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EX-23.1 - Protagenic Therapeutics, Inc.\newv178944_ex23-1.htm
EX-31.1 - Protagenic Therapeutics, Inc.\newv178944_ex31-1.htm
EX-31.2 - Protagenic Therapeutics, Inc.\newv178944_ex31-2.htm
EX-21.1 - Protagenic Therapeutics, Inc.\newv178944_ex21-1.htm
EX-32.1 - Protagenic Therapeutics, Inc.\newv178944_ex32-1.htm
EX-10.21 - Protagenic Therapeutics, Inc.\newv178944_ex10-21.htm
EX-10.20 - Protagenic Therapeutics, Inc.\newv178944_ex10-20.htm
EX-10.22 - Protagenic Therapeutics, Inc.\newv178944_ex10-22.htm
EX-10.23 - Protagenic Therapeutics, Inc.\newv178944_ex10-23.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
 
FORM 10-K
 
(Mark one)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the fiscal year ended December 31, 2009
 
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
For the transition period from ____________ to _______________


     
ATRINSIC, INC

(Exact name of registrant as specified in its charter)
 
Delaware
 
06-1390025
(State or other jurisdiction of
incorporation or organization)
  
(I.R.S. Employer Identification No.)
     
469 7th Avenue, 10th Floor, New York, NY 10018

 (Address of principal executive offices) (ZIP Code)
 
(212) 716-1977

 (Registrant’s telephone number, including area code)
 

 
 Securities registered pursuant to Section 12(b) of the Act:
Title of each class                                                          Name of each exchange on which registered
Common Stock, $0.01 par value                                   The NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes o No x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes   ¨  No x
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer  ¨  
Accelerated filer   ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)
Smaller reporting company    x  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act)
 Yes o No x
  
The aggregate market value of the voting and non-voting common equity held by non-affiliates, computed using the closing price of $1.34, as of June 30, 2009, was $18,129,060.

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13, or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes x No o

As of March 24, 2010, the issuer had 20,878,933 shares of common stock issued and outstanding (which number excludes 2,741,318 shares issued and held in treasury).  
 
DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement to be filed with the Securities and Exchange Commission are incorporated by reference into Part III, Items 10, 11, 12 and 13 of this Form 10-K.
 
 


 
 
PART I
       
         
Item 1
 
Business
 
4
         
Item 1A
 
Risk Factors
 
11
         
Item 1B
 
Unresolved Staff Comments
 
18
         
Item  2
 
Properties
 
18
         
Item 3
 
Legal Proceedings
 
18
         
Item 4
 
Removed and Reserved
 
18
         
PART II
       
         
Item 5
 
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
19
         
Item 6
 
Selected Financial Data
 
19
         
Item 7
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
20
         
Item 7A
 
Quantitative and Qualitative Disclosures about Market Risk
 
30
         
Item 8
 
Financial Statements and Supplementary Data
 
31
         
Item 9
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
32
         
Item 9A(T)
 
 Controls and Procedures
 
32
         
Item 9B
 
Other Information
 
32
         
PART III
       
         
Item 10
 
Directors, Executive Officers and Corporate Governance
 
33
         
Item 11
 
Executive Compensation
 
33
         
Item 12
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
33
         
Item 13
 
Certain Relationships and Related Transactions, and Director Independence
 
33
         
Item 14
 
Principal Accounting Fees and Services
 
33
         
PART IV
       
         
Item 15
 
Exhibits, Financial Statement Schedules
 
34

 

 

Part I

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
This report, including the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” contains “forward-looking statements” that include information relating to future events, future financial performance, strategies, expectations, competitive environment, regulation and availability of resources of Atrinsic, Inc. (“Atrinsic,” or the “Company”). These forward-looking statements include, without limitation, statements regarding: proposed new services; the Company’s expectations concerning litigation, regulatory developments or other matters; statements concerning projections, predictions, expectations, estimates or forecasts for the Company’s business, financial and operating results and future economic performance; statements of management’s goals and objectives; and other similar expressions concerning matters that are not historical facts. Words such as “may,” “will,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes” and “estimates,” and similar expressions, as well as statements in future tense, identify forward-looking statements.
 
Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of when, or how, that performance or those results will be achieved. Forward-looking statements are based on information available at the time they are made and/or management’s good faith belief as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements. Important factors that could cause these differences include, but are not limited to:
 
 
·
our limited operating history
 
·
the highly competitive market in which we operate;
 
·
our ability to develop and market new applications and services;
 
·
protection of our intellectual property rights;
 
·
costs and requirements as a public company;
 
·
other factors, including those discussed under the headings “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.”
 
Forward-looking statements speak only as of the date they are made. You should not put undue reliance on any forward-looking statements. We assume no obligation to update forward-looking statements to reflect actual results, changes in assumptions or changes in other factors affecting forward-looking information, except to the extent required by applicable securities laws. If we do update one or more forward-looking statements, no inference should be drawn that we will make additional updates with respect to those or other forward-looking statements.

 
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With respect to this discussion, the terms “we,” “us,” “our,” “Atrinsic”, and the “Company” refer to Atrinsic, Inc., a Delaware corporation and its wholly-owned subsidiaries, including New Motion Mobile, Inc. and Traffix, Inc. (“Traffix”), also Delaware corporations.
 
A Note Concerning Presentation
 
This Annual Report on Form 10-K contains information concerning Atrinsic, Inc. as it pertains to the period covered by this report – for the two years ended December 31, 2009 and 2008. As a result of the acquisitions of Traffix, Inc., a Delaware corporation (“Traffix”), and Ringtone.com LLC, a Minnesota limited liability company (“Ringtone”), by Atrinsic, Inc. on February 4, 2008 and June 30, 2008 respectively, (explained herein), this Annual Report on Form 10-K also contains information concerning the combination of Atrinsic, Traffix and Ringtone, as of the date of this Annual Report.
 
Background and History of Atrinsic
 
Atrinsic, formerly known as New Motion, Inc., and prior to New Motion, Inc. as MPLC, Inc., was incorporated under the laws of the State of Delaware in 1994 under the original name, The Millbrook Press, Inc. Until 2004, the Company was a publisher of children’s nonfiction books for the school and library market and the consumer market under various imprints. As a result of market factors, and after an unsuccessful attempt to restructure its obligations out of court, on February 6, 2004, the Company filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the District of Connecticut (the “Bankruptcy Court”). After filing for bankruptcy, the Company sold its imprints and remaining inventory and by July 31, 2004, had paid all secured creditors 100% of amounts owed. At that point in time, the Company was a “shell” company with nominal assets and no material operations. Beginning in January 2005, after the Bankruptcy Court’s approval, all pre-petition unsecured creditors had been paid 100% of the amounts owed (or agreed) and all post petition administrative claims submitted had been paid. In December 2005, $0.464 per eligible share was available for distribution and was distributed to stockholders of record as of October 31, 2005. The bankruptcy proceedings were concluded in January 2006 and no additional claims were permitted to be filed after that date.
 
New Motion Mobile, Inc. (our wholly-owned subsidiary) was formed in March 2005 and subsequently acquired the business of Ringtone Channel, an Australian aggregator of ringtones in June 2005. Ringtone Channel was originally incorporated on February 23, 2004. In 2004, Ringtone Channel began to sell ringtones internationally and then launched its first ringtone subscription service in the U.S. in February 2005. In August 2005, New Motion Mobile launched its first successful text message campaign incorporating music trivia. As of December 31, 2007, the Company’s Australian entity was dissolved.
 
On October 24, 2006, the Company and certain stockholders entered into a Common Stock Purchase Agreement with Trinad Capital Master Fund, Ltd. (“Trinad”), pursuant to which we agreed to redeem 23,448,870 shares of our common stock from existing stockholders and sell an aggregate of 69,750,000 shares of our common stock, representing 93% of our issued and outstanding shares of common stock, to Trinad in a private placement transaction for aggregate gross proceeds of $750,000.
 
In February 2007, we completed an exchange transaction (the “Exchange”) pursuant to which New Motion Mobile became our wholly-owned subsidiary. In connection with the Exchange, we raised gross proceeds of approximately $20 million in equity financing through the sale of our Series A Preferred Stock, Series B Preferred Stock and Series D Preferred Stock.
 
After receiving the requisite approval of our stockholders, on May 2, 2007, we filed a certificate of amendment to our restated certificate of incorporation with the Delaware Secretary of State to, among other things, change our corporate name to New Motion, Inc. from MPLC, Inc., and effect a 1-for-300 reverse split. In connection with these corporate actions, we also changed our ticker symbol to “NWMO.”
 
On February 4, 2008, we completed a merger with Traffix, Inc., a Delaware corporation.  Pursuant to the merger, Traffix became our wholly owned subsidiary.  Traffix was a leading online marketing company that provided complete marketing solutions for its clients seeking to increase sales and customer contact deploying the numerous facets of online marketing Traffix offered.   Following the consummation of our merger with Traffix, Traffix stockholders owned approximately 45% of our capital stock, on a fully-diluted basis.  Also upon the closing of our transaction with Traffix, we commenced trading on The NASDAQ Global Market under the symbol “NWMO.” 
 
On June 30 2008, Atrinsic entered into an Asset Purchase Agreement (“Ringtone APA”) with Ringtone.com, LLC (“Ringtone”) and W3i Holdings LLC (“W3i”) pursuant to which we acquired certain assets from Ringtone, including, but not limited to, short codes, a subscriber database, a covenant not to compete, working capital, and certain domain names. In consideration for the assets and certain liabilities assumed, we at the closing we paid to Ringtone approximately $7 million in cash. In addition, we delivered to Ringtone a convertible promissory note (the “Note”) in the aggregate principal amount of $1.75 million, which accrued interest at a rate of 10% per annum. In January 2009, we repaid the Note and have no further indebtedness to Ringtone and W3i.

 
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On July 30, 2008, we entered into an agreement to launch online and mobile marketing services and offer our mobile products in the Indian market.  Under the agreement, we own 19% of the Joint Venture and are required to pay up to $325,000 in return for Compulsory Convertible Debentures which can be converted to common stock at any time, at our sole discretion. We have paid $225,000 of the $325,000 we were required to pay. We are in the process of dissolving the venture and we will not be required to make the remaining $100,000 payment.
 
On October 30, 2008, we acquired a 36% minority interest in The Billing Resource, LLC (“TBR”). TBR is an aggregator of fixed line telephone billing, providing alternative billing services to us and unrelated third parties. We contributed $2.2 million in cash to TBR upon its formation and another $1.0 million of working capital advances subsequent to the close of the transaction.  As of December 31 2009, we received a distribution of $1.9 million.

On June 25, 2009, we amended our Restated Certificate of Incorporation to change our corporate name from New Motion, Inc. to Atrinsic, Inc.  In connection with the change in our corporate name, we also changed our ticker symbol on the NASDAQ Global Market from “NWMO” to “ATRN.”
 
On July 31, 2009, we entered into an Asset Purchase Agreement with Central Internet Corporation d/b/a/ ShopIt.com (“ShopIt”), pursuant to which we acquired certain net assets from ShopIt, including but not limited to software, trademarks and certain domain names. In consideration for the assets, at the closing we cancelled $1.8 million in aggregate principal amount of indebtedness owed by ShopIt to us, paid to ShopIt $450,000 and issued 380,000 shares of our common stock, of which 180,000 shares were distributed to certain secured debt-holders of ShopIt subject to put options, and 200,000 shares were placed in escrow to be available until July 31, 2010 until finalization of the opening balance sheet. 

On March 26, 2010,we entered into a Marketing Services Agreement (the “Marketing Agreement”) and a Master Services Agreement (the “Services Agreement”) with Brilliant Digital Entertainment, Inc. (“BDE”) effective as of July 1, 2009 (collectively, the “Agreements”), relating to the operation and marketing of the Kazaa digital music service.  The Agreements have a term of three years from the effective date, contain provisions for automatic one year renewals, subject to notice of non-renewal by either party, and may only be terminated generally upon a bankruptcy or liquidation event or in the event of an uncured material breach by either party. In accordance with the Agreements, Atrinsic and BDE will share equally in the “Net Profit” generated by the Kazaa music subscription service after all of our costs and expenses are recovered.  Under the Marketing Agreement, we are responsible for marketing, promotional, and advertising services in respect of the Kazaa service.  Pursuant to the Services Agreement, we are to provide services related to the operation of the Kazaa website and service, including billing and collection.  BDE is obligated to provide certain other services with respect to the service, including licensing the intellectual property underlying the Kazaa service to us.

 The Business of Atrinsic

We are a leading Internet focused marketing company.  We combine the power of the Internet with traditional direct response marketing techniques to sell entertainment and lifestyle subscription products directly to consumers.  We also leverage our media network and marketing expertise to provide lead generation and search related marketing services to our corporate and advertising clients.  We have developed our marketing media network, consisting of web sites, proprietary content and licensed media, to attract consumers, corporate partners and advertisers.  We believe our marketing media network and proprietary technology allows us to cost-effectively acquire consumers and provide targeted leads and marketing data to our corporate partners and advertisers.

Our strategy is to maximize the value of each media impression by maximizing the revenue and profit from each visitor to our media network.  We do this by using proprietary technology to match each consumer touch point (visit, registration or lead submission) with the highest value offer or series of offers.  These offers are sourced from a large pool of advertisers or from our own portfolio of consumer subscription products.  We also engage in targeted performance marketing activities, where we focus on acquiring customers for an advertiser on an exclusive basis.

Our premium subscription products include those that are wholly owned and administered by us and those that are executed in partnership with another party.  They represent an important component of our value maximization strategy.  By maintaining alternatives to third party offers, we are able to make use of a larger proportion of acquired Internet traffic and leads generated than would be the case with only third party offerings.  Our owned products typically provide a higher effective value for each media impression.  Consequently, we are continually working to maximize the presentation and conversion of our own offers to consumers who we touch in our media network.  We believe we have a competitive advantage relative to other direct marketing companies, including those that are marketing on the Internet.  The reason for this is because we are able to offer multiple billing modalities as a result of contracts and established relationships with billing aggregators and carriers, further expanding the pool of eligible customers or leads.  In addition to the standard credit card billing modality, we are sometimes able to bill directly to a user’s mobile phone or land-line telephone bill.

 
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Our services business is principally composed of services that we perform for third parties in the areas of lead generation and search related services.  Our lead generation business provides qualified inquiries to third party advertisers through form submissions, validated telephone calls, data delivery and other forms of targeting for advertisers.  We are continually developing new performance marketing products that correspond to our clients needs.  Our business model in this area is typically based on a cost per designated action and not on an impression basis.  Our search related services are comprised of search engine marketing services, search engine optimization, banner display advertising and search engine optimization to a range of clients.  This area of the business, historically, has arisen from expertise and technology that has been developed internally as a direct result of the development of our own performance marketing media network.  This business is concentrated on providing client representation and strategy assistance with paid search marketing for the larger search portals in the United States.

Our business principally serves two sets of customers:

 
·
Corporate clients and advertisers – our transactional marketing services, and

 
·
End user consumers – our subscription services.

Each of these business activities – transactional and subscription – may utilize the same originating media or derive a customer from the same source; the difference is reflected in the type of customer billing.  In the case of transactional marketing services, the billing is generally carried out on a service fee, percentage, or on a performance. For subscription services, the end user is able to access premium content and, in return, is billed a recurring monthly fee through their credit card, mobile phone, or land-line.

Direct-to-Consumer Subscription Services

We market our recurring revenue services direct-to-consumer across the entertainment and lifestyle categories.  We bill more than 300,000 subscribers each month, at fees ranging from $5.00 to $20.00 per monthly subscription.

Our subscribers principally originate from our performance marketing media network, which includes owned content sites, promotional and sweepstakes sites, email campaigns, social media and, mobile media applications, and an affiliate network.  Our direct model allows us to source large numbers of subscribers and by using our own media network, also allows us to control the quality of the subscribers.  We also incorporate advanced lead validation strategies to enhance consumer targeting for our subscription products and to ensure the highest data quality for our advertisers.  In addition, as a result of our alternative billing platforms, we are able to further expand the universe of eligible users for our services.  Depending on the subscription service and user profile, we can offer mobile phone, land-line, and credit card billing options to our users.

In order to be successful in the recurring revenue, direct-to-consumer subscription services we offer, we are constantly monitoring a range of key metrics that have a direct impact on our ability to retain existing subscribers and our efficiency in acquiring new subscribers.  We regularly monitor the Life Time Value (“LTV”) of those subscribers, taking into consideration cost per acquisition, churn rates of subscribers, average revenue per user, ability to bill new subscribers, ability to bill existing subscribers and refund rates, among others.  To be competitive in our subscription business, we also seek to leverage our considerable expertise in the alternative billing models we offer which we believe provides us with a competitive advantage in the marketplace.
 
Entertainment Subscriptions:  In conjunction with Brilliant Digital Entertainment, Inc. (“BDE”), a distributor of licensed digital content, we are offering Kazaa, a subscription-based digital music service that gives users unlimited access to hundreds of thousands of CD-quality tracks.  For a monthly fee of $19.98 users can download unlimited music files and play those files on up to three separate computers. The downloaded files remain playable as long as the user’s subscription is active.  The subscription package also allows users to download unlimited ringtones to a mobile phone.  Unlike other music services that charge you every time a song is downloaded, Kazaa allows users to listen to and explore as much music as they want for one monthly fee, without having to pay for every track or album.  We bill consumers for this service on a monthly recurring basis through a credit card, land-line, or mobile device. Royalties are paid to the music labels for licenses to the music utilized by this digital service.

We also offer consumers access to a premium ringtone service through Ringtone.com, which is billed to a users mobile device. Through this service, consumers can download premium ringtones to their mobile device.

Through our interactive contests, we allow subscribers to win money, prizes and discounts online and through mobile phones.  Our sweepstake services encourage an engaged, repeat audience.  Bid4Prizes is a sweepstakes and entertainment site that features a reverse-auction game where consumers can play for name-brand prizes. Visitors can also buy discount products, and enjoy the site's entertainment features. While ad-supported subscribers can access the site online for free, paid subscribers enjoy VIP benefits, including mobile access.

 
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Our casual gaming portfolio captures a wide-range of demographics and interests.  Our primary casual game subscription service, GatorArcade, has a broad selection of the most popular digital games, including top-rated games Zuma™, Diner Dash®, and World Series of Poker® Pro Challenge. The site also offers arcade games, strategy games, puzzles, and mobile entertainment. Subscribers can also play for free in an ad-supported environment and still download certain games.
 
Lifestyles Subscriptions: Through various partnerships, we have developed a range of subscription-based services and clubs which appeal to various lifestyle interest categories.  These services offer consumers access to shopping and entertainment coupons and premium services that can be redeemed online.  These memberships and clubs give consumers access to a broad range of benefits, offered by national businesses, including Universal Studios, Disney, and AMC Theatres.
 

Our online marketing services and lead generation offering gives corporate clients and advertisers access to a full suite of direct marketing services from a company with comprehensive Internet-based direct marketing experience.

Online and Search Marketing Services:  We develop and manage search engine marketing campaigns for our third party advertising clients, as well as for our own proprietary websites, promotions and offers.  Historically, these services developed as a result of our in-house expertise and technology which we used to support our own performance marketing network.  Using proprietary technology, we build, manage and analyze the effectiveness of hundreds of thousands of Pay Per Click (“PPC”) keywords in real time across each of the major search engines, including Google, Yahoo and Bing.  For our own products, we employ the same search marketing and optimization strategies that we deploy on behalf of advertisers, providing scalable search strategies, including organic and paid search campaigns.  Our goal is to manage our advertisers' media mix properly and minimize cannibalization between marketing channels. We also perform search engine optimization services, for which advertising clients are billed monthly. 

We also offer advertisers additional online marketing services, including a display media platform, online and business intelligence, and brand protection.  We provide advertisers with brand protection to mount an optimal defense against online risks to an advertiser’s brand.  Our brand protection provides advertisers with a high degree of visibility and actionable intelligence to curb online abuse.  Our business intelligence allows us to audit and analyze our advertisers' activities, their competitors' activities, industry trends and the marketplace as a whole.
 
A recent addition to our range of service offerings includes the Atrinsic Affiliate Network.  This network is a developing business and represents an advance in the development of affiliate marketing platforms.  The Atrinsic Affiliate Network offers a full-service solution for branded advertisers.  Using the Network, advertisers create partnerships with publishers to drive website traffic, customer acquisitions, and online sales. The system’s software increases the transparency between publishers and advertisers, giving both parties access to higher quality data and allowing advertisers to connect to customers in the most cost efficient way possible.  The system includes key differentiating features, including business intelligence and brand protection.
 
Lead Generation:  We leverage our performance marketing media network for third party lead generation activities.  We invest heavily in driving traffic to our network.  In an effort to maximize revenue and profit per visit, and as a result of advanced consumer targeting, users will frequently be directed by us to third party offers.  Our network of sites and media encourage an engaged audience ideal for both advertising programs and lead generation. These interactive sites and media programs provide performance driven marketing opportunities that expose an advertiser’s products or service offerings to our digital entertainment customer base.  Our sites feature music content, games, sweepstakes, and loyalty programs.  The Atrinsic performance marketing network also includes multiple email programs, which allows us to use collected data for emailing advertiser offers or for our own direct to consumer offers.

Our content sites generate consumers who are attracted to our proprietary or licensed content found on the sites.  Our websites feature specialized content across the entertainment and lifestyle categories. This content includes EZTracks.com, a library of 30,000 licensed songs by hundreds of artists across all different genres, and GameFiesta.com, a casual gaming site for premium online and downloadable games.  These sites allow third-party advertisers to present their own offers and advertising.  In addition, like our advertisers and corporate clients, we are able to capitalize on the lead generation capabilities of these promotional and content-based web properties to acquire customers for our own products.

Applying technology is an important aspect of our lead generation business. We manage a number of technology platforms which utilize dynamic targeting and advanced data validation to automatically match consumers with the highest value offer or series of offers, maximizing value per acquired customer.  This technology allows us to get the maximum return on the marketing dollars spent to drive traffic into our performance marketing network.

 
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In order to be successful in the lead generation business, we continually develop and implement innovative strategies to provide our advertisers and clients with access to targeted and qualified leads.  Such innovations include proprietary data validation and enhancement services, and real-time lead validation using call center and telephonic technologies.  Each layer of validation and qualification enhances the value of a user to our advertisers, which enables us to generate a higher value per acquired customer, or enables us to determine lead suitability for our own products.

In addition to our systems and technology that validate and enhance data and improve user targeting, we are continually developing new ad units that correspond to our clients needs for the delivery of their sales generation inquiries.  These new ad units range from expressions of interest, customized and targeted questions and data capture, to completed sales transactions.  This range of ad unit offering, and the corresponding flexibility of our technology and systems, allows us to work with a broad array of advertisers, from direct marketers to established brands.  It also allows us to go to market with products that have a corresponding range of price points.


We face competition in all areas of our business and expect that this competition will continue to intensify in the future as a result of industry consolidation, the continuing maturation of the industry and low barriers to entry.  These factors may result in price reductions and loss of market share, which could reduce our future revenues and otherwise harm our business. We compete with a diverse and large pool of advertising, media, Internet companies and wireless and traditional telephone carriers.  Larger, more established companies are increasingly focused on developing and distributing products and services that directly compete with us.  Our ability to compete depends upon several factors, including our customer service and support levels, our sales and marketing efforts, the ease of use, performance, price, and reliability of products and services provided by us, and our ability to remain price competitive while maintaining our operating margins.  The development, distribution and sale of subscription services is a highly competitive business.  In this market, we compete primarily on the basis of marketing acquisition costs, brand strength, and carrier and billing breadth.  The subscription and online marketing markets are characterized by frequent product introductions, evolving platforms, new technologies, and a fluid and changing regulatory environment.
 
Digital Music:  Consumers are fundamentally changing the way that they interact with and utilize music content, as the format used for digital music distribution is evolving to become more user friendly and increasingly device compatible.  With the increased availability of compatible music, consumers are embracing technologies and services that allow them to conveniently obtain, manage and move digital content in an easy and affordable manner.  The growth of consumer Internet connectivity, particularly broadband, WiFi, and the deployment of 3G mobile networks, has increased consumer access to digital media.  Broadband PC Internet connections enable consumers to transfer data more quickly than ever before.  We believe these trends, along with other new technologies, will improve consumers’ access to digital media.

As transfer speed for digital media to consumers’ PCs via the Internet, to other non-PC Internet connected devices and to consumers’ mobile phones via WiFi and 3G networks continues to improve, we believe that consumers will continue to seek products and services that help them quickly and easily find and access content, manage their own collection of digital assets, and help them enjoy, access and move their music collection from their PCs to other media such as CDs, DVDs and digital entertainment devices, including portable MP3 players and mobile phones.  Portable devices, including MP3 players and mobile phones, have proliferated and their uses have increased.  Portable digital music devices have revolutionized the way consumers listen to music.  Many users are playing back digital music, spoken word and video content via consumer electronics devices such as portable MP3 players.

Digital music rights management has evolved, expanding hardware compatibility and thereby reducing constraints on how consumers may use their digital content.  Prior to 2007, record labels had licensed digital music for distribution subject to specific requirements that all downloaded songs contained Digital Rights Management (“DRM”).  As is common in new technology industries, key market leaders each chose different, sometimes proprietary, approaches to DRM, which caused compatibility issues. During 2007 the record labels agreed to allow DRM-free distribution of permanent downloads in certain circumstances.  The new open DRM-free standard should increase consumer interest in paid online music and may also drive increased competition.  We also expect that DRM will allow companies like ours, that provide content, rather than hardware, an opportunity to succeed in this rapidly growing space.

Mobile Content and Marketing Landscape:  The wireless market has emerged as a result of the rapid growth and significant technological advancement in the wireless communications industry.  Wireless carriers are delivering new handsets to new and existing subscribers which have the capability to download rich media content.  Due to the increase in advanced mobile phones with the capabilities to handle rich media downloads, the potential market for mobile services will increase significantly in the coming years.  We expect that as a result of our mobile billing expertise, Internet marketing experience and unique content offerings that we will be able to capitalize on this rapidly growing market.

 
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Lead Generation Services Landscape: Attracting new customers is becoming increasingly more difficult and expensive given rising postage fees, the Do-Not-Call list, CAN-SPAM legislation and click-fraud via search engines. Online lead generation, qualification and email campaign management is an optimal solution to confront and mitigate some of these challenges.

Lead Generation involves the use of technology to gather information about Internet users.  Regulation requires users to grant permission or “opt-in” to allow this information to be gathered. This “opt-in” is often acquired through user registration forms. The information is then sold to advertisers for a price per lead that can vary from $5 to $60, depending on factors such as the quality of the lead, the lead exclusivity, the price level of product or service being sold and the “freshness” of the lead. The financial services, education, and automotive industries have been the most successful areas for lead generation.

The U.S. lead generation market has become increasingly competitive, as the largest U.S. advertisers are shifting more of their budgets from traditional media to the internet. We believe that we can successfully compete in the lead generation business because of our technology and media network.

Search Marketing Landscape:  The Internet is a global digital medium for commerce, content, advertising and communications. As the online population continues to grow, the Internet is increasingly becoming a tool for research and commerce and for distributing and consuming media. Online users regularly use the Internet to research offline purchases, making the Internet an important channel for both online and offline merchants. Consumers are also using the Internet to access an increasing amount of digital content across media formats including video, music, text and games. As consumers increasingly use the Internet to research and make purchases and to consume digital media, advertisers are shifting more of their marketing budgets to digital channels. Despite the size and growth of the digital marketing sector, the shift of traditional advertising spending to the Internet has yet to match the rate of consumption of online media. Marketers are expected to shift dollars away from traditional media and toward search marketing, display advertising, email marketing, social media, and mobile marketing. As advertisers spend more of their marketing budgets to reach Internet users, we believe the market for search marketing will continue to grow and we believe our business is structured to capitalize on this opportunity.

Technology Platform

 Our performance marketing network utilizes proprietary technologies to generate real-time marketing results for our direct to consumer subscriptions business and for our advertising clients.  Our proprietary technology continually analyzes marketing results to gauge whether campaigns are generating adequate results, and whether the media is being utilized cost-efficiently, and to determine whether different marketing techniques will yield better overall results.  We also employ other proprietary tools which allow us to monitor and analyze, in real time, our marketing and media costs associated with various campaigns. The technology measures effective buys on a per campaign basis which allows us to adjust marketing efforts immediately towards the most effective campaigns and mediums. These tools allow us to be more efficient and effective in our media buys. We believe we have a low cost per acquisition rate, due in large part to the application of these technologies.

We have also developed, or are developing, technologies related to our use and treatment of data, including the collection, processing and storage of data.  In order to enhance the value of our leads and data, we continue to improve our validation technology, including cross-checking and employing service bureau database lookups for our core products and services.  Central to our information strategy is a data warehouse that organizes and consolidates enterprise data to facilitate data modeling, reporting and the monetization of data.

Employees
 
As of December 31, 2009, Atrinsic had 144 employees and full-time consultants in the United States and Canada. We have never had a work stoppage and none of our employees are represented by a labor organization or under any collective bargaining arrangements. We consider our employee relations to be good.
 
Government Regulation
 
As a direct-to-consumer marketing company we are subject to a variety of Federal, State and Local laws and regulations designed to protect consumers that govern certain of our marketing and information collection practices. Also, since our products and services are accessible on mobile phones and the Internet, we are exposed to legal and regulatory developments affecting the Internet and telecommunications services in general.

 
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There is substantial uncertainty as to the applicability to the Internet of existing laws governing issues such as property ownership, copyrights and other intellectual property issues, taxation, defamation, obscenity and privacy. The vast majority of these laws were adopted prior to the advent of the Internet and, as a result, did not contemplate the unique issues of the Internet. In addition,  due to the increasing popularity and use of the Internet, a number of laws and regulations have been adopted at the international, federal, state and local levels with respect to the Internet. Many of these laws cover issues such as freedom of expression, pricing, online products and services including sweepstakes, taxation, advertising, intellectual property, and the convergence of traditional telecommunications services with Internet communications. Recently, growing public concern regarding privacy and the collection, distribution and use of Internet user information has led to increased federal and state scrutiny, as well as regulatory activity concerning data collection, record keeping, storage, security, notification of data theft, and associated use practices. Moreover, a number of laws and regulations have been proposed and are currently being considered by Federal, State, Local and foreign legislatures with respect to these issues.
 

 
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ITEM 1A. RISK FACTORS
 
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this report before purchasing our common stock. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is unaware of, or that it currently deems immaterial, also may become important factors that affect us. If any of the following risks occur, our business, financial condition, cash flows and/or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and stockholders are at risk of losing some or all of the money invested in purchasing our common stock.

We have a limited operating history in an emerging market, which may make it difficult to evaluate our business.
 
Our wholly-owned subsidiary, New Motion Mobile, commenced offering subscription products and services directly to consumers in 2005.  In addition, our merger with Traffix, which is responsible for generating the majority of our Transactional revenues, was completed at the beginning of 2008.  Accordingly, we have a limited history of generating revenues, and our future revenue and income generating potential is uncertain and unproven based on our limited operating history. As a result of our short operating history, we have limited financial data that can be used to develop trends and other historical based evaluation methods to project and forecast our business. Any evaluation of our business and the potential prospects derived from such evaluation must be considered in light of our limited operating history and discounted accordingly. Evaluations of our current business model and our future prospects must address the risks and uncertainties encountered by companies in early stages of development, that possess limited operating history, and that are conducting business in new and emerging markets.


 
·
Maintain existing and develop new carrier and billing aggregator relationships upon which our direct-to-consumer subscription business currently depends;
 
·
Maintain a compliance based control system to render our products and services compliant with carrier and aggregator demands, as well as marketing practices imposed by private marketing rule makers, such as the Mobile Marketing Association, and to conform with the stringent marketing demands as imposed by various States’ Attorney Generals;
 
·
Respond effectively to competitive pressures in order to maintain our market position;
 
·
Increase brand awareness and consumer recognition to grow our business;
 
·
Attract and retain qualified management and employees for the expansion of the operating platform;
 
·
Continue to upgrade our technology and information processing systems to assess marketing results, measure customer satisfaction and remain competitive;
 
·
Continue to develop and source high-quality, direct-to-consumer subscription-worthy content that achieves significant market acceptance;
 
·
Execute our business and marketing strategies successfully.

If we are unable to address these risks, and respond accordingly, our operating results may not meet our publicly forecasted expectations, and/or the expectations as derived by our investors, which could cause the price of our common stock to decline.
 
Our business relies on wireless and landline carriers and aggregators to facilitate billing and collections in connection with our subscription products sold and services rendered. The loss of, or a material change in, any of these relationships could materially and adversely affect our business, operating results and financial condition.
 
During the year ended December 31, 2009, we generated a significant portion of our revenues from the sale of our products and services directly to consumers which are billed through aggregators and telephone carriers. We expect that we will continue to bill a significant portion of our revenues through a limited number of aggregators for the foreseeable future, although these aggregators may vary from period to period. In a risk diversification and cost saving effort, we have established a direct billing relationship with a carrier that mitigates a portion of our revenue generation risk as it relates to aggregator dependence; conversely this risk is replaced with internal performance risk regarding our ability to successfully process billable messages directly with the carrier.  Moreover, in an effort to further mitigate such operational risk, we invested a 36% equity stake in a landline telephone aggregator, TBR, to give us more visibility in the billing and collection process associated with subscription services billed to customers of local exchange carriers.
 
Our aggregator agreements are not exclusive and generally have a limited term of less than three years with automatic renewal provisions upon expiration in the majority of the agreements. These agreements set out the terms of our relationships with the aggregator and carriers, and provide that either party to the contract can terminate such agreement prior to its expiration, and in some instances, terminate without cause.

 
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Many other factors exist that are outside of our control and could impair our carrier relationships, including:
 
 
·
a carrier’s decision to suspend delivery of our products and services to its customer base;
 
·
a carrier’s decision to offer its own competing subscription applications, products and services;
 
·
a carrier’s decision to offer similar subscription applications, products and services to its subscribers for price points less than our offered price points, or for free;
 
·
a network encountering technical problems that disrupt the delivery of, or billing for, our applications;
 
the potential for concentrations of credit risk embedded in the amounts receivable from the aggregator should any one, or group if aggregators encounter financial difficulties, directly or indirectly, as a result of the current period of slower economic growth currently affecting the United States; or
 
·
a carrier’s decision to increase the fees it charges to market and distribute our applications, thereby increasing its own revenue and decreasing our share of revenue.
 
If one or more carriers decide to suspend the offering of our subscription services, we may be unable to replace such revenue source with an acceptable alternative, within an acceptable time frame. This could cause us to lose the capability to derive revenue from those subscribers, which could materially harm our business, operating results and financial condition.
 
We depend on third-party Internet and telecommunications providers, over whom we have no control, for the conduct of our subscription business and transactional business. Interruptions in or the discontinuance of the services provided by one of the providers could have an adverse effect on revenue; and securing alternate sources of these services could significantly increase expenses and cause significant interruption to both our transactional and subscription businesses.
 
We depend heavily on several third-party providers of Internet and related telecommunication services, including hosting and co-location facilities, in conducting our business. These companies may not continue to provide services to us without disruptions in service, at the current cost or at all. The costs associated with any transition to a new service provider would be substantial, requiring the reengineering of computer systems and telecommunications infrastructure to accommodate a new service provider to allow for a rapid replacement and return to normal network operations. This process would be both expensive and time-consuming. In addition, failure of the Internet and related telecommunications providers to provide the data communications capacity in the time frame required by us could cause interruptions in the services we provide across all of our business activities. In addition to service interruptions arising from third-party service providers, unanticipated problems affecting our proprietary internal computer and telecommunications systems have the potential to occur in future fiscal periods, and could cause interruptions in the delivery of services, causing a loss of revenue and related gross margins, and the potential loss of customers, all of which could materially and adversely affect our business, results of operations and financial condition.
  
We depend on partners and third-parties for our content and for the delivery of services underlying our subscriptions.
 
We depend heavily on partners and third-parties to provide us with licensed content including the Kazaa music service.  We are reliant on such companies to maintain licenses with music labels so that we can deliver services that we are contractually obligated to deliver to our customers.  These companies may not continue to provide services to us without disruption, or maintain licenses with the owners of the delivered content.  In addition to licensed content, we are also reliant on partners and third parties to provide services and to perform other activities which allow us to bill our subscribers.  Failure of our partners to continue to provide these services, may result in disruption to our customers and a loss in our business.  The costs associated with any transition to a new service or content provider would be substantial, even if a similar partner is available.  Failure of our partners or other third parties to provide content or deliver services have the potential to cause interruptions in the delivery of services, causing a loss of revenue and related gross margins, and the potential loss of customers, all of which could materially and adversely affect our business, results of operations and financial condition.

Our working capital requirements are significant and we may need to raise cash in the future to fund our working capital requirements.

Our working capital requirements are significant.  If our cash flows from operations are less than anticipated or our working capital requirements or capital expenditures are greater than expectations, or if we expand our business by acquiring or investing in additional products or technologies, we may need to secure additional debt or equity financing. We are continually evaluating various financing strategies to be used to expand our business and fund future growth. There can be no assurance that additional debt or equity financing will be available on acceptable terms, if at all. The potential inability to obtain additional debt or equity financing, if required, could have a material adverse effect on our operations.

 
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If advertising on the internet loses its appeal, our revenue could decline.
 
Companies doing business on the Internet must compete with traditional advertising media, including television, radio, cable and print, for a share of advertisers' total marketing budgets. Potential customers may be reluctant to devote a significant portion of their marketing budget to Internet advertising or digital marketing if they perceive the Internet to be trending towards a limited or ineffective marketing medium. Any shift in marketing budgets away from Internet advertising spending or digital marketing solutions, could directly, materially and adversely affect our transactional business, as well as our subscription business, with both having a materially negative impact on our results of operations and financial condition.
 
During 2009, all of our revenue was generated, directly or indirectly, through the Internet in part by delivering advertisements that generate leads, impressions, click-throughs, and other actions to our advertiser customers' websites as well as confirmation and management of mobile services.  This business model may not continue to be effective in the future for various reasons, including the following:
 
 
·
click and conversion rates may decline as the number of advertisements and ad formats on the Web increases, making it less likely that a user will click on our advertisement;
 
·
the installation of "filter" software programs by web users which prevent advertisements from appearing on their computer screens or in their email boxes may reduce click-throughs;
 
·
companies may be reluctant or slow to adopt online advertising that replaces, limits or competes with their existing direct marketing efforts;
 
·
companies may prefer other forms of Internet advertising we do not offer, including certain forms of search engine placements;
 
·
companies may reject or discontinue the use of certain forms of online promotions that may conflict with their brand objectives;
 
·  
companies may not utilize online advertising due to concerns of "click-fraud", particularly related to search engine placements;  
 
·
regulatory actions may negatively impact certain business practices that we currently rely on to generate a portion of our revenue and profitability; and
 
·
perceived lead quality.
 
If the number of companies who purchase online advertising from us does not continue to grow, we may experience difficulty in attracting publishers, and our revenue could decline.

We no longer meet the minimum bid price requirement for continued listing on the NASDAQ Global Market and have until June 22, 2010 to correct it.

We received a notice from NASDAQ that we no longer meet the minimum bid price requirement for continued listing on the NASDAQ Global Market as set forth in NASDAQ’s Marketplace Rule 5450(a)(1), as a result of the bid price of our common stock closing below the required minimum $1.00 per share for 30 consecutive business days.  We have been provided with a customary grace period of 180 calendar days in which to regain compliance with the minimum bid price rule.  If at any time before June 22, 2010, the bid price of our stock closes at $1.00 per share or more for a minimum of 10 consecutive business days, NASDAQ will provide written confirmation to us that we have regained compliance. If we do not regain compliance with the bid price rule by June 22, 2010, NASDAQ will notify us that our common stock is subject to delisting from The NASDAQ Global Market. However, we may appeal the delisting determination to a NASDAQ hearing panel and the delisting will be stayed pending the panel's determination. Alternatively, we may apply to transfer the listing of its common stock to the NASDAQ Capital Market if we satisfy all criteria for initial listing on the NASDAQ Capital Market, other than compliance with the minimum bid price requirement. If such application to the NASDAQ Capital Market is approved, then we may be eligible for an additional grace period.

We intend to actively monitor the bid price for our common stock between now and June 22, 2010, and will consider available options to regain compliance with the NASDAQ minimum bid price requirements. If we are unable to regain compliance with the minimum bid rule and is delisted, or unable to qualify for listing on the NASDAQ Capital Market, market liquidity for our common stock could be severely affected, and our stockholders’ ability to sell securities in the secondary market could be limited. Delisting from NASDAQ would negatively affect the value of our common stock. Delisting could also have other negative results, including, but not limited to, the potential loss of confidence by employees, the loss of institutional investor interest and fewer business development opportunities.

Our revenue could decline if we fail to effectively monetize our content and our growth could be impeded if we fail to acquire or develop new content.
 
Our success depends in part on our ability to effectively manage our existing content. The Web publishers and email list owners that list their unsold leads, data or offers with us are not bound by long-term contracts that ensure us a consistent supply of same. In addition, Web publishers or email list owners can change the amount of content they make available to us at any time. If a Web publisher or email list owner decides not to make content from its websites, newsletters or email lists available to us, we may not be able to replace this content with content from other Web publishers or email list owners that have comparable traffic patterns and user demographics quickly enough to fulfill our advertisers' requests. This would result in lost revenue.

 
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If we fail to compete effectively against other internet advertising companies, we could lose customers or advertising inventory and our revenue and results of operations could decline.
 
The Internet advertising markets are characterized by rapidly changing technologies, evolving industry standards, frequent new product and service introductions, and changing customer demands. The introduction of new products and services embodying new technologies and the emergence of new industry standards and practices could render our existing products and services obsolete and unmarketable or require unanticipated technology or other investments. Our failure to adapt successfully to these changes could harm our business, results of operations and financial condition.
 
If we are unable to successfully keep pace with the rapid technological changes that may occur in the wireless communication, internet and e-commerce arenas, we could lose customers or advertising inventory and our revenue and results of operations could decline.
 
To remain competitive, we must continually monitor, enhance and improve the responsiveness, functionality and features of our services, offered both in our subscription and transactional activities. Wireless network and mobile phone technologies, the Internet and the online commerce industry in general are characterized by rapid innovation and technological change, changes in user and customer requirements and preferences, frequent new product and service introductions requiring new technologies to facilitate commercial delivery, as well as the emergence of new industry standards and practices that could render existing technologies, systems, business methods and/or our products and services obsolete or unmarketable in future fiscal periods. Our success in our business activities will depend, in part, on our ability to license or internally develop leading technologies that address the increasingly sophisticated and varied needs of prospective consumers, and respond to technological advances and emerging industry standards and practices on a timely-cost-effective basis. Website and other proprietary technology development entails significant technical and business risks, including the significant cost and time to complete development, the successful implementation of the application once developed, and time period for which the application will be useful prior to obsolescence. There can be no assurance that we will use internally developed or acquired new technologies effectively or adapt existing websites and operational systems to customer requirements or emerging industry standards. If we are unable, for technical, legal, financial or other reasons, to adopt and implement new technologies on a timely basis in response to changing market conditions or customer requirements, our business, prospects, financial condition and results of operations could be materially adversely affected.
 
We could be subject to legal claims, government enforcement actions, and be held accountable for our or our customers' failure to comply with federal, state and foreign laws, regulations or policies, all of which could materially harm our business.
 
As a direct-to-consumer marketing company, we are subject to a variety of federal, state and local laws and regulations designed to protect consumers that govern certain of aspects of our business.  For instance, recent growing public concern regarding privacy and the collection, distribution and use of information about Internet users has led to increased federal, state and foreign scrutiny and legislative and regulatory activity concerning data collection and use practices. Any failure by us to comply with applicable federal, state and foreign laws and the requirements of regulatory authorities may result in, among other things, indemnification liability to our customers and the advertising agencies we work with, administrative enforcement actions and fines, class action lawsuits, cease and desist orders, and civil and criminal liability.
 
Our customers are also subject to various federal and state laws concerning the collection and use of information regarding individuals. These laws include the Children's Online Privacy Protection Act, the Federal CAN-SPAM Act of 2003, as well as other laws that govern the collection and use of consumer credit information. We cannot assure you that our customers are currently in compliance, or will remain in compliance, with these laws and their own privacy policies. We may be held liable if our customers use our technologies in a manner that is not in compliance with these laws or their own stated privacy policies, which would have an adverse impact on our operations.
 
Our success depends on our ability to continue forming relationships with other Internet and interactive media content, service and product providers.
 
The Internet includes an ever-increasing number of businesses that offer and market consumer products and services. These entities offer advertising space on their websites, as well as profit sharing arrangements for joint effort marketing programs. We expect that with the increasing number of entrants into the Internet commerce arena, advertising costs and joint effort marketing programs will become extremely competitive. This competitive environment might limit, or possibly prevent us from obtaining profit generating advertising or reduce our margins on such advertising, and reduce our ability to enter into joint marketing programs in the future. If we fail to continue establishing new, and maintain and expand existing, profitable advertising and joint marketing arrangements, we may suffer substantial adverse consequences to our financial condition and results of operations. Additionally, we, as a result of our acquisition of Traffix, now have a significant economic dependence on the major search engine companies that conduct business on the Internet; such search engine companies maintain ever changing rules regarding scoring and indexing their customers marketing search terms. If we cannot effectively monitor the ever changing scoring and indexing criteria, and affectively adjust our search term applications to conform to such scoring and indexing, we could suffer a material decline in our search term generated acquisitions, correspondingly reducing our ability to fulfill our clients marketing needs. This would have an adverse impact on our company’s revenues and profitability.

 
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The demand for a portion of our transactional services may decline due to the proliferation of “spam” and the expanded commercial adoption of software designed to prevent its delivery.
 
Our business may be adversely affected by the proliferation of "spam" or unwanted internet solicitations. In response to the proliferation of spam, Internet Service Providers ("ISP's") have been adopting technologies, and individual computer users are installing software on their computers that are designed to prevent the delivery of certain Internet advertising, including legitimate solicitations such as those delivered by us. We cannot assure you that the number of ISP's and individual computer users who employ these or other similar technologies and software will not increase, thereby diminishing the efficacy of our transactional, as well as our subscription service activities. In the case that one or more of these technologies, or software applications, realize continued and/or widely increased adoption, demand for our services could decline in response.
 
We do not intend to pay dividends on our equity securities.
 
It is our current and long-term intention that we will use all cash flows to fund operations and maintain excess cash requirements for the possibility of potential future acquisitions.  We may also use our cash to repurchase shares pursuant to our share repurchase program discussed elsewhere in this report. Future dividend declarations, if any, will result from our reversal of our current intentions, and would depend on our performance, the level of our then current and retained earnings and other pertinent factors relating to our financial position. Prior dividend declarations should not be considered as an indication for the potential for any future dividend declarations.

 
In both our subscription services, including our Kazaa music service, and transaction services, we compete primarily on the basis of marketing acquisition cost, brand awareness, consumer penetration and carrier and distribution depth and breadth.  We face numerous competitors, many of whom are much larger than us, who have greater financial and operating resources than we do and who have been operating in our target markets longer than we have.  In the future, likely competitors may include other major media companies, traditional video game publishers, telephone carriers, content aggregators, wireless software providers and other pure-play direct response marketers publishing content and media, and Internet affiliate and network companies.
 
If we are not as successful as our competitors in executing on our strategy in targeting new markets, increasing customer penetration in existing markets, executing on marquee brand alignment, and/or effectively executing on business level accretive acquisition identification and successful closing and post acquisition integration, our sales could decline, our margins could be negatively impacted and we could lose market share, any and all of which could materially harm our business prospects, and potentially have a negative impact on our share price.
 
 System failures could significantly disrupt our operations, which could cause us to lose customers or content.
 
Our success depends on the continuing and uninterrupted performance of our systems. Sustained or repeated system failures that interrupt our ability to provide services to customers, including failures affecting our ability to deliver advertisements quickly and accurately and to process visitors' responses to advertisements, and, validate mobile subscriptions, would reduce significantly the attractiveness of our solutions to advertisers and Web publishers. Our business, results of operations and financial condition could also be materially and adversely affected by any systems damage or failure that impacts data integrity or interrupts or delays our operations. Our computer systems are vulnerable to damage from a variety of sources, including telecommunications failures, power outages, malicious or accidental human acts, and natural disasters. We operate a data center in Canada and have a co-location agreement with a service provider to support our operations. Therefore, any of the above factors affecting any of these areas could substantially harm our business. Moreover, despite network security measures, our servers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems in part because we cannot control the maintenance and operation of our third-party data centers. Despite the precautions taken, unanticipated problems affecting our systems could cause interruptions in the delivery of our solutions in the future and our ability to provide a record of past transactions. Our data centers and systems incorporate varying degrees of redundancy. All data centers and systems may not automatically switch over to their redundant counterpart. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our systems. 

 
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Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees and harm our business.
 
We have historically used stock options as a key component of our employee compensation program in order to align employees' interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. Volatility or lack of positive performance in our stock price may adversely affect our ability to retain key employees, many of whom have been granted stock options, or to attract additional highly-qualified personnel. As of December 31, 2009, a majority of our outstanding employee stock options have exercise prices in excess of the stock price on that date. To the extent this continues to occur, our ability to retain employees may be adversely affected. Moreover, applicable NASDAQ listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant stock options or other stock-based awards to employees in the future. As a result, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, any of which could materially, adversely affect our business.
 
We have been named as a defendant in litigation, either directly, or indirectly, with the outcome of such litigation being unpredictable; a materially adverse decision in any such matter could have a material adverse affect on our financial position and results of operations.
 
As described below and as described under the heading "Legal Proceedings" in our periodic reports filed pursuant to the Securities Exchange Act of 1934, from time to time we are named as a defendant in litigation matters. The defense of these claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses to the claims made in each and all of the litigation matters to which we have been a named party, whether directly or indirectly, and intend to contest each lawsuit vigorously, no assurances can be given that the results of these matters will be favorable to us. A materially adverse resolution of any of these lawsuits could have a material adverse affect on our financial position and results of operations.
 
On March 10, 2010, and subsequent to our fiscal year-end, Atrinsic received final approval of its settlement to its Class Action proceeding in the State of California on Allen v. Atrinsic, Inc. f/k/a New Motion, Inc., pending in Los Angeles County Superior Court.  The settlement covers all of the company’s mobile products, web sites and advertizing practices through December 2009. All costs of the settlement and defense were accrued for in 2008, therefore this settlement did not have an impact on the Company’s results of operations in 2009 and will not impact the Company’s results of operations in 2010.

As a result of the State of California Settlement and final approval of the  judgment, Atrinsic has filed stays, and will file dispositive motions, in the following actions, which it is either directly named in or has assumed the defense of the following cases: Baker v. Sprint Nextel Corp., Motricity, Inc., and New Motion, Inc. pending in Dade County Superior Court in Florida,  Stewart v New Motion, Inc. and Motricity, Inc., pending in Hennepin County District Court in Minnesota, Rynearson v. Motricty, Inc, pending in King County Superior Court in Washington Walker v. Motricity, Inc., pending in Alameda County Superior Court in California.  Management believes that it has accrued for all probable and estimable related costs of these actions.

On February 2, 2009 we filed a complaint, in the Superior Court of the State of California for the County of Los Angeles, against Mobile Messenger Americas, Inc. and Mobile Messenger PTY LTD, later amended to name Mobile Messenger Americas Pty, Ltd in place of the latter (collectively, “Mobile Messenger”), to recover monies owed to us in connection with transaction activity incurred in the ordinary and normal course of business.  The complaint also sought declaratory relief concerning demands made by Mobile Messenger for indemnification for amounts paid by Mobile Messenger in late 2008 in settlement of a class action lawsuit in Florida, Grey v. Mobile Messenger, et al. (the “Florida Class Action”).  Mobile Messenger brought upon us a cross complaint, filed in April 2009, seeking injunctive relief, indemnification for the settlement of the Florida Class Action and other matters, damages allegedly exceeding $17 million, declaratory relief and recoupment of attorneys fees.  In November 2009, we reached a settlement of the action in principle with Mobile Messenger.  The terms of this settlement are to be confidential but in general will result in a complete dismissal of the entire action, including the cross-complaint, with prejudice. The settlement is not expected to have a material impact on our results from operations, beyond what we have already expensed and accrued for in 2009.

 We may incur liabilities to tax authorities in excess of amounts that have been accrued which may adversely impact our results of operations and financial condition.
 
As more fully described in note 11 "Provision (Benefit) for Income Taxes" to our consolidated financial statements contained in this annual report on Form 10-K, we have recorded significant income tax liabilities. The preparation of our consolidated financial statements requires estimates of the amount of income tax that will become payable in each of the jurisdictions in which we operate. We may be challenged by the taxing authorities in these jurisdictions and, in the event that we are not able to successfully defend our position, we may incur significant additional income tax liabilities and related interest and penalties which may have an adverse impact on our results of operations and financial condition.

 
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We may be impacted by the affects of the current slowdown of the United States economy.
 
Our performance is subject to United States economic conditions and its impact on levels of consumer spending.   Consumer spending recently has deteriorated significantly as a result of the current economic situation in the United States and may remain depressed, or be subject to further deterioration for the foreseeable future.  Purchases of our subscription based services as well as our transactional services tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines. Many factors affect the level of spending for our products and services, including, among others: prevailing economic conditions, levels of employment, salaries and wage rates, energy costs, interest rates, the availability of consumer credit, taxation and consumer confidence in future economic conditions. During periods of recession or economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers or maintain or increase our international operations on a profitable basis. As a result, our operating results may be adversely and materially affected by downward trends in the United States or global economy, including the current recession in the United States. 
 
The requirements of the Sarbanes-Oxley act, including section 404, are burdensome, and our failure to comply with them could have a material adverse affect on the company’s business and stock price.
 
Effective internal control over financial reporting is necessary for us to provide reliable financial reports and effectively prevent fraud. Section 404 of the Sarbanes-Oxley Act of 2002 requires us to evaluate and report on our internal control over financial reporting. Our independent registered public accounting firm will need to annually attest to the Company’s evaluation, and issue their own opinion on the Company’s internal control over financial reporting beginning with the Company’s Annual Report on Form 10-K for the fiscal year ending December 31, 2010. The process of complying with Section 404 is expensive and time consuming, and requires significant management attention. We cannot be certain that the measures we will undertake will ensure that we will maintain adequate controls over our financial processes and reporting in the future. Furthermore, if we are able to rapidly grow our business, the internal controls over financial reporting that we will need, will become more complex, and significantly more resources will be required to ensure that our internal controls over financial reporting remain effective. Failure to implement required controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we or our auditors discover a material weakness in our internal control over financial reporting, the disclosure of that fact, even if the weakness is quickly remedied, could diminish investors’ confidence in our financial statements and harm our stock price. In addition, non-compliance with Section 404 could subject us to a variety of administrative sanctions, including the suspension of trading, ineligibility for listing on one of the Nasdaq Stock Markets or national securities exchanges, and the inability of registered broker-dealers to make a market in our common stock, which would further reduce our stock price.

Revenue from our new businesses may be difficult to predict

We are devoting resources to service offerings where we have limited operation history. This makes it difficult to predict revenue and could result in longer than expected sales and implementation cycles.
 

 
17

 
 
 
Not applicable
 
ITEM 2. PROPERTIES
 
Atrinsic’s corporate headquarters are located at 469 7th Avenue, New York, NY.
 
The following table details the various properties leased and owned by us as of March 24, 2010.
 
Location
 
Leased/
Owned
 
Square
Feet
   
Expiration
 
Dieppe, New Brunswick, Canada
 
Owned
    17,000       N/A  
469 7th Avenue, New York, NY
 
Leased
    17,000    
9/30/2018
 
1 Blue Hill Plaza, Pearl River, NY
 
Leased
    14,220    
11/15/2011
 
 
The spaces listed above are adequate for our current needs and we believe suitable additional or substitute space will be available to accommodate the foreseeable expansion of our operations. Our owned property in Dieppe, Canada is not subject to a mortgage or any liens. Atrinsic’s telephone number is (212) 716-1977.
 
ITEM 3. LEGAL PROCEEDINGS.
 
On March 10, 2010, and subsequent to our fiscal year-end, Atrinsic received final approval of its settlement to its Class Action proceeding in the State of California on Allen v. Atrinsic, Inc. f/k/a New Motion, Inc., pending in Los Angeles County Superior Court.  The settlement covers all of the company’s mobile products, web sites and advertizing practices through December 2009. All costs of the settlement and defense were accrued for in 2008. Therefore this settlement did not have an impact on the Company’s results of operations in 2009 and will not impact its results of operations in 2010.

As a result of the State of California Settlement and final approval of the  judgment, Atrinsic has filed stays, and will file dispositive motions, in the following actions, which it is either directly named in or has assumed the defense of the following cases: Baker v. Sprint Nextel Corp., Motricity, Inc., and New Motion, Inc. pending in Dade County Superior Court in Florida,  Stewart v New Motion, Inc. and Motricity, Inc., pending in Hennepin County District Court in Minnesota, Rynearson v. Motricty, Inc, pending in King County Superior Court in Washington Walker v. Motricity, Inc., pending in Alameda County Superior Court in California.  Management believes that it has accrued for all probable and estimable related costs of these actions.

On February 2, 2009 the Company filed a complaint, in the Superior Court of the State of California for the County of Los Angeles, against Mobile Messenger Americas, Inc. and Mobile Messenger PTY LTD, later amended to name Mobile Messenger Americas Pty, Ltd in place of the latter (collectively, “Mobile Messenger”), to recover monies owed the Company in connection with transaction activity incurred in the ordinary and normal course of business.  The complaint also sought declaratory relief concerning demands made by Mobile Messenger for indemnification for amounts paid by Mobile Messenger in late 2008 in settlement of a class action lawsuit in Florida, Grey v. Mobile Messenger, et al. (the “Florida Class Action”).  Mobile Messenger brought upon the Company a cross complaint, filed in April 2009, seeking injunctive relief, indemnification for the settlement of the Florida Class Action and other matters, damages allegedly exceeding $17 million, declaratory relief and recoupment of attorneys fees.  In November 2009, the Company reached a settlement of the action in principle with Mobile Messenger. The terms of the settlement are to be confidential but in general will result in a complete dismissal of the entire action, including the cross complaint, with prejudice. The settlement is not expected to have a material impact on the Company’s results from operations, beyond what the Company has already expensed and accrued for in 2009.

In the ordinary course of business, the Company is involved in various disputes, which are routine and incidental to the business and the industry in which it operates. In the opinion of management the results of such disputes will not have a significant adverse effect on the financial position or the results of operations of the Company.


 
18

 
 
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
On June 25, 2009, the Company changed its corporate name and ticker symbol from New Motion, Inc., (NWMO) to Atrinsic, Inc., (ATRN). Our common stock is quoted on The NASDAQ Global Market.” Prior to our acquisition of Traffix which occurred on February 4, 2008, our common stock was quoted on the Over-The-Counter Bulletin Board under the symbol NWMO. The following table sets forth, for the periods indicated, the high and low sales prices (or high and low bid quotations with respect to the periods during which our common stock was traded on the Over-The-Counter Bulletin Board as determined from quotations on the Over-The-Counter Bulletin Board) for our common stock, as well as the total number of shares of common stock traded during the periods indicated.  With respect to the Over-The-Counter market quotations referenced above, such quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not represent actual transactions.
 
               
Average
 
               
Daily
 
   
High
   
Low
   
Volume
 
Year Ended December 31, 2009:
                 
First Quarter
    1.46       0.75       44,077  
Second Quarter
    1.50       0.87       33,344  
Third Quarter
    1.42       0.90       14,863  
Fourth Quarter
    1.17       0.52       43,920  
                         
Year Ended December 31, 2008:
                       
First Quarter
    14.00       3.70       44,166  
Second Quarter
    5.25       3.26       82,617  
Third Quarter
    4.35       2.20       39,769  
Fourth Quarter
    3.41       1.01       42,630  
 
As of March 26, 2009, there were approximately 165 record holders of common stock. As of March 26, 2009, the closing sales price of our common stock as reported on the NASDAQ Global Market was $0.88 per share. Our transfer agent is American Stock Transfer & Trust Company and their phone number is (718) 921-8275.
 
Dividend Policy
 
We do not anticipate paying any dividends on our common stock for the foreseeable future. We intend to retain our future earnings to re-invest in our ongoing business. The declaration of cash dividends in the future will be determined by our board of directors based upon our earnings, financial condition, capital requirements and other relevant factors.
 
Recent Sales of Unregistered Securities
 
During the 2009 fiscal year, other than as disclosed in our Quarterly Reports on Form 10-Q or on Form 8-K, as filed with the Securities and Exchange Commission, we did not sell unregistered securities.

ITEM 6. SELECTED FINANCIAL DATA
 
Not required.

 
19

 

 
Cautionary Statement

The following discussion and analysis should be read together with the Consolidated Financial Statements of Atrinsic, Inc. and the “Notes to Consolidated Financial Statements” included elsewhere in this report.  This discussion summarizes the significant factors affecting the consolidated operating results, financial condition and liquidity and cash flows of Atrinsic, Inc. for the fiscal years ended December 31, 2009 and 2008. Except for historical information, the matters discussed in this Management’s Discussion and Analysis of Financial Condition and Results of Operations are forward-looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond our control.
 
Executive Overview
 
As a direct to consumer Internet marketing company, our strategy is to maximize the value of each media impression by maximizing the revenue and profit from each visitor to our media network.  We do this by using proprietary technology to match each consumer touch point (visit, registration or lead submission) with the highest value offer or series of offers.  These offers are sourced from a large pool of advertisers or from our own portfolio of consumer subscription products.  We also engage in targeted performance marketing activities where we focus on acquiring customers for an advertiser on an exclusive basis.

Our premium subscription products, which are marketed directly to consumers, are an important component of the maximization strategy.  By maintaining alternatives to third party offers, we are able to make use of a larger proportion of acquired Internet traffic and leads generated than would be the case with only third party advertisers’ offerings, since our owned products typically provide a higher effective value for each media impression.

Over an extended period of time, our ability to generate incremental revenues relies on our ability to increase the size and scope of our media network, our ability to target campaigns, and our ability to convert qualified leads into appropriate revenue generating opportunities, including into subscribers of our own products.  Revenue growth also depends on our ability to market and sell our services, including search services and lead generation activities, to third parties.

We combine our direct response capability with an Internet-based customer acquisition model, which allows us to use proprietary lead generation, search and email marketing strategies, to generate a greater volume of Internet traffic at a lower effective cost of acquisition.  Our success at acquiring qualified customers at a low effective cost is due, in part to our portfolio of attractive web properties, content and licensed media. This performance marketing media network ensures a continual base of subscribers to our subscription products, and also generates qualified traffic that is complementary to our third-party advertisers.

Our direct response marketing business principally serves two sets of customers. Corporate clients and third party advertisers (transactional services) use our products and services to enhance their online marketing programs.  Consumers (subscriptions) subscribe to our services to receive premium content on the Internet and on their mobile device. Each of these business activities – transactional and subscription – may utilize the same originating media or derive a customer from the same source; the difference is reflected in the type of customer billing.  In the case of transactional marketing services, the billing is generally carried out on a service fee, percentage, or on a performance basis. For subscription services, the end user (the consumer) is able to access premium content and in return is charged a recurring monthly fee to a credit card, mobile phone, or land-line phone.

 
Similar to other media based companies, our ability to specifically isolate the relative historical aggregate impact of price and volume regarding our revenue is not practical as the majority of our services are sold and managed on an order by order basis and our revenues are greatly impacted by our ability to qualify, validate and enhance leads that we acquire.  Factors impacting the pricing of our services include, but are not limited to: (1) the dollar value, length and breadth of the order; (2) the quality of the desired action; (3) the quantity of actions or services requested by our clients; (4) our ability to enhance the value of leads through validation and traffic disaggregation; (5) matching leads to the highest relative value offer; and (6) the level of customization required by our clients.

 
20

 

The principal components of our operating expense are labor, media and media related expenses (including media content costs, lead validation and affiliate compensation), product or content development and royalties or licensing fees, marketing and promotional expense (including sales commissions, customer service and customer retention expense) and corporate general and administrative expense. We consider our operating cost structure to be predominantly variable in nature over a short time horizon, and as a result, we are immediately able to make modifications to our cost structure to what we believe to be increases or decreases in revenue and market trends. This factor is important in monitoring our performance in periods when revenues are increasing or decreasing. In periods where revenues are increasing as a result of improved market conditions, we will make every effort to best utilize existing resources, but there can be no guarantee that we will be able to increase revenues without incurring additional marketing or operating costs and expenses. Conversely, in a period of declining market conditions we are immediately able to reduce certain operating expenses and preserve operating income. Furthermore, if we perceive a decline in market conditions to be temporary, we may choose to maintain or increase operating expenses for the future maximization of operating results.

As a growing part of our direct-to-consumer business, the Kazaa music service is an important focus for management.  The Kazaa digital music service is offered in conjunction with BDE, an online distributor of licensed digital content.  On March 26, 2010, we entered into a Marketing Services Agreement (the “Marketing Agreement”) and a Master Services Agreement (the “Services Agreement”) with BDE effective as of July 1, 2009 (collectively, the “Agreements”), relating to the operation and marketing of the Kazaa digital music service.  The Agreements have a term of three years from the effective date, contain provisions for automatic one year renewals, subject to notice of non-renewal by either party, and may only be terminated generally upon a bankruptcy or liquidation event or in the event of an uncured material breach by either party.  In accordance with the Agreements, Atrinsic and BDE will share equally in the “Net Profit” generated by the Kazaa music subscription service after all of our costs and expenses are recovered.

Under the Marketing Agreement, we are responsible for marketing, promotional, and advertising services in respect of the Kazaa service.  In exchange for these marketing services, we will be reimbursed for the pre-approved costs and expenses incurred in connection with the provision of the services plus all other agreed budgeted amounts.  Pursuant to the Services Agreement, we are to provide services related to the operation of the Kazaa website and service, including billing and collection services and the operation of the Kazaa online storefront.  BDE is obligated to provide certain other services with respect to the service, including licensing the intellectual property underlying the Kazaa service to us, obtaining all licenses to the content offered as part of the service and delivering that content to the subscribers via the service interface.

As part of the Agreements, we are required to make advance payments and expenditures in respect of certain expenses incurred in order to provide the required services and operate the Kazaa music service.  These advances and expenditures are recoverable on a dollar for dollar basis against future revenues.  BDE has agreed to repay up to $2,500,000 of these advances and expenditures which are not otherwise recovered from Kazaa generated revenues and this repayment obligation will be secured under separate agreement.  Similarly, we are not obligated to make additional expenditures if more than $5,000,000 remains unrecovered or unrecouped by us from Kazaa revenues.

Business Strategy
 
To become a leading direct to consumer Internet marketing company, our strategy is to continue to develop a broad marketing and media network that allows us to cost-efficiently acquire consumers for our subscription-based services and for our third-party lead generation activities.  We also must continually develop best in class service offerings for our clients in the area of search related services.

Expand Online Distribution Capabilities: we consider our distribution capabilities as encompassing the various ways we generate Internet traffic by attracting users to various web properties and converting visitors into subscribers and third-party leads.  We employ a multifaceted approach to generating traffic: (i) users may navigate directly to our web properties, (ii) users respond to our email marketing, (iii) we garner users of our promotional and sweepstakes sites, (iv) we attract users to our content sites by offering valuable media and other content, (v) we utilize call center technology in the acquisition process, and (vi) we use search engine optimization and search marketing efforts which attract users to our sites and services on a PPC-basis.  Our strategy is to increase our volume of visitors, subscribers, and third-party leads by improving the reach and widening our breadth of distribution. We expect to do this by increasing our portfolio of web properties and sites, and improving existing, or employing innovative techniques, to source traffic.  We expect that by expanding our online distribution capability, we will lower our customer acquisition costs by improving margins through greater scale.

Publish High-Quality, Branded Subscription Content: As a direct to consumer Internet marketing company, we are focused on partnering with companies, and developing proprietary sources of content, for our direct to consumer subscription products.  We believe that publishing a diversified portfolio of the highest quality content, like the Kazaa music service, is important to our business. We intend to continue to develop innovative and sought-after content and intend to continue to devote significant resources to the development of high-quality and innovative products and services.  We will focus on subscription based products in the entertainment and lifestyle categories as these products correspond to the visitor base in our media network.

 
21

 

Lead Generation Product Development:  In order to be competitive in the performance marketing areas, companies must de-commoditize the leads they generate.  We are pursuing a number of value enhancing strategies to increase the marketability of our leads to third parties and to increase the conversion of leads into subscribers of our direct-to-consumer subscription services.  These innovations include ad units designed to drive direct telephone calls, where a call center operator will respond instantly to a user’s request for information and, in some instances, transfer the consumer directly to an advertiser.  We also actively increase the value of a consumer inquiry by validating the submission of online information through automated data lookups and validation, or through call center confirmation.  All of these lead value enhancement techniques assist us in increasing the average sales price of leads sold to our advertisers, or improves the conversion of users into subscribers to our direct-to-consumer subscription services and the corresponding increases in LTV that result from more highly qualified subscribers.

Multiple Billing Platforms:  As a direct result of being proficient in multiple billing platforms, we are able to create customer acquisition efficiencies because we can acquire direct subscribers and generate third-party leads.  This provides us with a competitive advantage over traditional direct response marketers, who may only offer a single billing modality – credit cards.  We have agreements through multiple aggregators who have access to U.S. carriers – both wireless and landline – for billing.  These relationships include our 36% interest in TBR, which is an aggregator of fixed-line billing.  In addition to agreements with aggregators, we also have an agreement in place with AT&T Wireless to distribute and bill for our services directly to subscribers on their network.  As a result of our multiple billing protocols, we are able to expand our potential customer base, attracting consumers who may prefer a different billing mechanism than is traditionally offered.  Many of our new product initiatives leverage and expand upon our alternative billing capabilities.

Online Marketing Services: In order to be competitive in the area of online marketing services, particularly in search related marketing services, we must continue to expand our staff and technology capabilities.  Our product offering will not remain competitive if we don’t offer our clients leading edge technology and strategies designed to drive their online sales efforts.  Adding more services revenue will involve prospecting a targeted set of clients who are natural consumers of our services.  Our initiatives include delivering an integrated suite of services, which include search engine marketing services, search engine optimization, display advertising, and affiliate marketing.  Our ability to integrate brand protection and competitive intelligence is a source of differentiation and growth for our existing and new client base.

Technology: Through our use of technology, we attempt to display the highest value offer to the consumer.  On a real-time basis, our technology dynamically analyzes user data, media source, and estimated offer values and progressions to gauge which offer maximizes the value of the media impression.  If the user is “qualified,” we will expose one of our targeted consumer subscription offers.  In the event that the user does not correspond to our internal targeting criteria, the most profitable third-party offers will be displayed.  In every case, we are continually working on technology to improve targeting capability so as to maximize the value of each media impression.  We also employ proprietary technology which measures, in real time, the effectiveness of our media buying by media source.  This allows us to adjust marketing efforts immediately towards the most effective partners. These tools allow us to be more effective in our media buying, reducing our acquisition costs and improving convertibility and profitability.

 
22

 

Results of Operations for the year ended December 31, 2009 compared to the year ended December 31, 2008.
 
Revenues presented by type of activity are as follows for the year ended December 31:

   
For the Year
   
Change
   
Change
 
   
December 31,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
   
2009
   
2008
   
$
   
%
 
                         
Subscription
  $ 22,254     $ 44,196     $ (21,942 )     -50 %
Transactional
    46,835       69,688       (22,853 )     -33 %
                                 
Total Revenues (1)
  $ 69,089     $ 113,884     $ (44,795 )     -39 %
 
(1)
As described above, we currently aggregate revenues based on the type of user activity monetized. Our objective is to optimize total revenues from the user experiences. Accordingly, this factor should be considered in evaluating the relative revenues generated from our Subscription and Transactional Services.

Revenues decreased approximately $44.8 million, or 39%, to $69.1 million for the year ended December 31, 2009, compared to $113.9 million for the year ended December 31, 2008.

Subscription revenue consists of content applications billed direct to consumers via mobile or land based telephone lines or credit card.  These services are delivered through the Internet to PCs, or mobile phones, or through other Internet-connected devices.  Subscription revenue decreased by approximately $22.0 million, or 50%, to $22.2 million for the year ended December 31, 2009, compared to $44.2 million for the year ended December 31, 2008. The decrease in subscription service revenue was principally attributable to a decrease in the number of billable subscribers during the period. At December 31, 2009 the number of subscribers was 338,000 compared to 501,000 at December 31, 2008.  This also compares to 346,000 subscribers at September 30, 2009.  The decrease in billable subscribers from a year ago was due primarily to a significant reduction in mobile customer acquisition rates, offset by approximately 70,000 net billable additions from the introduction of the Kazaa music subscription service.  Net billable additions refers to the number of subscribers added during the period, less attrition.  During 2009, we reduced our mobile marketing spends, which directly impacted customer acquisition rates. We elected to cut our mobile marketing spends because of the uncertain regulatory and legal environment associated with marketing mobile subscription services and due to the less profitable economics – a result of higher customer acquisition costs – of our mobile subscription service offerings.

Transactional revenue is derived from our online marketing and lead generation activities, which are targeted and measurable online campaigns and programs for marketing partners, corporate advertisers, or their agencies, generating qualified customer leads, online responses and activities, or increased brand recognition. Transactional revenue decreased by approximately $22.9 million or 33% to $46.8 million for the year ended December 31, 2009 compared to $69.7 million for the year ended December 31, 2008. The decrease is principally attributed to the reduction in discretionary advertising spending by our search customers.

We also experienced weakness in our marketing services and lead generation business, including a reduction in page views, site visits, and registrations, which manifested itself in lower revenue for these service lines on a year-over-year basis.  As a result of the slow-down in economic activity in the United States during 2009, spending on advertising decreased markedly, leading to increased competition in the Internet marketing and lead generation markets which, in turn, created significant downward pricing pressure on our offerings and resulted in a lower volume of registrations and leads that could be sourced at an attractive price.

 
23

 
 
Operating Expenses
 
   
For the Year
   
Change
   
Change
 
   
December 31,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
   
2009
   
2008
   
$
   
%
 
Operating Expenses 
                       
Cost of Media – 3rd party
  $ 43,313     $ 74,541     $ (31,228 )     -42 %
Product and distribution
    10,559       9,749       810       8 %
Selling and marketing
    8,386       9,974       (1,588 )     -16 %
General, administrative and other operating
    14,706       16,060       (1,354 )     -8 %
Depreciation and Amortization
    3,698       5,867       (2,169 )     -37 %
Impairment of Goodwill and Intangible Assets
    17,289       114,783       (97,494 )     -85 %
                                 
 Total Operating Expenses
  $ 97,951     $ 230,974     $ (133,023 )    
-58
%

Cost of Media
 
Cost of Media – 3rd party decreased by $31.2 million to $43.3 million for the year ended December 31, 2009 from $74.5 million for the year ended December 31, 2008. Cost of Media – 3 rd party includes media purchased for monetization of both transactional and subscription revenues. Because of its strictly variable nature, this decrease was proportionately correlated to the decline in the related revenue.  As a percentage of revenue, Cost of Media -3rd party improved to 63% for the year ended December 31, 2009 from 65% for the year ended December 31, 2008.  This improvement in Cost of Media -3rd party margin is attributable to reductions in the pace of mobile customer acquisition, partially offset by increased search marketing spend associated with the Kazaa music subscription service. It is to be expected that for businesses with a significant recurring revenue component, if direct marketing expense is significantly curtailed, the business, as a result of the recurring nature of revenue generated by the subscription service, will exhibit a short term period of improved Cost of Media – 3 rd party margins.

Product and Distribution
 
Product and distribution expense increased by $0.8 million to $10.5 million in the year ended December 31, 2009 as compared to $9.7 million for the year ended December 31, 2008. Product and distribution expenses are costs necessary to develop and maintain proprietary content and support and maintain our websites and technology platforms – which drive both our transactional and subscription based revenues.  In 2009, we experienced higher product and distribution expense as a result of costs incurred to further develop the Kazaa music service, greater royalty and license expense, also associated with Kazaa, and other general marketing and distribution technology-related expense.  These higher technology and royalty costs were offset by a reduction in product and distribution salary expense. Included in product and distribution cost is stock compensation expense of $111,000 and $7,000 for the year ended December 31, 2009 and 2008, respectively.

Selling and marketing
 
Selling and marketing expense decreased by $1.6 million to $8.4 million in the year ended December 31, 2009 as compared to $10.0 million for the year ended December 31, 2008. The decrease is primarily due to a reduction in salaries and other marketing costs, in accordance with the decrease in our revenue over the same period.  This decrease in selling and marketing expense was partially offset by higher customer service expense as a result of new service offerings and call center activity.

General, Administrative and Other Operating
 
General and administrative expenses decreased by approximately $1.4 million to $14.7 million for the year ended December 31, 2009 compared to $16.1 million for the year ended December 31, 2008. The decrease is due primarily due to a reduction in labor and related costs, professional and consulting fees, facilities and related costs, partially offset by an increase in Sarbanes Oxley consulting fees, legal expense and severance payments and accruals to former executives. While we consider it important to make appropriate and modest investments in labor, facilities, and utilization of third party professional service providers to support our continued growth, business development, and corporate governance initiatives, management has also made steps to reduce our overall cost structure as a result of the challenging and competitive business environment, and the associated decrease in revenue and unfavorable operating results we have experienced over the last year.  We continue to look for opportunities to leverage our existing infrastructure or to generate appropriate cost savings without affecting employee morale or jeopardizing business development opportunities. Included in general and administrative expense is severance of $1.1 million for the year ended December 31, 2009 and stock compensation expense of $0.7 million and $1.3 million for the year ended December 31, 2009 and 2008, respectively.

 
24

 

Depreciation and amortization
 
Depreciation and amortization expense decreased $2.2 million to $3.7 million for the year ended December 31, 2009 compared to $5.9 million for the year ended December 31, 2008 principally as a result of a reduction in capital expenditure and a decrease of $1.4 million of Ringtone subscriber database amortization expense from 2008 to 2009. The database was fully amortized by the second quarter of 2009.

Impairment of Goodwill and Intangible Assets
 
The Company conducts its annual impairment test in the fourth quarter of the year, unless an event occurs prior to the fourth quarter that would more likely than not reduce the fair value of the Company below its carrying amount. In connection with our annual goodwill impairment testing conducted in the fourth quarter, and for the year ended December 31, 2009, we determined there was impairment of the carrying value of goodwill and intangible assets and recorded a non-cash charge of $17.3 million compared to an impairment charge of $114.8 million in 2008. The goodwill and intangibles impairment, the majority of which is not deductible for income tax purposes, is primarily due to our declining market price, reduced expectations for future operating results and reduced valuation multiples. Such negative factors are reflected in our stock price and market capitalization.
 
Loss from Operations
 
Operating loss decreased to approximately $28.9 million for the year ended December 31, 2009 compared to $117.1 million for the year ended December 31, 2008. Excluding the effect of goodwill and intangibles impairment in 2009 and 2008, operating loss increased to approximately $11.6 million for the year ended December 31, 2009, compared to $2.3 million for the year ended December 31, 2008. The higher operating loss is the result of the revenue decrease, together with proportionately higher product and distribution expense, selling and marketing expense and general and administrative expense, offset by an improvement in the Cost of Media – 3rd party margin.

Interest income and dividends

 Interest and dividend income decreased approximately $676,000 to $72,000 for the year ended December 31, 2009, compared to $748,000 for the year ended December 31, 2008. The reduction is mainly due to a decrease in the balances of cash and marketable securities at December 31, 2009 compared to December 31, 2008, as well as a reduction in the rate of return on invested capital.

Interest expense
 
Interest expense was $76,000 for the year ended December 31, 2009 compared to $147,000 for the year ended December 31, 2008. The interest paid is primarily related to the note payable to Ringtone which was paid in January 2009.

Other Income (Expense)
 
Other income was $5,000 for the year ended December 31, 2009 compared to other expense of ($153,000) for the year ended December 31, 2008. The 2008 expense was due to a loss on sale of marketable securities.
 
Income Taxes
 
 Income tax expense (benefit), before noncontrolling interest and equity in income of investee, for the year ended December 31, 2009 and 2008 was $0.6 million and ($0.9) million, respectively and reflects an effective tax rate of 2.2% and 0.7% respectively. The effective tax rates were computed taking into consideration non-deductible impairment charges of $12.1 million and $114.8 million for 2009 and 2008, respectively, and the establishment of an income tax valuation allowance of $11.0 million for 2009.

Equity in Loss of Investee
 
Equity in income of investee was $59,000, net of taxes at December 31, 2009 and represents our 36% interest in The Billing Resource, LLC (TBR). We acquired the interest in TBR in the 4th Quarter 2008 and  the operating results were de minimis.

 
25

 


Net loss attributable to noncontrolling interest was $28,000 for the year ended December 31, 2009 as compared to net income of ($24,000) for the year ended December 31, 2008. This related to our investment in MECC which was dissolved in June 2009.

Net Loss Attributable to Atrinsic, Inc.


Liquidity and Capital Resources
 
We continually project anticipated cash requirements, which may include business combinations, capital expenditures, and working capital requirements. As of December 31, 2009, we had cash and cash equivalents of approximately $16.9 million and working capital of approximately $15.3 million. We used approximately $3.0 million in cash for operations for the year ended December 31, 2009 and, contingent on prospective operating performance, may require reductions in discretionary variable costs and other realignments to permanently reduce fixed operating costs. We generated $2.4 million in cash from investing activities, principally from proceeds from sale of marketable securities and a distribution from The Billing Resource, offset by the investment in ShopIt. Cash used in financing activities was $2.8 million and was principally attributable to repayment of the Ringtone note payable of $1.8 million and stock repurchases. Our Board of Directors authorized a share repurchase program which expired in May 2009. Under this share repurchase program we purchased 832,392 shares of our common stock for an aggregate price of $939,000.

We believe that our existing cash and cash equivalents and anticipated cash flows from operating activities will be sufficient to fund minimum working capital and capital expenditure needs for at least the next twelve months. The extent of our future capital requirements will depend on many factors, including our results of operations. If our cash flows from operations is less than anticipated or our working capital requirements or capital expenditures are greater than expectations, or if we expand our business by acquiring or investing in additional products or technologies, we may need to secure additional debt or equity financing. We are continually evaluating various financing strategies to be used to expand our business and fund future growth. There can be no assurance that additional debt or equity financing will be available on acceptable terms, if at all. The potential inability to obtain additional debt or equity financing, if required, could have a material adverse effect on our operations.
 
Critical Accounting Policies and Estimates
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of all majority and wholly-owned subsidiaries and significant intercompany balances and transactions have been eliminated.
 
The equity method is used to account for investments in entities in which we have an ownership of less than 50% and have significant influence over the operating and financial policies of the affiliate.
 
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, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions. Management has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors.  

 
26

 

Accounts Receivable and Related Allowances
 
The Company maintains allowances for doubtful accounts for estimated losses which may result from the inability of its customers to make required payments. The Company bases its allowances on the likelihood of recoverability of accounts receivable by customer, based on past experience, the age of the accounts receivable balance, the credit quality of the Company’s customers, and, taking into account current collection trends. If specific customer circumstances change or industry trends worsen beyond the Company’s estimates, the Company would be required to increase its allowances for doubtful accounts. Alternatively, if trends improve beyond the Company’s estimates, the Company would be required to decrease its allowance for doubtful accounts. The Company’s estimates are reviewed periodically, and adjustments are reflected through bad debt expense in the period they become known. Changes in the Company’s bad debt experience can materially affect its results of operations.
 
The Company also makes estimates for refunds and provides for these probable uncollectible amounts through a reduction of recorded revenues in the period for which the sale occurs, based on analyses of previous rates and trends.
 
Due to the payment terms of the carriers requiring in excess of 60 days from the date of billing or sale, at its sole discretion, the Company can elect to use trade discounts in order to facilitate quicker payment. This discount or fee allows for payments of approximately 80% of the prior month’s billings 15 to 20 days after the end of the month. The Company records revenue net of that fee, if incurred, which is 3.5% to 5% of the associated revenue.
 
Goodwill and Intangible Assets
 
Goodwill represents the excess of cost over fair value of net assets of businesses acquired. In accordance with ASC 350 formerly Statement of Financial Accounting Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”, the value assigned to goodwill and indefinite lived intangible assets is not amortized to expense, but rather it is evaluated at least on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value. If the fair value of an indefinite lived intangible is less than its carrying amount, an impairment loss is recorded. Fair value is determined based on discounted cash flows, market multiples or appraised values as appropriate. Discounted cash flow analysis requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about the Company’s businesses and their prospects, or changes in market conditions, could result in an impairment charge. Some of the more significant estimates and assumptions inherent in the intangible asset valuation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory trends.
 
The Company has determined that there was an impairment of the carrying value of  goodwill and non-amortizable intangible assets as a result of completing its annual impairment analysis as of December 31, 2009. In performing the related valuation analysis the company used various valuation methodologies including probability weighted discounted cash flows, comparable transaction analysis, and market capitalization and comparable company multiple comparison. The results of this review and impact of the impairment are more fully described in Note 7 - “Goodwill and Intangible Assets”.
 
Intangible assets subject to amortization primarily consist of customer lists, trade names and trademarks, and restrictive covenants that were acquired.  The intangible asset values assigned to the identified assets for each acquisition were generally determined based upon the expected discounted aggregate cash flows to be derived over the estimated useful life. The method of amortizing the intangible asset values reflects, based upon the Company’s historical experience, an accelerated rate of attrition in the subscriber database based over the expected life of the underlying subscriber database after considering turnover.  Accordingly, the Company amortizes the value assigned to subscriber database based on the actual depletion of the acquired subscriber database. The Company reviews the recoverability of its finite-lived intangible assets for recoverability whenever events or circumstances indicated that the carrying amount of an asset may not be recoverable. Recoverability is assessed by comparison to associated undiscounted cash flows. In the fourth quarter of 2009, and prior to ASC 350 evaluation, the Company recognized an impairment of $2.1 million under ASC 360.
  
Stock-Based Compensation
 
The Company records stock based compensation in accordance with ASC 718 formerly Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123 (revised 2004). In estimating the grant date fair value at stock option awards and performance based restricted stock, we use the Black Scholes option pricing model and other binomial pricing models where appropriate. The key assumptions for these models to derive fair value include expected term, rate of risk free returns and volatility. If different assumptions and estimates were used, the amounts charged to compensation expense would be different.

 
27

 

Revenue Recognition
 
The Company monetizes a portion of its user activities through subscription based sources by providing on-going monthly access to and usage of premium products and services.  In general, customers are billed at standard rates, at the beginning of the month, and revenues are recognized upon receipt of information confirming an arrangement. The Company estimates a provision for refunds and credits which is recorded as a reduction to revenues. In determining the estimate for refunds and credits, the Company relies upon historical data, contract information and other factors. The estimated provision for refunds can vary from actual results.
 
The Company effectuates its subscription revenues through a carrier or distributors who are paid a transaction fee for their services.  In accordance with ASC 605 formerly Emerging Issues Task Force (“EITF” No 99-19) “Reporting Revenues Gross as Principal Versus Net as an Agent”, the Company recognizes as revenues the net amount received from the carrier or distributor, net of their fee.  
 
The Company monetizes a portion of its user activities through transactional based services generated primarily from (a) fees earned, primarily on a Cost Per Click basis, from search syndication services; (b) fees earned for the Company's search engine marketing ("SEM") services; and (c) other fees for marketing services including data and list management services, which can be either periodic or transactional. Commission fee revenue is recognized in the period that the Company's advertiser customer generates a sale or other agreed-upon action on the Company's affiliate marketing networks or as a result of the Company's SEM services, provided that no significant Company obligations remain, collection of the resulting receivable is reasonably assured, and the fees are fixed or determinable. All transaction services revenues are recognized on a gross basis in accordance with the provisions of EITF 99-19, due to the fact that the Company is the primary obligor and bears all credit risk to its customer, and publisher expenses that are directly related to a revenue-generating event are recorded as a component of 3rd part Media Cost.
 
Income Taxes
 
The Company uses the asset and liability method of financial accounting and reporting for income taxes required by ASC 740 formerly Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”. Under ASC 740, deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.

We maintain valuation allowances where it is more likely than not that all or a portion of  a deferred tax asset will not be realized.
 
Effective January 1, 2007, the Company adopted FIN No. 48, “Accounting for Uncertainty in Income Taxes” subsequently codified under ASC 740-10-25 which resulted in no material adjustment in the liability for unrecognized tax benefits. The Company classifies interest expense and penalties related to unrecognized tax benefits as income tax expense. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with this Interpretation is a two-step process. The first step is recognition, in which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.

The Company and its subsidiaries file income tax returns in the U.S and Canada. The Company is subject to federal,  state and Canadian examinations. The statute of limitations for 2008 and 2009 in all jurisdictions remains open and are subject to examination by tax authorities.
 
Contractual Obligations and Off-Balance Sheet Arrangements
 
At December 31, 2009, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if it had engaged in such relationships.

 
28

 
 
The following table shows the Company’s future commitments for future minimum lease payments required under operating leases that have remaining non cancellable lease terms in excess of one year, future commitments under investment and marketing agreements and future commitments under employment agreements as of December 31, 2009:

   
Operating
   
Employment
   
Total
 
(in thousands)
 
Leases
   
Agreements
   
Obligations
 
2010
  $ 1,165     $ 717     $ 1,882  
2011
    1,127       135       1,262  
2012
    886       -       886  
2013
    936       -       936  
2014
    987       -       987  
2015 and thereafter
    3,618       -       3,618  
                         
    $ 8,719     $ 852     $ 9,571  

Recent Accounting Pronouncements

Adopted in 2009

In August 2009, the FASB issued ASU 2009-05 “Measuring Liabilities at Fair Value” (“ASC 820-10”). ASC 820-10 is effective for interim and annual reporting periods beginning after August 27, 2009.  It clarifies the application of certain valuation techniques in circumstances in which a quoted price in an active market for the identical liability is not available and clarifies that when estimating the fair value of a liability, the fair value is not adjusted to reflect the impact of contractual restrictions that prevent its transfer.  We adopted ASC 820-10 for the year ended December 31, 2009 and it did not have a material impact on our consolidated financial statements.

In the third quarter of 2009, the Company adopted the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”). The ASC is the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the Securities and Exchange Commission (SEC).  The adoption of the ASC did not have an impact on the Company’s results of operations or financial position.

In June 2009, the FASB issued SFAS No. 165, “Subsequent Events”, which has been superseded by the FASB codification and included in ASC 855-10.  ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued.  The effective date of ASC 855-10 is interim or annual financial periods ending after June 15, 2009.  The adoption of ASC 855-10 did not have a material effect on the Company’s consolidated financial statements.
 
In June 2008, the FASB issued Staff Position No. EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” which has been superseded by the FASB codification ASC 260-10 gives guidance as to the circumstances when unvested share-based payment awards should be included in the computation of EPS. ASC 260-10 is effective for fiscal years beginning after December 15, 2008. The adoption of ASC 260-10 did not have an impact on the Company’s financial statements.

 In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” which has been superseded the FASB codification and included in ASC 805. ASC 805 establishes the principles and requirements for how an acquirer: (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. ASC 805 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008, with early adoption prohibited. Previously, any release of valuation allowances for certain deferred tax assets would serve to reduce goodwill, whereas under the new standard any release of the valuation allowance related to acquisitions currently or in prior periods will serve to reduce our income tax provision in the period in which the reserve is released. Additionally, under ASC 805 transaction-related expenses, which were previously capitalized, will be expensed as incurred. The adoption of ASC 805 did not have a material effect on our results of operations or financial position.

 
29

 

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” which has been superseded by the FASB codification and included in ASC 810-10-65-1 and establishes requirements for ownership interests in subsidiaries held by parties other than us (minority interests) be clearly identified and disclosed in the consolidated statement of financial position within equity, but separate from the parent's equity. Any changes in the parent's ownership interests are required to be accounted for in a consistent manner as equity transactions and any noncontrolling equity investments in deconsolidated subsidiaries must be measured initially at fair value. ASC 810-10-65-1 is effective, on a prospective basis, for fiscal years beginning after December 15, 2008; however, presentation and disclosure requirements must be retrospectively applied to comparative financial statements. Except for presentation and disclosure requirements, the adoption of ASC 810-10-65-1 had no material impact on the Company’s financial statements.

Not Yet Adopted

In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded by the FASB Codification and included in ASC 810 to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the variable interest. These revisions to ASC 810 will be effective as of the beginning of the annual reporting period commencing after November 15, 2009 and will be adopted by the Company in the first quarter of 2010. We do not believe that the adoption of these revisions to ASC 810 will have a material impact to our results of operations or financial position.
 
In October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue 08-01, Revenue Arrangements with Multiple Deliverables which has been superseded by FASB codification and included in ASC 605-25. This statement provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. The EITF introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company is currently evaluating the impact of adopting this pronouncement.

 
Not required. 

 
30

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
 
Report of Independent Registered Public Accounting Firm
   
F-1
 
         
Consolidated Balance Sheets
   
F-2
 
         
Consolidated Statements of Operations
   
F-3
 
         
Consolidated Statements of Comprehensive Loss
   
F-4
 
         
Consolidated Statement of Equity
   
F-5
 
         
Consolidated Statements of Cash Flows
   
F-6
 
         
Notes to the Consolidated Financial Statements
   
F-7 – F-29
 

 
31

 
 
Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders
Atrinsic, Inc.:
 
We have audited the accompanying consolidated balance sheets of Atrinsic, Inc. and subsidiaries, as of December 31, 2009 and 2008, and the related consolidated statements of operations, equity, comprehensive loss, and cash flows for each of the years in the two-year period ended December 31, 2009. These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of Atrinsic, Inc. and subsidiaries as of December 31, 2009 and 2008 and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2009 in conformity with U.S. generally accepted accounting principles.

/s/ KPMG LLP

New York, New York
March 30, 2010 

 
F-1

 

ATRINSIC, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of December 31,
(Dollars in thousands, except per share data)

   
2009
   
2008
 
ASSETS
           
Current Assets
           
Cash and cash equivalents
  $ 16,913     $ 20,410  
Marketable securities
    -       4,245  
Accounts receivable, net of allowance for doubtful accounts of $4,295 and $2,938
    7,985       16,790  
Income tax receivable
    4,373       2,666  
Prepaid expenses and other current assets
    2,643       3,686  
                 
Total Currents Assets
    31,914       47,797  
                 
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $1,078 and $1,435
    3,553       3,525  
GOODWILL
    -       11,075  
INTANGIBLE ASSETS, net of accumulated amortization of $8,605 and $5,683
    7,253       12,508  
DEFERRED INCOME TAXES
    -       778  
INVESTMENTS, ADVANCES AND OTHER ASSETS
    1,878       3,080  
                 
TOTAL ASSETS
  $ 44,598     $ 78,763  
LIABILITIES AND EQUITY
               
Current Liabilities
               
Accounts payable
  $ 6,257     $ 7,194  
Accrued expenses
    9,584       13,941  
Note payable
    -       1,858  
Deferred revenues and other current liabilities
    725       152  
                 
Total Current Liabilities
    16,566       23,145  
                 
DEFERRED TAX LIABILITY, NET
    1,697       -  
OTHER LONG TERM LIABILITIES
    988       969  
                 
TOTAL LIABILITIES
  $ 19,251     $ 24,114  
                 
COMMITMENTS AND CONTINGENCIES (see note 14)
               
      -       -  
STOCKHOLDERS' EQUITY
               
Common stock - par value $.01, 100,000,000 authorized, 23,583,581 and 22,992,280 shares issued at 2009 and 2008, respectively; and, 20,842,263 and 21,083,354 shares outstanding at 2009 and 2008, respectively.
  $ 236     $ 230  
Additional paid-in capital
    178,442       177,347  
Accumulated other comprehensive loss
    (20 )     (286 )
Common stock, held in treasury, at cost, 2,741,318 and 1,908,926 shares at 2009 and 2008, respectively.
    (4,992 )     (4,053 )
Accumulated deficit
    (148,319 )     (118,849 )
                 
Total Stockholders' Equity
    25,347       54,389  
                 
NONCONTROLLING INTEREST
    -       260  
                 
TOTAL EQUITY
    25,347       54,649  
                 
TOTAL LIABILITIES AND EQUITY
  $ 44,598     $ 78,763  


 
F-2

 

ATRINSIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
Years ended December 31,
(Dollars in thousands, except per share data)

   
2009
   
2008
 
             
Subscription
  $ 22,254     $ 44,196  
Transactional
    46,835       69,688  
                 
REVENUE
    69,089       113,884  
                 
OPERATING EXPENSES
               
Cost of media-third party
    43,313       74,541  
Product and distribution
    10,559       9,749  
Selling and marketing
    8,386       9,974  
General, administrative and other operating
    14,706       16,060  
Depreciation and amortization
    3,698       5,867  
Impairment of Goodwill and Intangible Assets
    17,289       114,783  
                 
      97,951       230,974  
                 
LOSS FROM OPERATIONS
    (28,862 )     (117,090 )
                 
OTHER (INCOME) EXPENSE
               
Interest income and dividends
    (72 )     (748 )
Interest expense
    76       147  
Other (income) expense
    (5 )     153  
                 
      (1 )     (448 )
                 
LOSS BEFORE TAXES AND EQUITY IN LOSS OF INVESTEE
    (28,861 )     (116,642 )
                 
INCOME TAXES
    640       (852 )
                 
EQUITY IN INCOME OF INVESTEE, AFTER TAX
    (59 )     -  
                 
NET LOSS
    (29,442 )     (115,790 )
                 
LESS: NET  LOSS (INCOME) ATTRIBUTABLE TO NONCONTROLLING INTEREST,  AFTER TAX
    28       (24 )
                 
NET LOSS ATTRIBUTABLE TO ATRINSIC, INC
  $ (29,470 )   $ (115,766 )
                 
NET LOSS PER SHARE ATTRIBUTABLE TO ATRINSIC COMMON STOCKHOLDERS
               
Basic
  $ (1.43 )   $ (5.43 )
Diluted
  $ (1.43 )   $ (5.43 )
                 
WEIGHTED AVERAGE SHARES OUTSTANDING:
               
Basic
    20,648,929       21,320,638  
Diluted
    20,648,929       21,320,638  

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

 
F-3

 
 
ATRINSIC, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
Years Ended December 31,
(Dollars in thousands, except per share data)

   
2009
   
2008
 
NET LOSS
  $ (29,442 )   $ (115,790 )
                 
OTHER COMPREHENSIVE LOSS, NET OF TAX:
               
Unrealized gain on available-for-sale securities
    -       38  
Net Currency translation adjustment
    267       (287 )
                 
Total Other Comprehensive loss, Net of Tax
  $ (29,175 )   $ (116,039 )
Comprehensive loss attributable to noncontrolling interest
    (28 )   $ 24  
                 
Comprehensive loss attributable to Atrinsic, Inc
  $ (29,147 )   $ (116,063 )

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

 
F-4

 
 
CONSOLIDATED STATEMENT OF EQUITY
Years Ended December 31,
(Dollars in thousands, except per share data)

                     
Accumulated
                   
         
Additional
         
Other
                   
   
Common Stock
   
Paid-In
   
(Accumulated
   
Comprehensive
   
Treasury Stock
   
Noncontrolling
   
Total
 
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Loss
   
Shares
   
Amount
   
Interest
   
Equity
 
                                                       
Balance at January 1, 2008
    12,021,184     $ 120     $ 19,583     $ (3,083 )   $ (38 )     -     $ -     $ 283       16,865  
Net loss
    -       -       -       (115,766 )     -       -       -       (23 )     (115,789 )
 Unrealized loss on investments
    -       -       -       -       38       -       -       -       38  
Foreign currency translation adjustment
    -       -       -       -       (287 )     -       -       -       (287 )
Stock based compensation expense
    -       -       1,282       -       -       -       -       -       1,282  
Exercise of stock options
    561,738       6       337       -       -       -       -       -       343  
Excess tax benefit on share-based compensation
    -       -       1,017       -       -       -       -       -       1,017  
Purchase of common stock, at cost
    -       -       -       -       -       1,908,926       (4,053 )     -       (4,053 )
Common stock issued in connection with business combination
    10,409,358       104       155,128       -       -       -       -       -       155,232  
                                                                         
Balance at December 31, 2008
    22,992,280     $ 230     $ 177,347     $ (118,849 )   $ (287 )     1,908,926     $ (4,053 )   $ 260       54,648  
Net loss
                            (29,470 )                             28       (29,442 )
Foreign currency translation adjustment
    -       -       -       -       267       -       -       -       267  
Liquidation of non controlling interest
                                                            (288 )     (288 )
Stock based compensation expense
    91,301       1       856       -       -       -       -       -       857  
Issuance of common stock
    40,000       -       47       -       -       -       -       -       47  
Tax shortfall on Stock based compensation
    -       -       (430 )     -       -       -       -       -       (430 )
Purchase of common stock, at cost
    -       -       -       -       -       832,392       (939 )     -       (939 )
Return of Equity
    -       -       138       -       -       -       -       -       138  
Common stock issued in connection with a business combination
    460,000       5       484       -       -       -       -       -       489  
                                                                         
Balance at December 31, 2009
    23,583,581     $ 236     $ 178,442     $ (148,319 )   $ (20 )     2,741,318     $ (4,992 )     (0 )     25,347  

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

 
F-5

 

CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(Dollars in thousands, except per share data)

   
2009
   
2008
 
             
Cash Flows From Operating Activities
           
Net loss
  $ (29,442 )   $ (115,790 )
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
               
Allowance for doubtful accounts
    1,991       2,152  
Depreciation and amortization
    3,698       5,867  
Impairment of goodwill and intangible assets
    17,289       114,783  
Stock-based compensation expense
    857       1,282  
Stock based consulting expense
    40       -  
Excess tax benefit from share-based compensation
    -       (1,017 )
Impairment of investment in Mango Networks
    225       -  
Net loss on sale of marketable securities
    -       175  
Deferred income taxes
    3,651       (2,345 )
Equity in loss (income) of investee
    (108 )     -  
Changes in operating assets and liabilities of business, net of acquisitions:
               
Accounts receivable
    6,686       4,532  
Prepaid income tax
    (1,617 )     (2,464 )
Prepaid expenses and other current assets
    (359 )     1,152  
Accounts payable
    (937 )     (3,205 )
Other, principally accrued expenses
    (4,989 )     (767 )
Net cash (used in) provided by operating activities
    (3,015 )     4,355  
                 
Cash Flows From Investing Activities
               
Cash received from investee
    1,940       11,212  
Cash paid to investees
    (914 )     (2,519 )
Purchases of marketable securities
    -       (6,577 )
Proceeds from sales of marketable securities
    4,242       24,708  
Business combinations
    (1,740 )     (7,030 )
Acquisition of loan receivable
    (480 )     -  
Capital expenditures
    (682 )     (2,029 )
Net cash provided by investing activities
    2,366       17,765  
                 
Cash Flows From Financing Activities
               
Repayments of notes payable
    (1,750 )     (111 )
Liquidation of non-controlling interest
    (288 )     -  
Return of investment - noncontrolling interest
    138       -  
Excess tax benefit on share-based compensation
    -       1,017  
Purchase of common stock held in treasury
    (939 )     (4,053 )
Proceeds from exercise of options
    -       343  
Net cash used in financing activities
    (2,839 )     (2,804 )
                 
Effect of exchange rate changes on cash and cash equivalents
    (9 )     (18 )
                 
Net (Decrease) Increase In Cash and Cash Equivalents
    (3,497 )     19,298  
Cash and Cash Equivalents at Beginning of Year
    20,410       1,112  
Cash and Cash Equivalents at End of Period
  $ 16,913     $ 20,410  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash paid for interest
  $ (76   $ (35 )
Cash refunded (paid) for taxes
  $ 867     $ (2,620 )
Acquisition of intangibles assets by issuance of note payable
  $ -     $ 1,750  
Extinguishment of loan receivable in connection with business combination
  $ 480     $ -  
Common stock issued for extinguishment of loan receivable in connection with business combination
  $ 155     $ -  
Common stock issued in connection with business combination
  $ 600     $ 155,232  
 

 
F-6

 
 
 
Atrinsic is a direct marketing company based in the United States. Atrinsic has two main service offerings. Transactional services and Subscription services. Transactional services offers full service online marketing and distribution services which are targeted and measurable online campaigns and programs for marketing partners, corporate advertisers, or their agencies, generating qualified customer leads, online responses and activities, or increased brand recognition. Subscription services offer our portfolio of subscription based content applications direct to users working with wireless carriers and other distributors.
 
NOTE 2 - Summary of Significant Accounting Policies
 
Principles of Consolidation
 
The consolidated financial statements include the accounts of all majority and wholly-owned subsidiaries and significant intercompany balances and transactions have been eliminated.
 
The equity method is used to account for investments in entities in which we have an ownership of less than 50% and have significant influence over the operating and financial policies of the affiliate.
 
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, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions.
 
Segment Reporting
 
The Company has determined it operates in one operating segment. Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company in deciding how to allocate resources and in assessing performance. The business model is centered around the monetization of user activities either online, mobile, or other. The Company monetizes that activity on either a subscription basis (i.e. Subscription Services) or on a transactional basis (i.e. Network) largely at the discretion of the Chief Operating Decision Maker and discrete financial information by source of monetization is not available.
 
Foreign Currency Translation
 
The Company has a wholly owned subsidiary based in Canada which is included in the Company’s consolidated financial statements. The subsidiary’s financials are reported in Canadian dollars and translated in accordance with FASB Accounting Standards Codification (“ASC”) 830. Assets and liabilities for these foreign operations are translated at the exchange rate in effect at the balance sheet date, and income and expenses are translated at average exchange rates prevailing during the period. We include accumulated net translation adjustments in stockholders’ equity as a component of accumulated other comprehensive loss.
 
Cash and Cash Equivalents
 
  The Company considers all highly liquid instruments purchased with a maturity of less than three months to be cash equivalents. The carrying amount of cash equivalents approximates fair value because of the short-term maturity of these instruments.
 
Accounts Receivable and Related Allowances
 
The Company maintains allowances for doubtful accounts for estimated losses which may result from the inability of its customers to make required payments. The Company bases its allowances on the likelihood of recoverability of accounts receivable by customer, based on past experience, the age of the accounts receivable balance, the credit quality of the Company’s customers, and, taking into account current collection trends. If specific customer circumstances change or industry trends worsen beyond the Company’s estimates, the Company would be required to increase its  allowances for doubtful accounts. Alternatively, if trends improve beyond the Company’s estimates, the Company would be required to decrease its allowance for doubtful accounts. The Company’s estimates are reviewed periodically, and adjustments are reflected through bad debt expense in the period they become known. Changes in the Company’s bad debt experience can materially affect its results of operations.

 
F-7

 

Goodwill and Intangible Assets
 
 Goodwill represents the excess of cost over fair value of net assets of businesses acquired. In accordance with ASC 350 formerly Statement of Financial Accounting Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”, the value assigned to goodwill and indefinite lived intangible assets is not amortized to expense, but rather it is evaluated at least on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value. If the fair value of an indefinite lived intangible is less than its carrying amount, an impairment loss is recorded. Fair value is determined based on discounted cash flows, market multiples or appraised values as appropriate. Discounted cash flow analysis requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about the Company’s businesses and their prospects, or changes in market conditions, could result in an impairment charge. Some of the more significant estimates and assumptions inherent in the intangible asset valuation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory trends.
 
The Company has determined that there was an impairment of the carrying value of goodwill as a result of completing its annual impairment analysis as of December 31, 2009. The results of this review and impact of the impairment are more fully described in Note 7 - “Goodwill and Intangible Assets”.
 
Intangible assets subject to amortization primarily consist of customer lists, trade names and trademarks, and restrictive covenants that were acquired.  The intangible asset values assigned to the identified assets for each acquisition were generally determined based upon the expected discounted aggregate cash flows to be derived over the estimated useful life. The method of amortizing the intangible asset values reflects, based upon the Company’s historical experience, an accelerated rate of attrition in the subscriber database based over the expected life of the underlying subscriber database after considering turnover.  Accordingly, the Company amortizes the value assigned to subscriber database based on the actual depletion of the acquired subscriber database. The Company reviews the recoverability of its finite-lived intangible assets for recoverability whenever events or circumstances indicated that the carrying amount of an asset may not be recoverable. Recoverability is assessed by comparison to associated undiscounted cash flows.

The Company has determined that there was an impairment of finite-lived intangible assets during the fourth quarter of 2009. The results of this assessment are more fully described in Note 7.

 Stock-Based Compensation
 
The Company records stock based compensation in accordance with ASC 718, formerly Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123 (revised 2004). In estimating the grant date fair value of stock option awards and performance based restricted stock, we use the Black Scholes option pricing model and other binomial pricing models where appropriate. The key assumptions for these models to derive fair value include expected term, rate of risk free returns and volatility. Information about our specific award plans can be found in Note 13.
 
Revenue Recognition
 
In accordance with ASC 605 and SEC Staff Accounting Bulletin 104, the Company monetizes a portion of its user activities through subscription based sources by providing on-going monthly access to and usage of premium products and services.  In general, customers are billed at standard rates, at the beginning of the month, and revenues are recognized upon receipt of information confirming an arrangement. The Company estimates a provision for refunds, charge-backs, or credits which are recorded as a reduction to revenues. In determining the estimate for refunds and credits, the Company relies upon historical data, contract information and other factors. The estimated provision for refunds can vary from actual results.
 
The Company effectuates its subscription service revenues through a carrier or distributors who are paid a transaction fee for their services. In accordance with ASC subtopic 605-45 “Principal Agent Considerations”,  the Company recognizes as revenues the net amount received from the carrier or distributor, net of their fee.

 
F-8

 

The Company monetizes a portion of its user activities through transactional based services generated primarily from (a) fees earned, primarily on a cost per click (“CPC”) basis, from search syndication services; (b) fees earned for the Company's search engine marketing ("SEM") services; and (c) other fees for marketing services including data and list management services, which can be either periodic or transactional. Fee revenue is recognized in the period that the Company's advertiser customer generates a sale or other agreed-upon action on the Company's affiliate marketing networks or as a result of the Company's SEM services, provided that no significant Company obligations remain, collection of the resulting receivable is reasonably assured, and the fees are fixed or determinable. All transactional services revenues are recognized on a gross basis in accordance with the provisions of ASC Subtopic 605-45, due to the fact that the Company is the primary obligor, and bears all credit risk to its customer, and publisher expenses that are directly related to a revenue-generating event are recorded as a component of 3rd party Media Cost.
 
Accumulated Other Comprehensive Loss
 
Comprehensive  loss consists of two components, net loss and other comprehensive income (loss). Other comprehensive income (loss) refers to revenue, expenses, gains and losses that under generally accepted accounting principles in the United States, or GAAP, are recorded as an element of shareholders’ equity but are excluded from net income (loss).  The Company’s other comprehensive loss consists of foreign currency translation adjustments from those subsidiaries not using the US dollar as their functional currency and unrealized gains on marketable securities categorized as available for sale.
 
Income Taxes
 
The Company uses the asset and liability method of financial accounting and reporting for income taxes required by ASC 740, formerly Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”. Under ASC 740, deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.

We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized.
 
Effective January 1, 2007, the Company adopted FIN No. 48, “Accounting for Uncertainty in Income Taxes” subsequently codified under ASC 740-10-25 which resulted in no material adjustment in the liability for unrecognized tax benefits. The Company classifies interest expense and penalties related to unrecognized tax benefits as income tax expense. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with this Interpretation is a two-step process. The first step is recognition, in which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the largest amount of benefit that is more likely than not to be sustained.


Fair Value Measurements

We apply the fair value measurement guidance of ASC 820 for our financial assets and liabilities that are required to be measured at fair value and for our nonfinancial assets and liabilities that are not required to be measured at fair value on a recurring basis, including goodwill and intangible assets. The measurement of fair value requires the use of techniques based on observable and unobservable inputs. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The inputs create the following fair value hierarchy:

•       Level 1 —       Quoted prices for identical assets or liabilities in active markets.   

•       Level 2 —       Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations where inputs are observable or where significant value drivers are observable.
       
•       Level 3 —       Assets or liabilities where inputs are unobservable to third parties.  

When available, we use quoted market prices for the same or similar instruments to determine the fair value of our assets and liabilities and classify such items in Level 1 or Level 2.  In some cases, and where observable inputs are not available, we use unobservable inputs to measure fair value and classify such items in Level 3.

 
F-9

 
Reclassification
 
Certain amounts reported in prior years have been reclassified to conform to the current year presentation.
 
NOTE 3 – Purchase of the Assets of ShopIt

On December 2, 2008 the Company entered into a Marketing Services and License Agreement (the “Agreement”) with ShopIt.  Under the Agreement the Company performed certain marketing and administrative services for ShopIt and distributed proprietary and third party advertisements through Shopit.com and its social media advertising network. The Agreement provided ShopIt with a revenue share of all leads monetized by the Company. Under the Agreement, the Company made periodic advance payments and made incremental advances to ShopIt to support continued marketing and product development.

On July 31, 2009, the Company entered into an Asset Purchase Agreement (“APA”) with ShopIt.com pursuant to which the Company acquired certain net assets from ShopIt.com, including but not limited to software, trademarks and certain domain names. The Company purchased ShopIt to be the foundation of its e-commerce platform and a distribution point for its social media application. In consideration for the assets, the Company at the closing cancelled $1.8 million in aggregate principal amount of indebtedness owed by ShopIt to the Company, paid to ShopIt $450,000 and issued 380,000 shares of the Company’s common stock, of which 180,000 shares were distributed to certain secured debt-holders of ShopIt and 200,000 shares were placed in escrow to be available in July 2010 or upon finalization of the opening balance sheet. Of the $1.8 million of indebtedness owed by ShopIt, $1.1 million related to a marketing agreement between the Company and ShopIt and $640,000 of debt was purchased at a discount from ShopIt’s debt-holders’ prior to entering into the APA. The Company purchased the $640,000 debt for $480,000 in cash and 80,000 shares of the Company’s stock. The debt-holder share consideration for both the 180,000 and the 80,000 shares, issued to debt-holders, are subject to put options at $2 per share which were valued at fair market value using an option pricing model, recorded as a liability and marked to market through earnings each accounting period. The put options are exercisable at any time during the 30 day period commencing on the date which is twelve months following the closing date of the APA and the debt Assignment Agreements as applicable. The put options are recorded in other current liabilities on the Consolidated Balance Sheets and classified as Level II in accordance with ASC 820.

The purchase was accounted for as a business combination in accordance with ASC 805 (formerly SFAS No. 141R), “Business Combinations.” Goodwill of $1.1 million was recorded as a result of the acquisition and all acquisition costs are recorded in the Consolidated Statement of Operations in the period incurred. The Company has up to one year after the acquisition date to finalize business combination accounting. During the fourth quarter of 2009, the company revised its provisional estimates of the fair market value of the intangible assets of ShopIt it acquired by a $0.3 million reduction of software, a $0.8 million reduction of domain names and a $0.1 million increase for trademarks and trade names, with the offset of $1.1 million recorded as an increase to Goodwill. Revisions were based on a formal evaluation conducted by management in the fourth quarter of 2009.

The table below shows the fair value of the consideration paid in connection with the Asset Purchase Agreement:

Closing payment
  $ 450  
Pre existing cash advances to ShopIt
    1,175  
Extinguishment of loan receivable by ShopIt
    480  
Equity instruments (380,000 shares at closing )
    414  
Equity instruments (80,000 shares in connection with prior period consideration)
    74  
Put options (180,000 shares at closing)
    186  
Put options (80,000 shares in connection with prior period consideration)
    81  
         
Total consideration
  $ 2,860  

 
F-10

 
 

Goodwill
  $ 1,052  
Software, estimated useful life - 5 yrs
    705  
Domain names
    196  
Trademarks and Trade names
    907  
         
Estimated fair value of assets acquired
  $ 2,860  

At December 31, 2009, all the Goodwill from the acquisition of ShopIt was impaired as part of the year end impairment analysis (see footnote 7).

The Company has not presented the pro forma effect of the ShopIt acquisition because there is insufficient continuity of the acquired entity's operations prior to and after the transaction and because of the limited activity and deminimus operations of ShopIt. The Company believes that pro forma financial information involving ShopIt is immaterial to an understanding of future operations of the Company.

NOTE 4 – Investments and Advances

Joint Venture with Visionaire and Mango Networks

On July 30, 2008, the Company entered into an agreement to launch online and mobile marketing services and offer the Company’s mobile products in the Indian market.  Under the agreement, the Company owns 19% of the Joint Venture and is entitled to one of three seats on the Board of Directors. The Company is required to pay up to $325,000 in return for Compulsory Convertible Debentures which can be converted to common stock at any time, at the Company’s sole discretion. The Company paid $225,000 of the $325,000 it was required to pay and subsequently recorded, at December 31, 2009, an other-than-temporary impairment for the $225,000 paid. The Company is in the process of dissolving the Joint Venture called Mango Networks and will not be required to make the remaining $100,000 payment.
 
Investment in The Billing Resource, LLC

On October 30, 2008, the Company acquired a 36% non-controlling interest in The Billing Resource, LLC (“TBR”). TBR is an aggregator of fixed telephone line billing, providing alternative billing services to the Company and unrelated third parties. The Company contributed $2.2 million in cash on formation and provided an additional $0.9 million of working capital advances in 2009 to support near term growth. As of December 31, 2009, the Company received a distribution $1.9 million from TBR. As of December 31, 2009 the Company’s net investment in TBR totals $1.4 million and is included in Investments, Advances and Other Assets on the accompanying  Consolidated Balance Sheet.

In addition, the Company has an operating agreement with TBR whereby TBR provides billing services to the Company and its customers.  The agreement reflects transactions in the normal course of business and was negotiated on an arm’s length basis.

The Company records its investment in TBR under the equity method of accounting and as such presents its prorata share of the equity in earnings and losses of TBR within its quarterly and year end reported results. The Company recorded $59,000 as equity in income for the year ended December 31, 2009.