however, to any director or
executive officer in certain limited circumstances, including on account of
knowingly fraudulent, deliberately dishonest or willful misconduct. To the
extent the provisions of the indemnification agreements exceed the
indemnification permitted by applicable law, such provisions may be
unenforceable or may be limited to the extent they are found by a court of
competent jurisdiction to be contrary to public policy. In addition, in the
opinion of the Securities and Exchange Commission, indemnification for
liabilities arising under the Securities Act of 1933, as amended (the "Act"), is
against public policy and, therefore, unenforceable. Accordingly, these
indemnification provisions may not limit the liability of directors and
executive officers under the Act.

SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended (the
"Exchange Act") requires the Company's executive officers and directors and
persons who own more than ten percent of a class of the Company's equity
securities registered under the Exchange Act, to file with the Commission
reports of ownership and changes in ownership of Common Stock and other equity
securities of the Company. Executive officers, directors and greater than ten
percent stockholders are required by Commission regulations to furnish the
Company with copies of all Section 16(a) forms they file. Based solely on review
of this information, including written representations that no other reports
were required, the Company believes that during the fiscal year ended December
31, 1998, each of the Company's executive officers, directors and holders of ten
percent or more of the Company's Common Stock timely filed all reports required
to be filed pursuant to Section 16(a) of the Exchange Act, except as follows:
Mr. Robert Leff, a director, inadvertently failed to list one warrant on his
Form 3, which disclosure was subsequently made on Form 5.

38
<PAGE>
ITEM 10. EXECUTIVE COMPENSATION

The following table sets forth certain information regarding compensation
paid during the Company's fiscal year ended December 31, 1998 to the Company's
Chief Executive Officer and to each other executive officer who received salary
and bonus in excess of $100,000 in 1999 (the "Named Executive Officers").

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG TERM
COMPENSATION
-------------------- ----------------- ALL OTHER
SALARY BONUS AWARDS OPTIONS/ COMPENSATION
NAME AND PRINCIPAL POSITION YEAR ($$) ($$) SAR'S(#) ($$)
- --------------------------------------------------- --------- --------- --------- ----------------- -------------
<S> <C> <C> <C> <C> <C>
Nathan M. Schulhof ................................ 1998 170,500 75,000 20,850 --
Chief Executive Officer and President 1997 157,500 -- -- --
1996 121,950 50,000 20,850 --

Grant Jasmin ...................................... 1998 140,000 37,500 20,850 172,000*
Executive Vice President, Chief Operating Officer 1997 108,000 -- -- --
and Vice President, Finance 1996 74,200 50,000 20,850 --

Theodore Richards ................................. 1998 114,500 31,000 -- --
Vice President and Creative Director 1997 99,500 4,000 -- --
1996 46,000 -- 26,062 --
</TABLE>

- ------------------------

*Represents payroll accrued during earlier periods which was paid during 1998.

DIRECTORS' COMPENSATION

Directors receive no fees, other than reimbursement of travel expenses, for
attendance at meetings of the Board of Directors. Each director (including
employee directors) receives a one-time grant of warrants to purchase 26,062
shares of Common Stock at a price equal to the fair market value on the date of
grant, which vest over a two year period.

EMPLOYMENT AGREEMENTS

The Company presently has no formal employment agreements with any of the
Named Executive Officers.

STOCK OPTION GRANTS AND EXERCISES

The Company has adopted a 1996 Stock Option Plan (the "1996 Plan"),
authorizing the grant of up to 364,869 options. The 1996 Plan was adopted to
promote and advance the interests of the Company and its shareholders by (i)
enabling the Company to attract, retain and reward managerial and other key
employees, non-employees and directors and (ii) strengthening the mutuality of
interests between participants in the 1996 Plan and the shareholders of the
Company in its long-term growth, profitability and financial success by offering
stock options.

No options under the 1996 Plan were exercised by any of the Named Executive
Officers during the year ended December 31, 1998. Mr. Schulhof and Mr. Jasmin
were each granted options under the 1996 Plan to purchase 20,850 shares during
the year ended December 31, 1998.

39
<PAGE>
The following table sets forth information regarding exercises of stock
options and other related information as of the year ended December 31, 1998 by
the executive officers named in the Summary Compensation Table:

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR-END OPTION/SAR VALUE

<TABLE>
<CAPTION>
NUMBER OF UNEXERCISED VALUE OF IN-THE-MONEY
OPTIONS/SAR'S AT OPTIONS/SAR'S AT
FISCAL YEAR-END FISCAL YEAR-END
SHARES ACQUIRED VALUE ---------------------------- ----------------------------
NAME ON EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
- --------------------------------- ----------------- ------------- ----------- --------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Nathan M. Schulhof............... 0 $ 0 13,031 7,819 57,010(1) 34,208(1)
20,850 0 106,648(2) 0(2)

Grant Jasmin..................... 0 $ 0 13,031 7,819 57,010(1) 34,208(1)
20,850 0 106,648(2) 0(2)

Theodore Richards................ 0 $ 0 21,718 4,344 111,305(2) 22,220(2)
</TABLE>

- ------------------------

(1) Calculated as the difference between the fair market value of the Common
Stock at December 31, 1998 of $10 7/8 and the option exercise price of $6.50
per share.

(2) Calculated as the difference between the fair market value of the Common
Stock at December 31, 1998 of $10 7/8 and the option exercise price of $5.76
per share.

ITEM 11. SECURITY OWNERSHIP OR CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The following table sets forth certain information as of March 31, 1999 with
respect to the shares of Common Stock beneficially owned by (i) persons known by
the Company to own more than five percent of the outstanding shares of Common
Stock; (ii) each director of the Company; (iii) the executive officers named in
the Summary Compensation Table (see "Executive Compensation") and (iv) all
directors and executive officers of the Company as a group. Ownership
information is based upon information furnished by the respective individuals.

<TABLE>
<CAPTION>
NUMBER OF SHARES
NAME & ADDRESS OF DIRECTORS BENEFICIALLY
& 5% SHAREHOLDERS(2) OWNED(1) PERCENT
- ----------------------------------------------------------------------------------- -------------------- -----------
<S> <C> <C>
Nathan M. Schulhof................................................................. 314,917(3) 6.4%
Grant Jasmin....................................................................... 201,574(3) 4.1%
Robert S. Leff..................................................................... 46,738(4) *
Theodore Richards.................................................................. 24,324(5) *
Lee M. Gammill..................................................................... 16,289(6) *
Muninderpal Rehki.................................................................. 35,031(7) *
Marvin M. Reiss.................................................................... 70,518(8) 1.4%
All Executive Officers and Directors as a group (7 persons)........................ 647,968(9) 11.8%
</TABLE>

- ------------------------

* Less than 1%.

(1) Beneficial ownership of shares by directors, officers and 5% or more
shareholders includes both outstanding Common Stock and shares issuable upon
exercise of warrants or options that are currently exercisable or will be
exercisable within 60 days after the date of this table. Except as indicated
in the footnotes to this table and pursuant to applicable community property
laws the persons named in the table have sole voting and investment power
with respect to all shares of Common Stock beneficially owned by them.

40
<PAGE>
(2) The address of Messrs. Schulhof, Jasmin, Leff, Richards, Gammill, Rehki and
Reiss is c/o audiohighway.com, 20600 Mariani Avenue, Cupertino, California
95014.

(3) Includes 66,459 shares of Common Stock issuable upon exercise of outstanding
warrants and options exercisable within 60 days of March 31, 1999.

(4) Includes 29,971 shares of Common Stock issuable upon exercise of outstanding
warrants exercisable within 60 days of March 31, 1999.

(5) Includes 21,718 shares of Common Stock issuable upon exercise of outstanding
warrants exercisable within 60 days of March 31, 1999.

(6) Includes 16,289 shares of Common Stock issuable upon exercise of outstanding
warrants exercisable within 60 days of March 31, 1999.

(7) Includes 13,031 shares of Common Stock issuable upon exercise of outstanding
warrants exercisable within 60 days of March 31, 1999.

(8) Includes (i) 24,577 shares of Common Stock issuable upon exercise of
outstanding warrants exercisable within 60 days of March 31, 1999, (ii)
18,061 shares of Common Stock issuable upon conversion of currently
convertible outstanding convertible promissory notes, (iii) 11,808 shares of
Common Stock issuable upon conversion of currently convertible outstanding
convertible promissory notes held by Susan L. Reiss, Mr. Reiss' spouse, and
(iv) 6,950 shares of Common Stock issuable upon exercise of outstanding
warrants exercisable within 60 days of March 31, 1999 held by Mrs. Reiss.

(9) Includes 275,322 shares of Common Stock issuable upon exercise of
outstanding convertible promissory notes, warrants and options convertible
or exercisable, as the case may be, within 60 days of March 31, 1999.

ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

From October 1996 through June 1998, Marvin M. Reiss, a director of the
Company since October 1998, together with his wife, has invested in the Company
from time to time by purchasing Common Stock and by participating in certain of
the Company's convertible promissory note offerings. During the two year period
ended December 31, 1998, Mr. Reiss invested a total of $350,000. For his various
investments, he received 10% convertible notes and warrants to purchase an
aggregate of 23,589 shares of the Company's Common Stock. The warrants are
exercisable at exercise prices ranging from $4.88 to $7.67.

Mr. Reiss is the Chairman of the Board, Chief Executive Officer and a
principal shareholder of The Rebot Corporation, a record company that produces,
manufactures and distributes recorded music under various labels, including
Arabesque Recordings. In October 1998, the Company signed a sponsorship
agreement with Arabesque Recordings under the terms of which Arabesque became
the first sponsor of the Music Channel on the Company's Web site and, as such,
currently receives the premiere advertising position on the opening Web page of
the Music Channel. The Company also delivers Arabesque audio commercials in
connection with downloaded or streamed audio-based music content, for which
Arabesque receives a royalty. The Company cannot determine at this time the
financial value of this advertising relationship either to Arabesque or the
Company.

The Company has adopted a policy with respect to future related party
transactions. Pursuant to that policy, any future transactions with officers,
directors or affiliates of the Company will be approved or ratified by a
majority of independent, outside members of the Board of Directors who do not
have an interest in the transactions, and such transactions will be no less
favorable to the Company than those that can be obtained from unaffiliated third
parties. At all times, the Company expects to maintain at least two independent
directors on its Board.

41
<PAGE>
During 1998, the Company incurred $265,221 in expenses to TDP, Inc., for
software consulting and systems development expenses. Mr. Rehki, a member of the
Board of Directors of the Company, is the President of TDP, Inc. As of December
31, 1998, $141,626 of this amount was unpaid.

On February 23, 1999, the Company made an unsecured loan to Mr. Rehki in the
amount of $107,250 bearing interest at the rate of 10% per annum due February
23, 2000.

ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K

(a) The following documents are filed as part of this report:

<TABLE>
<C> <S>
3.1.1(1) Articles of Incorporation of the Registrant

3.1.2(1) Certificate of Amendment of Articles of Incorporation of the Registrant

3.1.3(2) Certificate of Amendment of Articles of Incorporation of the Registrant

3.1.4(2) Certificate of Amendment of Articles of Incorporation of the Registrant

3.2(1) Bylaws of the Registrant

4.1(2) Specimen Common Stock Certificate

4.2(1) Form of Warrant Agreement between the Registrant and U.S. Stock Transfer
Corporation, as Warrant Agent

4.3(1) Form of Representative's Warrants

10.1(1) Office Building Lease dated June 15, 1995 between Information Highway
Media Corporation (audiohighway.com) and Eldon Hoffman for premises
located at 20600 Mariana Ave., Cupertino, California

10.2(1) Standard Sublease dated September 16, 1997 between Audio Highway Media
(audiohighway.com) and Packeteer, Inc. for premises located at 10495
DeAnza Boulevard, Cupertino, California

10.3(1) High Speed Services agreement dated April 3, 1998 between Audio Highway
and UUNET Technologies, Inc.

10.4(1) Edge Information Systems Mission Critical Tricord Maintenance Agreement
dated March 28, 1997 between Audio Highway and Edge Information Systems,
Inc.

10.5(1) Settlement Agreement and Mutual Release dated April 24, 1998 between
Tricord Systems, Inc. and Audio Highway

10.6(1) Mobile Audio Delivery Agreement dated July 13, 1998 between Sycom
Technologies, Inc. and Audio Highway

10.7(3) 1996 Stock Option Plan(4)

27.1(5) Financial Data Schedule
</TABLE>

- ------------------------

(1) Filed as an exhibit to the Registrant's original filing of the Registration
Statement on Form SB-2, filed July 24, 1998.

(2) Filed as an exhibit to the Registrant's Pre-effective Amendment No. 2 to the
Registration Statement on Form SB-2, filed December 11, 1998.

(3) Filed as an exhibit to the Registrant's Pre-effective Amendment No. 1 to the
Registration Statement on Form SB-2, filed November 23, 1998.

(4) Denotes a management contract or compensatory plan or arrangement.

(5) Filed herewith.

(b) There were no reports on Form 8-K filed by the Registrant during the
last quarter covered by this Report.

42
<PAGE>
SIGNATURES

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

<TABLE>
<S> <C> <C>
Dated: April 15, 1999 audiohighway.com

By: /s/ NATHAN M. SCHULHOF
-----------------------------------------
Nathan M. Schulhof
PRESIDENT AND CHIEF EXECUTIVE OFFICER
</TABLE>

KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears
below constitutes and appoints Nathan M. Schulhof and Grant Jasmin and each of
them, as his true and lawful attorneys-in-fact and agents, with full power of
substitution and resubstitution, for him and in his name, place, and stead, in
any and all capacities, to sign any and all amendments to this Report, and to
file the same, with all exhibits thereto, and other documents in connection
therewith, with the Securities and Exchange Commission, granting unto said
attorneys-in-fact and agents, and each of them, full power and authority to do
and perform each and every act and thing requisite and necessary to be done in
connection therewith, as fully to all intents and purposes as he might or could
do in person, hereby ratifying and confirming that all said attorneys-in-fact
and agents, or any of them or their or his substitute or substitutes, may
lawfully do or cause to be done by virtue hereof.

In accordance with the Securities Exchange Act of 1934, as amended, this
Report has been signed by the following persons on behalf of the registrant and
in the capacities and on the dates indicated:

<TABLE>
<C> <S> <C>
President, Chief Executive
/s/ NATHAN M. SCHULHOF Officer and Director
- ------------------------------ (Principal Executive April 15, 1999
Nathan M. Schulhof Officer)

/s/ GREGORY SUTYAK Chief Financial Officer
- ------------------------------ (Principal Accounting April 15, 1999
Gregory Sutyak and Financial Officer)

/s/ GRANT JASMIN Chief Operating Officer,
- ------------------------------ Vice President, Finance April 15, 1999
Grant Jasmin and Director

/s/ ROBERT S. LEFF
- ------------------------------ Director April 15, 1999
Robert S. Leff

/s/ LEE M. GAMMILL
- ------------------------------ Director April 15, 1999
Lee M. Gammill

/s/ MUNINDERPAL REHKI
- ------------------------------ Director April 15, 1999
Muninderpal Rehki

/s/ MARVIN M. REISS
- ------------------------------ Director April 15, 1999
Marvin M. Reiss
</TABLE>

43
<PAGE>
EXHIBIT INDEX

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBIT
- ---------- ------------------------------------------------------------------------------------------------------
<C> <S>
3.1.1(1) Articles of Incorporation of the Registrant

3.1.2(1) Certificate of Amendment of Articles of Incorporation of the Registrant

3.1.3(2) Certificate of Amendment of Articles of Incorporation of the Registrant

3.1.4(2) Certificate of Amendment of Articles of Incorporation of the Registrant

3.2(1) Bylaws of the Registrant

4.1(2) Specimen Common Stock Certificate

4.2(1) Form of Warrant Agreement between the Registrant and U.S. Stock Transfer Corporation, as Warrant Agent

4.3(1) Form of Representative's Warrants

10.1(1) Office Building Lease dated June 15, 1995 between Information Highway Media Corporation
(audiohighway.com) and Eldon Hoffman for premises located at 20600 Mariana Ave., Cupertino, California

10.2(1) Standard Sublease dated September 16, 1997 between Audio Highway Media (audiohighway.com) and
Packeteer, Inc. for premises located at 10495 DeAnza Boulevard, Cupertino, California

10.3(1) High Speed Services agreement dated April 3, 1998 between Audio Highway and UUNET Technologies, Inc.

10.4(1) Edge Information Systems Mission Critical Tricord Maintenance Agreement dated March 28, 1997 between
Audio Highway and Edge Information Systems, Inc.

10.5(1) Settlement Agreement and Mutual Release dated April 24, 1998 between Tricord Systems, Inc. and Audio
Highway

10.6(1) Mobile Audio Delivery Agreement dated July 13, 1998 between Sycom Technologies, Inc. and Audio Highway

10.7(3) 1996 Stock Option Plan(4)

27.1(5) Financial Data Schedule
</TABLE>

- ------------------------

(1) Filed as an exhibit to the Registrant's original filing of the Registration
Statement on Form SB-2, filed July 24, 1998.

(2) Filed as an exhibit to the Registrant's Pre-effective Amendment No. 2 to the
Registration Statement on Form SB-2, filed December 11, 1998.

(3) Filed as an exhibit to the Registrant's Pre-effective Amendment No. 1 to the
Registration Statement on Form SB-2, filed November 23, 1998.

(4) Denotes a management contract or compensatory plan or arrangement.

(5) Filed herewith.

<PAGE>
<ARTICLE> 5

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 13,007
<SECURITIES> 0
<RECEIVABLES> 80
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,134
<PP&E> 333
<DEPRECIATION> 0
<TOTAL-ASSETS> 13,467
<CURRENT-LIABILITIES> 2,284
<BONDS> 376
0
0
<COMMON> 19,130
<OTHER-SE> (8,323)
<TOTAL-LIABILITY-AND-EQUITY> 13,467
<SALES> 139
<TOTAL-REVENUES> 139
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 3,750
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,845
<INCOME-PRETAX> (5,442)
<INCOME-TAX> 0
<INCOME-CONTINUING> (5,442)
<DISCONTINUED> 0
<EXTRAORDINARY> (425)
<CHANGES> 0
<NET-INCOME> (5,867)
<EPS-PRIMARY> (5.12)
<EPS-DILUTED> (5.12)

</TABLE>