10-Q 1 v239334_10q.htm 10-Q Unassociated Document

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

FORM 10-Q
(Mark One)
x
Quarterly Report Pursuant to Section13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011 or

¨
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from __________ to __________
Commission File Number: 001-12555
 
  
ATRINSIC, INC
(Exact name of registrant as specified in its charter)
 
Delaware
 
06-1390025
(State or other jurisdiction of
 
(I.R.S. Employer Identification No.)
incorporation or organization)
   

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)
 
 
(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and 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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date 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 x No ¨
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 Exchange Act).
Yes ¨ No x
As of November 8, 2011, the Company had 7,205,719 shares of Common Stock, $0.01 par value, outstanding, which includes 681,509 shares held in treasury.

 
 

 

Table of Contents

   
Page
     
PART I
FINANCIAL INFORMATION
 
     
Item 1
Financial Statements
3
     
Item 2
Management’s Discussion and Analysis of Financial Condition and Results of Operations
19
     
Item 3
Quantitative and Qualitative Disclosures about Market Risk
29
     
Item 4
Controls and Procedures
29
     
PART II
OTHER INFORMATION
30
     
Item 1A
Risk Factors
30
     
Item 6
Exhibits
38

 
[2]

 

Item1. Financial Statements

ATRINSIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

   
As of
   
As of
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
   
(Unaudited)
       
ASSETS
           
Current Assets
           
Cash and cash equivalents
  $ 1,998     $ 6,319  
Accounts receivable, net of allowance for doubtful accounts of $849 and $1,168
    5,297       4,994  
Income tax receivable
    81       437  
Asset held for sale
    787       -  
Prepaid expenses and other current assets
    900       565  
                 
Total Current Assets
    9,063       12,315  
                 
PROPERTY AND EQUIPMENT, net of accumulated depreciation of $2,107 and $1,813
    2,484       2,692  
INTANGIBLE ASSETS, net of accumulated amortization of $3,027 and $3,813
    1,380       3,083  
DEFERRED TAX ASSET
    278       276  
INVESTMENTS, ADVANCES AND OTHER ASSETS
    869       976  
                 
TOTAL ASSETS
  $ 14,074     $ 19,342  
                 
LIABILITIES AND EQUITY
               
Current Liabilities
               
Accounts payable
  $ 5,231     $ 4,470  
Accrued expenses
    6,799       5,172  
Convertible notes
    4,020       -  
Derivative liability
    1,883       -  
Deferred tax liability
    347       347  
Deferred revenues and other current liabilities
    542       274  
                 
Total Current Liabilities
    18,822       10,263  
                 
OTHER LONG TERM LIABILITIES
    903       907  
                 
TOTAL LIABILITIES
    19,725       11,170  
                 
COMMITMENTS AND CONTINGENCIES (See Note 15)
    -       -  
                 
STOCKHOLDERS' EQUITY
               
Common stock - par value $0.01, 100,000,000 shares authorized, 7,022,289 and 6,964,125 shares issued at September 30, 2011 and December 31, 2010, respectively; and, 6,340,780 and 6,282,616 shares outstanding at September 30, 2011 and December 31, 2010, respectively.
    70       70  
Additional paid-in capital
    181,462       181,087  
Accumulated other comprehensive income
    32       42  
Common stock, held in treasury, at cost, 681,509 shares at September 30, 2011 and December 31, 2010.
    (4,981 )     (4,981 )
Accumulated deficit
    (182,234 )     (168,046 )
                 
Total Stockholders' Equity
    (5,651 )     8,172  
                 
TOTAL LIABILITIES AND EQUITY
  $ 14,074     $ 19,342  
  
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
 
 
[3]

 

ATRINSIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(Dollars in thousands, except per share data)

   
 
Three Months Ended
   
Nine Months Ended
 
   
 
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Subscriptions
  $ 2,496     $ 4,261     $ 9,495     $ 15,234  
Transactional services
    9,830       4,916       16,157       16,956  
   
                               
NET REVENUE
    12,326       9,177       25,652       32,190  
   
                               
OPERATING EXPENSES
                               
Cost of media – 3rd party  
    9,208       4,589       16,119       17,943  
Content costs
    1,997       1,831       6,210       5,689  
Product and distribution  
    1,799       2,565       6,529       8,197  
Selling and marketing
    793       938       2,908       3,225  
General, administrative and other operating  
    1,893       2,597       5,720       7,538  
Depreciation and amortization
    233       325       640       972  
Impairment of intangible assets  
    1,421       -       1,421       -  
                                 
   
    17,344       12,845       39,547       43,564  
                                 
LOSS FROM OPERATIONS
    (5,018 )     (3,668 )     (13,895 )     (11,374 )
                                 
OTHER (INCOME) EXPENSE
                               
Interest income and dividends
    (0 )     (4 )     (2 )     (9 )
Interest expense, net
    (550 )     1       619       2  
Other expense (income)
    0       (77 )     (384 )     (87 )
 
                               
      (550 )     (80 )     233       (94 )
 
                               
LOSS BEFORE TAXES AND EQUITY IN (EARNINGS) LOSS OF INVESTEE
    (4,468 )     (3,588 )     (14,128 )     (11,280 )
 
                               
INCOME TAXES
    45       35       107       208  
 
                               
EQUITY IN (EARNINGS) LOSS OF INVESTEE, AFTER TAX
    9       13       (47 )     74  
 
                               
NET LOSS ATTRIBUTABLE TO ATRINSIC, INC.
  $ (4,522 )   $ (3,636 )   $ (14,188 )   $ (11,562 )
 
                               
NET LOSS PER SHARE ATTRIBUTABLE TO ATRINSIC COMMON STOCKHOLDERS:
                               
Basic
  $ (0.72 )   $ (0.70 )   $ (2.25 )   $ (2.22 )
Diluted
  $ (0.72 )   $ (0.70 )   $ (2.25 )   $ (2.22 )
 
                               
WEIGHTED AVERAGE SHARES OUTSTANDING:
                               
Basic
    6,298,662       5,216,274       6,314,795       5,214,889  
Diluted
    6,298,662       5,216,274       6,314,795       5,214,889  
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements

 
[4]

 

 
ATRINSIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(Dollars in thousands)

   
Nine Months Ended
 
   
September 30,
 
   
2011
   
2010
 
             
Cash Flows From Operating Activities
           
Net loss
  $ (14,188 )   $ (11,562 )
Adjustments to reconcile net loss to net cash used in operating activities:
               
Allowance for doubtful accounts  
    (319 )     (20 )
Depreciation and amortization
    640       972  
Impairment of intangible assets  
    1,421       -  
Stock-based compensation expense
    285       860  
Deferred income taxes  
    -       37  
Equity in loss (earnings) of investee
    (47 )     74  
Interest expense relating to debt discount and derivative liability losses  
    648       -  
Changes in operating assets and liabilities:
               
Accounts receivable  
    15       1,310  
Prepaid income tax
    334       896  
Prepaid expenses and other assets  
    234       1,765  
Accounts payable
    766       (1,993 )
Deferred revenue  
    148       -  
Other, principally accrued expenses
    2,313       (5,306 )
Net cash used in operating activities
    (7,750 )     (12,967 )
                 
Cash Flows From Investing Activities
               
Cash received from investee
    -       360  
Capital expenditures  
    (911 )     (41 )
                 
Net cash provided by (used in) investing activities
    (911 )     319  
                 
Cash Flows From Financing Activities
               
Proceeds from issuance of convertible notes and warrants  
    4,715       -  
Financing costs for the convertible notes and warrants
    (446 )     -  
Proceeds from exercise of stock options and issuance of common stock  
    90       -  
Purchase of common stock held in treasury
    -       (9 )
Net cash provided by (used in) financing activities
    4,359       (9 )
                 
Effect of exchange rate changes on cash and cash equivalents  
    (19 )     (7 )
                 
Net Decrease In Cash and Cash Equivalents
    (4,321 )     (12,664 )
Cash and Cash Equivalents at Beginning of Year
    6,319       16,913  
Cash and Cash Equivalents at End of Period
  $ 1,998     $ 4,249  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
               
Cash refunded for taxes
  $ 241     $ 696  
Cash paid for interest
  $ -     $ 2  
Reduction of proceeds from issuance of convertible notes (see Note 17)
  $ 535     $ -  
Non-cash financing costs
  $ 51     $ -  
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.

 
[5]

 
 
ATRINSIC, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY AND COMPREHENSIVE LOSS
(UNAUDITED)
For the Nine Months Ended September 30, 2011
(Dollars in thousands, except per share data)

                            
Accumulated
             
               
Additional
         
Other
             
   
Comprehensive
   
Common Stock
   
Paid-In
   
(Accumulated
   
Comprehensive
   
Treasury Stock
   
Total
 
   
Loss
   
Shares
   
Amount
   
Capital
   
Deficit)
   
Income
   
Shares
   
Amount
   
Equity
 
                                                       
Balance at January 1, 2011
    -       6,964,125     $ 70     $ 181,087     $ (168,046 )   $ 42       681,509     $ (4,981 )   $ 8,172  
Net loss
  $ (14,188 )     -       -       -       (14,188 )     -       -       -       (14,188 )
Foreign currency translation adjustment
    (10 )     -       -       -       -       (10 )     -       -       (10 )
Comprehensive loss
  $ (14,198 )     -       -       -       -       -       -       -       -  
Stock based compensation expense
    -               -       285       -       -       -       -       285  
Issuance of common stock
            58,164               90                                       90  
Balance at September 30, 2011
    -       7,022,289     $ 70     $ 181,462     $ (182,234 )   $ 32       681,509     $ (4,981 )   $ (5,651 )
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements

 
[6]

 

ATRINSIC, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1 - Basis of Presentation

The accompanying Condensed Consolidated Balance Sheet as of  September 30, 2011, the Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2011 and 2010, and the Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010 are unaudited, but in the opinion of management include all adjustments necessary for the fair presentation of financial position, the results of operations and cash flows for the periods presented and have been prepared in a manner consistent with the audited financial statements for the year ended December 31, 2010. Results of operations for interim periods are not necessarily indicative of annual results. These financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2010, on Form 10-K filed on April 7, 2011.

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 and the associated allowances for refunds and credits, 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 impairment of intangible assets, pre-acquisition contingencies, income taxes, convertible notes, warrants and derivative liabilities 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.

Atrinsic, Inc. (the “Company”) is organized into two operating segments: Subscription Services and Transactional Services. See Note 16 – Business Segments, for further information about the Company’s operating segments.

On December 2, 2010, the Company effected a 1-for-4 reverse stock split of its common stock. Unless clearly indicated in this report or other sections of the Form 10-Q to the contrary, all references to stock price or number of shares of common stock contained in this report (whether prior to, on or after December 2, 2010) are presented on an “as adjusted” basis to reflect the effect of the reverse stock split.

Certain prior year amounts have been reclassified to conform to the current year presentation.

Note 2 - Going Concern and Liquidity Considerations

The Company’s consolidated financial statements are prepared using accounting principles generally accepted in the United States applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The accompanying historical consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

The assessment of the Company’s ability to continue as a going concern was made by management considering, among other factors: (i) the Company’s current levels of expenditures, including subscriber acquisition costs, operating expense, including product development, and overhead, (ii) the Company’s ongoing working capital needs, (iii) the uncertainty concerning the outcome of future financings, (iv) the Company’s history of losses and use of cash for operating activities (v) outstanding balance of cash and cash equivalents of $2.0 million at the end of the quarter, and (vi) the Company’s budgets and financial projections of future operations, including the likelihood of achieving operating profitability without the need for additional financing.

For periods subsequent to September 30, 2011, the Company expects to continue to incur losses and negative cash flows as it continues to incur expenditures to develop the Kazaa digital music service, acquire subscribers for the Kazaa service, and is not able to reduce other operating expenses and overhead sufficiently to a level in line with its level of revenues.  If the Company is unable to increase revenues sufficiently or decrease its expenditures to a sustainable level, its financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about the Company’s ability to continue as a going concern.

For the nine months ended September 30, 2011, the Company incurred a net loss of $14.2 million, and used $7.8 million of cash in operations.

 
[7]

 
 
Based on current financial projections, management believes the continuation of the Company as a going concern is primarily dependent on its ability to, among other factors: (i) consummate a suitable financing, or obtain financing from the sale of its assets or lines of business , (ii) scale the Kazaa subscriber base to a level where the monthly revenue generated from the Company’s subscriber base exceeds subscriber acquisition costs, net of expenses required to operate Kazaa, (iii) eliminate or reduce operating and overhead expenditures to a level more in line with the Company’s revenue (iv) improve utilization of the Kazaa digital music service and improve lifetime values (LTVs) of subscribers to that service, (v) acquire profitable subscribers to the Kazaa digital music service at cost effective rates (vi) grow the Company’s search marketing agency revenue base through the addition of new customers or expansion of business with existing customers and, (vii) expand margins in the Company’s search marketing agency and on its affiliate platform.

While the Company addresses these operating matters, it must continue to meet expected near-term obligations, including normal course operating cash requirements and costs associated with developing and operating the Kazaa digital music service, as well as funding overhead and the working capital needs of the Company’s other businesses.  If the Company is not able to obtain sufficient funds through future financings, or if the Company experiences adverse outcomes with respect to its operational forecasts, the Company’s financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected.

In the near term, the Company is focused on: (i) raising additional debt or equity capital to fund the Company’s cash needs and to finance its longer term growth to further develop the Kazaa business and grow its subscriber base, and (ii) pursuing various means to minimize operating costs and increase cash, including the potential sale of assets.  The Company cannot provide assurance that it will be able to realize cost reductions in the Company’s operations, or that it can obtain additional cash through asset sales or the issuance of equity or raising debt. If the Company is unsuccessful in its efforts it will be required to further reduce the Company’s operations or it may be required to cease certain or all of its operations in order to offset the lack of available funding.

Note 3Investments and Advances

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.  As of September 30, 2011, the Company’s net investment in TBR totals $0.5 million and is included in Investments, Advances and Other Assets on the accompanying Condensed 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 pro-rata share of the equity in earnings and losses of TBR within its quarterly and year end reported results. The Company recorded equity in earnings of $47,000 for the nine months ended September 30, 2011 and equity in loss of $74,000 for the nine months ended September 30, 2010.

Note 4Kazaa
 
Kazaa is a subscription-based digital music service that gives users unlimited access to millions of CD-quality tracks. For a monthly fee users can stream and download unlimited music files and play those files on multiple computers and mobile devices.  Unlike other music services that charge each 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. Consumers are billed for this service on a monthly recurring basis through a credit card, or mobile device. Royalties are paid to the rights’ holders for licenses to the music utilized by this digital service. Atrinsic and Brilliant Digital Entertainment, Inc. (“Brilliant Digital”) jointly offer the Kazaa digital music service pursuant to a Marketing Services Agreement and a Master Services Agreement between the two companies, each entered into effective as of July 1, 2009.
 
Under the Marketing Services Agreement, Atrinsic is responsible for marketing, promotional, and advertising services in respect of the Kazaa business. Pursuant to the Master Services Agreement, Atrinsic provides services related to the operation of the Kazaa business, including billing and collection services and the operation of the Kazaa online storefront. Brilliant Digital is obligated to provide certain other services with respect to the Kazaa business, including licensing the intellectual property underlying the Kazaa business to Atrinsic, obtaining all licenses to the content offered as part of the Kazaa business and delivering that content to subscribers. As part of the agreements, Atrinsic is required to make advance payments and expenditures in respect of certain expenses incurred in order to operate the Kazaa business. Since inception on July 1, 2009, and through September 30, 2011, the Company has incurred $17.4 million of cumulative net losses, net of recouped funds in order to support the development of the Kazaa brand. 

 
[8]

 

Also in accordance with the original Marketing Service Agreement and Master Service Agreement, Atrinsic and Brilliant Digital were to share equally in the “Net Profit” generated by the Kazaa music subscription service after all of the Company’s costs and expenses have been recouped.  For the nine months ended September 30, 2011 and 2010, the Company has included in its statement of operations, Kazaa revenue of $7.1 million, net of deferred revenue, and Kazaa revenue of $8.4 million, respectively, and expenses incurred for the Kazaa music service of $12.7 million and $11.5 million, respectively, net of reimbursements from Brilliant Digital. Kazaa revenue and expenses are recorded as part of subscription services segment.

Effective January, 2011, in order to more accurately report revenue based upon the effective date of customer subscriptions, the Company began recognizing subscription revenue related to the Kazaa business, net of deferred revenue.

On October 13, 2010, Atrinsic entered into amendments to its existing Marketing Services Agreement and Master Services Agreement with Brilliant Digital and entered into an agreement with Brilliant Digital to acquire all of the assets of Brilliant Digital that relate to its Kazaa subscription based music service business.

Among other things, the amendments extend the term of each of the Marketing Services Agreement and Master Services Agreement from three years to thirty years, provide Atrinsic with an exclusive license to the Kazaa trademark in connection with Atrinsic’s services under the agreements, and modify the Kazaa digital music service profit share payable to Atrinsic under the agreements from 50% to 80%. In addition, the amendments remove Brilliant Digital’s obligation to repay up to $2.5 million of Atrinsic’s advances and expenditures which are not otherwise recovered from Kazaa generated revenues and remove the $5.0 million cap on expenditures that Atrinsic was required to advance in relation to the operation of the Kazaa business. As consideration for entering into the amendments, Atrinsic issued 1,040,358 unregistered shares of its common stock to Brilliant Digital on October 13, 2010.  The issuance of these shares resulted in the Company recording an intangible asset of $1.4 million which is being amortized over 10 years.

The amendments to the Marketing Services Agreement and Master Services Agreement are part of a broader transaction between Atrinsic and Brilliant Digital pursuant to which Atrinsic will acquire all of the assets of Brilliant Digital that relate to its Kazaa digital music service business in accordance with the terms of an asset purchase agreement entered into between the parties. The purchase price for the acquired assets includes the issuance by Atrinsic of an additional 1,781,416 shares of its common stock at the closing of the transactions contemplated by the asset purchase agreement as well as the assumption of certain liabilities related to the Kazaa business. The closing of the transactions contemplated by the asset purchase agreement will occur when all of the assets associated with the Kazaa business, including the Kazaa trademark and associated intellectual property, as well as Brilliant Digital’s content management, delivery and customer service platforms and licenses with third parties, have been transferred to Atrinsic. The closing of the transactions contemplated by the asset purchase agreement is subject to receipt of all necessary third party consents as well as other customary closing conditions. At the closing of the transactions contemplated by the asset purchase agreement, Atrinsic has agreed to appoint two individuals to be selected by Brilliant Digital to serve on Atrinsic’s Board of Directors. In addition, at the closing, each of the Marketing Services Agreement and Master Services Agreement will terminate.

Note 5 – Convertible Notes and Warrants

On May 31, 2011, the Company entered into a Securities Purchase Agreement, pursuant to which it sold Notes and issued Warrants (defined below) to certain buyers (the “Buyers”).

Pursuant to the terms of the Securities Purchase Agreement, the Company sold to the Buyers senior secured convertible notes in the aggregate original principal amount of $5,813,500 (the “Notes”), which Notes are convertible into shares of the Company’s common stock.  The Notes were issued with an original issue discount of approximately 9.1%, and the aggregate proceeds of the Notes were $5,285,000, before certain financing costs of $35,000. The Notes are not interest bearing, unless the Company is in default on the Notes, in which case the Notes carry an interest rate of 18% per annum.

The Notes are initially convertible into shares of common stock at a conversion price of $2.90 per share, provided that if the Company makes certain dilutive issuances (with limited exceptions), the conversion price of the Notes will be lowered to the per share price paid in the applicable dilutive issuance. The Company is required to repay the Notes in six equal monthly installments commencing on December 31, 2011 and ending on May 31, 2012, either in cash or in shares of its common stock at the option of the Company. If the Company chooses to utilize shares of its common stock for all or part of the payment, it must make an irrevocable decision to use shares 23 trading days prior to the installment payment date, and the value of the Company’s shares will be equal to the lower of the conversion price then in effect or 85% of the arithmetic average of the closing bid prices of its common stock during the 20 trading day period prior to payment of the installment amount (the “Installment Conversion Price”). If the Company chooses to make an installment payment in shares of common stock, it must make a pre-installment payment of shares (the “Pre-Installment Shares”) to the Note holder 21 trading days prior to the applicable installment date based on the value of its shares equal to the lower of the conversion price then in effect or 85% of the arithmetic average of the closing bid prices of its common stock during the 20 trading day period prior to payment of the installment amount. On the installment date, to the extent the Company owes a Note holder additional shares in excess of the Pre-Installment Shares to satisfy the installment payment, the Company will issue such Note holder additional shares, and to the extent it has issued excess Pre-Installment Shares, such shares will be applied to future payments. If an event of default occurs under the Notes, each Buyer may require the Company to redeem its Note in cash at the greater of up to 110% of the unconverted principal amount or 110% of the greatest equity value of the shares of common stock underlying the Notes from the date of the default until the redemption is completed. The conversion price of each Note is subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. The convertibility of each Note may be limited if, upon conversion, the holder or any of its affiliates would beneficially own more than 4.9% or 19.9% (as applicable) of the Company’s common stock.

 
[9]

 

Brilliant Digital, which prior to the transaction held approximately 16.5% of the Company’s issued and outstanding common stock, purchased Notes in the aggregate principal amount of $2,200,000.

Pursuant to the terms of the Purchase Agreement, the Company also agreed to issue to each Buyer warrants to acquire shares of common stock, in the form of three warrants: (i) “Series A Warrants,” (ii) “Series B Warrants” and (iii) “Series C Warrants” (collectively, the “Warrants”).

The Series B Warrants are exercisable immediately after issuance and expire nine months after the date the Company obtains shareholder approval (discussed below). The Series B Warrants provide that the holders are initially entitled to purchase an aggregate of 1,002,329 shares at an initial exercise price of $2.93 per share. If the Company makes certain dilutive issuances (with limited exceptions), the exercise price of the Series B Warrants will be lowered to the per share price paid in the applicable dilutive issuance. The number of shares underlying the Series B Warrants will adjust whenever the exercise price adjusts, such that at all times the aggregate exercise price of the Series B Warrants will be $2,936,824.  To the extent the Company enters into a fundamental transaction (as defined in the Series B Warrants and which include, without limitation, the Company entering into a merger or consolidation with another entity, selling all or substantially all of its assets, or a person acquiring 50% of the Company’s common stock), the Company has agreed to purchase the Series B Warrants from the holders at their Black-Scholes value (if a holder so elects to have its Series B Warrant so purchased).  If our common stock trades at a price at least 200% above the Series B Warrants exercise price for a period of 10 trading days at any time after the Company obtains shareholder approval (discussed below), the Company may force the exercise of the Series B Warrants if it meets certain conditions.

The Series A and Series C Warrants are exercisable immediately after issuance and have a five year term. The Series A Warrants provide that the holders are initially entitled to purchase an aggregate of 2,004,656 shares at an initial exercise price of $2.90 per share. The Series C Warrants provide that the holders are initially entitled to purchase an aggregate of 952,212 shares at an initial exercise price of $2.97 per share. If on the expiration date of the Series B Warrants, a holder of such warrant has not exercised such warrant for at least 80% of the shares underlying such warrant, we have the right to redeem from such holder its Series C Warrant for $1,000 under certain circumstances.  If the Company makes certain dilutive issuances (with limited exceptions), the exercise price of the Series A and Series C Warrants will be lowered to the per share price paid in the applicable dilutive issuance. The number of shares underlying the Series A Warrants and the Series C Warrants will adjust whenever the exercise price adjusts, such that at all times the aggregate exercise price of the Series A Warrants and Series C Warrants will be $5,813,502 and $2,828,070, respectively. To the extent the Company enters into a fundamental transaction (as defined in the Series A and Series C Warrants and which include, without limitation, the Company entering into a merger or consolidation with another entity, selling all or substantially all of its assets, or a person acquiring 50% of the Company’s common stock), the Company has agreed to purchase the Series A and Series C Warrants from the holder at their Black-Scholes value (if a holder so elects to have its Series A Warrant or Series C Warrant so purchased).

The exercise price of all the Warrants is subject to adjustment in the case of stock splits, stock dividends, combinations of shares and similar recapitalization transactions. The exercisability of the Warrants may be limited if, upon exercise, the holder or any of its affiliates would beneficially own more than 4.9% or 19.9% (as applicable) of the Company’s common stock. The Notes may not be converted and the Warrants may not be exercisable if the total number of shares that would be issued would exceed 19.99% of our common stock outstanding on the date the Purchase Agreement was executed prior to our receiving shareholder approval (as discussed below).

Atrinsic and its subsidiaries, New Motion Mobile, Inc. and Traffix, Inc., entered into a security agreement (“Security Agreement”) with the Buyers pursuant to which the Company granted each of the Buyers a security interest in all of its assets securing the Company’s obligations under the Notes. In addition, New Motion Mobile, Inc. and Traffix, Inc. executed guaranties (each, a “Guaranty”) with each Buyer pursuant to which such subsidiaries guarantee our obligations under the Notes.

The Company also entered into a registration rights agreement (“Registration Rights Agreement”) with the Buyers pursuant to which, among other things, it agreed to register the resale of the shares of common stock underlying the Notes and Warrants. The Company agreed to file a registration statement by June 30, 2011 and to the extent it fails to file the registration statement on a timely basis or if the registration statement is not declared effective within 90 days after the closing of the transaction (120 days if reviewed by the Securities and Exchange Commission), the Company agreed to make certain payments to the Buyers. The Company filed a registration statement on Form S-3 with the Securities Exchange Commission registering for re-sale the common stock underlying the Notes and Warrants on July 1, 2011, which was subsequently declared effective on September 30, 2011.

 
[10]

 
 
In the Purchase Agreement, the Company has agreed to, among other things, (i) subject to certain exceptions, not issue any securities for a period of beginning on May 31, 2011 to the date that is 30 trading days from the date on which the resale by the Buyers of all registrable securities (as defined in the Registration Rights Agreement) is covered by one or more registration statements, (ii) not to enter into a variable rate transaction at any time while the Notes are outstanding and (iii) for a period of one year from the date of the Purchase Agreement, to allow the Buyers to participate in future financing transactions

The Company engaged Wedbush Securities, Inc. to act as placement agent, on a reasonable best efforts basis in connection with the offering and in addition to a placement fee, received five year warrants to purchase 41,234 shares of the Company’s common stock.  The warrant is exercisable immediately at an exercise price of $2.90 per share.

The Company recorded the issuance of the convertible note payable, original issue discount, net of additional debt discount, in its balance sheet and is amortizing the debt discount using the effective interest method over the 12-month term of the Notes.  The table below summarizes the transactions and components related to this convertible notes financing:
 
   
Convertible
   
Original
   
Debt
   
Net Value of
 
(in thousands)
 
Notes Payable
   
Issue Discount
   
Discount
   
Convertible Notes Payable
 
Issuance of notes on May 31, 2011
  $ 5,814     $ (529 )   $ (2,308 )   $ 2,977  
Accretion: June - September 2011
    -       194       849       1,043  
Value as of September 30, 2011
  $ 5,814     $ (335 )   $ (1,459 )   $ 4,020  
 
The Company also recorded a derivative liability, representing the fair market value of the Notes’ embedded convertible derivative and the fair market value of the Warrants.  This derivative liability will be marked-to-market each period and any resulting increase or (decrease) in the derivative liability will be recorded as interest expense (income).  As a result of the marked-to-market adjustment, the Company recorded interest expense of $0.6 million during 2011. See Note 11 for further information on the accounting for the derivative liability.

Note 6 – Fair Value Measurements

 U.S. GAAP includes a framework for measuring fair value, which also addresses disclosure requirements for fair value measurements. Fair value is the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value, in this context, should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity. In addition, the fair value of liabilities should include consideration of non-performance risk, including the Company’s own credit risk.

Under the measurement framework, a fair valuation hierarchy for disclosure of the inputs to valuation used to measure fair value has been established. This hierarchy prioritizes the inputs into three broad levels that reflect the degree of subjectivity necessary to determine fair value measurements, as follows.  Level 1 inputs are based on unadjusted quoted prices in active markets for identical assets or liabilities.  Level 2 inputs are based on quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly, through market corroboration, for substantially the full term of the asset or liability.  Level 3 inputs are unobservable inputs and reflect the Company’s estimates of assumptions that market participants would use to measure assets and liabilities at fair value.  The fair values are therefore determined using model-based techniques that include option pricing models and discounted cash flow models. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of September 30, 2011 (unaudited):
 
   
Quoted Prices in
                         
   
Active Markets
   
Significant
   
Significant
             
   
for Identical
   
Unobservable
   
Unobservable
   
Total
   
Total
 
(in thousands)
 
Assets (Level 1)
   
Inputs (Level 2)
   
Inputs (Level 3)
   
Fair Value
   
Gain
 
                               
Derivative liabilities
  $ -     $ -     $ 1,883     $ 1,883     $ 441  

 
[11]

 

The derivative liabilities are measured at fair value using quoted market prices and estimated volatility factors, and are classified within Level 3 of the valuation hierarchy, due to use of an estimate of volatility factors.
 
The carrying amounts of cash equivalents, accounts receivable, accounts payable and accrued expenses are believed to approximate fair value due to the short-term maturity of these financial instruments.

Note 7 - Concentration of Business and Credit Risk

Financial instruments which potentially subject the Company to credit risk consist primarily of cash and cash equivalents and accounts receivable.

Atrinsic is currently utilizing several billing aggregators in order to provide content and billings to the end users of its subscription products. These billing aggregators act as a billing interface between Atrinsic and the carriers that ultimately bill Atrinsic’s end user subscribers. These billing aggregators have not had long operating histories in the U.S. or operations with traditional business models. These companies face a greater business risk in the marketplace, due to a constant evolving business environment that stems from the infancy of the U.S. mobile content industry. In addition, the Company also has customers other than aggregators that represent significant amounts of revenues and accounts receivable.

The table below represents the company’s concentration of business and credit risk by customers and aggregators.
 
   
For The Nine Months Ended
 
    
September 30,
 
   
2011
   
2010
 
             
Revenues
           
Aggregator A
    14 %     19 %
Customer B
    9 %     6 %
Customer C
    27 %     0 %
Other Customers & Aggregators
    50 %     75 %

   
As of
 
   
September 30,
   
December 31,
 
   
2011
   
2010
 
             
Accounts Receivable
 
 
       
Aggregator A
    29 %     44 %
Customer B
    5 %     5 %
Customer C
    30 %     0 %
Other Customers & Aggregators
    36 %     51 %
 
 
[12]

 

Note 8 - Property and Equipment

Property and equipment consists of the following:
 
   
 
Useful Life
   
September 30,
   
December 31,
 
(dollars in thousands)
 
in years
   
2011
   
2010
 
   
                 
Computers and software applications
    3     $ 2,611     $ 1,700  
Leasehold improvements
    10       1,813       1,835  
Building
    40       -       804  
Furniture and fixtures
    7       167       166  
Gross PP&E
            4,591       4,505  
Less: accumulated depreciation
            (2,107 )     (1,813 )
Net PP&E
          $ 2,484     $ 2,692  

Depreciation expense for the nine months ended September 30, 2011 and 2010 totaled $0.4 million and $0.5 million, respectively, and is recorded on a straight line basis.

In the first quarter of 2011, the Company put its building and land up for sale as part of the closing of its Canadian facility.  The net fixed asset value of the building and land has been reclassified as an Asset held for Sale in the Current Assets section of the Balance Sheet and depreciation on the asset was terminated as of December 31, 2010.

Note 9 –Intangibles
 
ASC 360 requires that an entity test for the recoverability of long-lived assets if events or changes in circumstances indicate that the carrying value may not be recoverable.  As a result of significant adverse changes in the business climate, the Company concluded that triggering events had occurred and the Company tested long-lived assets for impairment as of September 30, 2011, and concluded that the carrying value of certain amortizable intangibles may not be recoverable.

The Company assessed the recoverability of the long-lived asset groups classified as held and used by comparing their undiscounted future cash flows to their individual carrying value.  The future undiscounted cash flows associated with certain acquired amortizable intangible assets were determined to be less than the carrying value of such assets.

The Company then determined the fair value of such amortizable intangible assets and recognized an impairment charge of $0.7 million and $3.4 million during the quarter ended September 30, 2011 and December 31, 2010, respectively.

An intangible asset that is not subject to amortization shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired in accordance with ASC 350. The Company concluded that triggering events had occurred and performed impairment test for the intangible assets. The impairment test consisted of a comparison of the fair value of intangible assets with their carrying amount. If the carrying amount of the intangible assets exceed their fair value, an impairment loss shall be recognized in an amount equal to that excess. In valuing the intangible assets, the Company applied the relief from royalty method. This method assumes that the assets have value to the extent that their owner is relieved of the obligation to pay royalties for the benefits received from them. Factors used to determine the fair value of the intangible assets included estimates and assumptions of the Company’s projected revenue, cash flows, operating expenses, weighted average cost of capital, operating ratios and valuation of comparable companies.  These estimates and assumptions are complex and subject to a significant degree of judgment with respect to certain factors including, but not limited to, the cash flows of our long-term operating plans, market and interest rate risk, and risk-commensurate discount rates and cost of capital.

As a result of the impairment analysis, the Company recorded an impairment loss of $0.7 million and $1.5 million during the quarter ended September 30, 2011 and December 31, 2010, respectively, for its indefinite lived intangible assets.
 
 
[13]

 

The carrying amount and accumulated amortization of intangible assets as of September 30, 2011 and December 31, 2010, respectively, are as follows:
 
   
Weighted average
 
Gross Book
   
Accumulated
         
Net Book
 
(dollars in thousands)
 
Useful Life in Years
 
Value
   
Amortization
   
Impairment
   
Value
 
                             
As of September 30, 2011
                           
                             
Indefinite Lived assets
                           
Tradenames
      $ 11     $ -     $ -     $ 11  
    Domain names
        773       -       689       84  
                                     
Amortized Intangible Assets
                                   
Acquired software technology
 
0.4
    1,809       1,809       -       -  
Domain names
 
0.1
    426       426       -       -  
Tradenames
 
5
    805       121       669       15  
Restrictive covenants
 
2.1
    631       568       63       -  
Kazaa Marketing Services Agreement
 
10
    1,373       103       -       1,270  
 
                                   
Total
      $ 5,828     $ 3,027     $ 1,421     $ 1,380  
                                     
As of December 31, 2010
                                   
                                     
Indefinite Lived assets
                                   
Tradenames
      $ 918     $ -     $ 907     $ 11  
Domain names
        1,298       -       525       773  
                                     
Amortized Intangible Assets
                                   
Acquired software technology
 
0.4
    2,516       1,968       531       17  
Domain names
 
0.1
    426       420       -       6  
Tradenames
 
5
    3,966       320       2,841       805  
Customer lists
 
0.1
    582       570       12       -  
Restrictive Covenants
 
2.1
    667       535       34       98  
Kazaa Marketing Services Agreement
 
10
    1,373       -       -       1,373  
                                     
Total
      $ 11,746     $ 3,813     $ 4,850     $ 3,083  

Note 10 - Stock-based compensation

The fair value of share-based awards granted is estimated on the date of grant using the Black-Scholes option pricing model. The key assumptions for this model are expected term, expected volatility, risk-free interest rate, dividend yield and strike price. Many of these assumptions are judgmental and the value of share-based awards is highly sensitive to changes in these assumptions.

During the nine months ended September 30, 2011, the Company granted no stock options and 75,000 restricted stock units. There were 30,000 stock options exercised, 210,000 stock options and 91,000 restricted stock units forfeited.

 
[14]

 

Stock based compensation expense for the three and nine months ended September 30, 2011and 2010 are as follows:
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
(in thousands)
 
2011
   
2010
   
2011
   
2010
 
                         
Product and distribution
  $ 3     $ 23     $ 23     $ 44  
Selling and marketing
    6       11       29       28  
General and administrative and other operating
    24       191       233       788  
                                 
Total
  $ 33     $ 225     $ 285     $ 860  

Note 11- Derivative Liabilities

Accounting Standard Codification “ASC” 815 – Derivatives and Hedging, which provides guidance on determining what types of instruments or embedded features in an instrument issued by a reporting entity can be considered indexed to its own stock for the purpose of evaluating the first criteria of the scope exception in the pronouncement on accounting for derivatives.  These requirements can affect the accounting for the Warrants and Notes issued by the Company.  As the conversion features within, and the detachable warrants issued with the Company’s Notes do not have fixed settlement provisions because their conversion and exercise prices may be lowered if the Company issues securities at lower prices in the future, we have concluded that the instruments are not indexed to the Company’s stock, are to be bifurcated from notes and are to be treated as derivative liabilities.  The derivative liability is booked as a current liability in the Company's balance sheet and will be marked to market each reporting period, with a corresponding entry to interest income or expense, until their respective exercise or extinguishment.

The following table shows the inputs and assumptions used to determine the fair market values of the Warrants and embedded derivative portion of the Notes as of September 30, 2011.  The table also discloses the number of underlying common shares into which the Notes or Warrants can be converted or exercised.
 
   
Series A
   
Series B
   
Series C
   
Convertible Notes
 
   
Warrants
   
Warrants
   
Warrants
   
Imbedded Derivative
 
Stock price
  $ 2.25     $ 2.25     $ 2.25     $ 2.25  
Strike price
  $ 2.90     $ 2.93     $ 2.97     $ 2.90 (1)
Maturity (years)
    4.67       0.42       4.67       0.67  
Risk free interest rate
    0.96 %     0.06 %     0.96 %     0.13 %
Volatility
    65 %     57 %     65 %     54 %
Fair market value of derivative liability (in thousands)
  $ 822     $ 10     $ 53     $ 984 (2)
Underlying Common Shares
    2,004,656       1,002,329       952,212       2,004,656  
 
(1)
Strike price based on original contractual agreement
 
(2)
The convertible note embedded derivative liability is calculated as the full value of the convertible note, using the assumptions above, minus the straight debt and dilution protection value of $5.3 million.

The Company engaged Wedbush Securities, Inc. to act as placement agent, on a reasonable best efforts basis in connection with the offering and in addition to a placement fee, received five year warrants to purchase 41,234 shares of the Company’s common stock.  The warrant is exercisable immediately at an exercise price of $2.90 per share. The fair value of Series D Warrants was $14,000 as of September 30, 2011.

Note 12 – Loss per Share Attributable to Atrinsic, Inc

Basic (loss) earnings per share attributable to Atrinsic, Inc. is computed by dividing reported (loss) earnings by the weighted average number of shares of common stock outstanding for the period. Diluted (loss) earnings per share includes the effect, if any, of the potential issuance of additional shares of common stock as a result of the exercise or conversion of dilutive securities, using the treasury stock method. Potential dilutive securities for the Company include convertible notes, outstanding stock options and warrants.
 
[15]

 
 
The computational components of basic and diluted (loss) earnings per share are as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(dollars in thousands, except per share data)
 
2011
   
2010
   
2011
   
2010
 
EPS Denominator:
                       
Basic weighted average shares
    6,298,662       5,216,274       6,314,795       5,214,889  
Effect of dilutive securities
    -       -       -       -  
Diluted weighted average shares
    6,298,662       5,216,274       6,314,795       5,214,889  
                                 
EPS Numerator (effect on net loss):
                               
Net loss attributable to Atrinsic, Inc.
  $ (4,522 )   $ (3,636 )   $ (14,188 )   $ (11,562 )
Effect of dilutive securities
    -       -       -       -  
Diluted loss attributable to Atrinsic, Inc.
  $ (4,522 )   $ (3,636 )   $ (14,188 )   $ (11,562 )
                                 
Net loss per common share:
                               
Basic weighted average loss attributable to Atrinsic, Inc.
  $ (0.72 )   $ (0.70 )   $ (2.25 )   $ (2.22 )
Effect of dilutive securities
    -       -       -       -  
Diluted weighted average loss attributable to Atrinsic, Inc.
  $ (0.72 )   $ (0.70 )   $ (2.25 )   $ (2.22 )
 
Common stock underlying outstanding options and convertible securities were not included in the computation of diluted earnings per share for the three and nine months ended September 30, 2011 and 2010, because their inclusion would be anti-dilutive when applied to the Company’s net loss per share.

Financial instruments, which may be exchanged for equity securities are excluded in periods in which they are anti-dilutive. The following shares were excluded from the calculation of diluted earnings per share:

Anti-Dilutive EPS Disclosure
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2011
   
2010
   
2011
   
2010
 
                         
Options
    306,550       670,460       306,550       670,460  
Warrants
    4,080,286       78,611       4,080,286       78,611  
Restricted Shares
    -       1,043       -       8,543  
Restricted Stock Units
    97,660       136,122       97,660       136,122  
Convertible Note
    2,004,656       -       2,004,656       -  
 
The per share weighted average exercise prices of the options were $1.92 for the three and nine months ended September 30, 2011 and 2010.  The per share exercise prices of the warrants ranged from $2.90 - $22.00 and $13.76 - $22.00 for the three and nine months ended September 30, 2011 and 2010, respectively.
 
Note 13 - Income Taxes

Income tax expense before equity in (earnings) loss of investee for the nine months ended September 30, 2011 and 2010, was $107,000 and $208,000, respectively and reflects an effective tax rate of (1%) and (2%)  respectively. The Company has provided a valuation allowance against its deferred tax assets because it is more likely than not that such benefits will not be realized by the Company.

Uncertain Tax Positions

The Company is subject to taxation in the United States at Federal and State levels, and is also subject to taxation in certain foreign jurisdictions. The Company’s tax years for 2007 and forward are subject to examination by the tax authorities (except California is open for 2006 and forward).  In addition, the tax returns for certain acquired entities are also subject to examination. As of September 30, 2011, an estimated liability of $0.5 million for uncertain tax positions related to pending examinations by taxing authorities is recorded in our Condensed Consolidated Balance Sheets. Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. The outcome of tax examinations however, cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax to the extent such adjustments relate to acquired entities.  Although the timing or the resolution and/or closure of the audits is highly uncertain, the Company does not believe that its unrecognized tax benefit will materially change in the next twelve months.

 
[16]

 
 
Note 14 - New Accounting Pronouncements

In December 2010, the FASB issued ASU 2010-28, Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (“ASU 2010-28”). Upon adoption of ASU 2010-28, an entity with reporting units that have carrying amounts that are zero or negative is required to assess the likelihood of the reporting units’ goodwill impairment. ASU 2010-28 is effective January 1, 2011 and the adoption of ASU 2010-28 did not have any impact on our results of operations or financial position.

Also in December 2010, FASB issued amendments to Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force). The amendments in this Update are effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010.  The adoption of the aforementioned amendment did not have any impact on our results of operations or financial position.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). Under ASU 2011-05, an entity will have the option to present comprehensive income on the income statement or as a separate financial statement. ASU 2011-05 is effective January 1, 2012 and requires retrospective adoption. ASU 2011-05 affects financial statement presentation only and has no effect on results of operations or financial position.
 
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment ("ASU 2011-08") that gives an entity the option of performing a qualitative assessment to determine whether it is necessary to perform step 1 of the annual goodwill impairment test. An entity is required to perform step 1 only if it concludes that it is more likely than not that a reporting unit's fair value is less than its carrying amount. An entity may choose to perform the qualitative assessment on none, some or all of its reporting units or an entity may bypass the qualitative assessment for any reporting unit in any period and proceed directly to step 1 of the impairment test. ASU 2011-08 is effective January 1, 2012 and we do not believe that the adoption of ASU 2011-08 will have a significant effect on our results of operations or financial position.
 
Note 15 - Commitments and Contingencies
 
           In November, 2009, the Company reached a settlement regarding a suit it had filed earlier that year against Mobile Messenger Americas, Inc. and Mobile Messenger Americas Pty, Ltd. (collectively Mobile Messenger) to recover monies owed to 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, seeking injunctive relief, indemnification for the settlement of the Florida Class Action and other matters.  The terms of the settlement are confidential, but in general resulted in a complete dismissal of the entire action, including the cross-complaint, with prejudice.  Pursuant to the settlement agreement, independent auditors conducted an accounting of payments made to the Company by Mobile Messenger.  In August, 2010, the independent auditors issued their report detailing their findings which Mobile Messenger disputed, and as dictated by the terms of the settlement agreement, the parties have engaged in arbitration.  Rather than continuing with litigation, the Company and Mobile Messenger have agreed to settle all of the disputes remaining in the litigation.  The terms of the settlement are confidential, but in general the settlement will conclude the litigation between Company and Mobile Messenger with regards to the amount determined by the Auditor to be paid to the Company and releases the Company of all obligations in this matter.  It is anticipated that the litigation will conclude by the end of the 4th quarter of 2011. 
 
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. The results of such disputes are not expected to have a significant adverse effect on the Company’s financial position or results of operations.

 
[17]

 

Note 16 – Business Segments

Starting in 2011, the Company has begun segmenting operating results into two segments: Consumer Subscription Services and Transactional Services. This change was precipitated by the fact that effective January 1, 2011, the Company’s Chief Operating Decision Maker (“CODM”) began to review the operating results in assessing performance and allocating resources in a manner based upon the operations of these separate segments.   This change in approach was caused by changes in the structure of the organization due to the restructuring of the Company that took place in the second half of 2010 and was completed at year end.  During this restructuring, the Company closed its unprofitable lead generation business.  As a result of this, beginning in 2011, the Company purchases media separately for each business segment and no longer looks at this purchase as a fungible transaction between the segments.  Additionally, due to the restructuring and turnover among executive personnel, the members of the Company’s management making up the CODM function changed in 2011.

The Company’s CODM reviews the revenue (as it had in previous periods), operating expenses and operating income (loss) information for each of the reportable segments.

The Subscription Services segment derives revenue from monthly subscription services consisting of music content and other services. The Transactional Services segment derives revenue from the development and management of search engine marketing campaigns for third party advertising clients.

Segment operating income (loss) includes allocations of “Cost of media-3rd party,” as well as allocations of “Product and distribution,” and “Selling and marketing.”  There are no internal revenue transactions between the Company’s reporting segments and the Company does not identify or allocate its assets by reportable segment since assets are not a measure used by our CODM function.

The Company does not allocate Administrative Overhead expenditures such as rent, insurance, technology costs and compensation for certain corporate employees such as finance, human resources, information technology and executive staff members.  These are analyzed by the Company’s CODM separate from the Subscription Service and Transactional Service operating segments.

The Company’s accounting policies are discussed in more detail in the Company’s Annual Report on Form 10-K, under the heading, Note 2 – Summary of Significant Accounting Policies.

Segment information for the three and nine months ended September 30, 2011 and 2010 are as follows:
 
    
For the Three Months Ended
   
For the Nine Months Ended
 
(in thousands)
 
Subscriptions
   
Transactional
Services
   
Administrative
Overhead
   
Consolidated
   
Subscriptions
   
Transactional
Services
   
Administrative
Overhead
   
Consolidated
 
September 30, 2011
                                               
Revenues
  $ 2,496     $ 9,830     $ -     $ 12,326     $ 9,495     $ 16,157     $ -     $ 25,652  
Impairment, depreciation and amortization
    -       -       1,654       1,654                       2,061       2,061  
Operating Income (Loss)
    (1,604 )     16       (3,430 )     (5,018 )     (5,799 )     (725 )     (7,371 )     (13,895 )
                                                                 
September 30, 2010
                                                               
Revenues
  $ 4,261     $ 4,916     $ -     $ 9,177     $ 15,234     $ 16,956     $ -     $ 32,190  
Impairment, depreciation & amortization
    -       -       325       325       -       -       972       972  
Operating Income (Loss)
      (466 )     (439 )     (2,763 )     (3,668 )     (266 )     (3,159 )     (7,949 )     (11,374 )
 
Note 17 – Related Party Transactions
 
           On May 23, 2011, the Company issued a demand promissory note (the “Demand Note”) to Brilliant Digital, a related party, in exchange for the principal sum of $0.5 million.  The Demand Note was subject to an annual simple interest rate of 0.56% on the unpaid principal.  The proceeds of the note were used to satisfy a portion of the Company’s accrued expenses. On May 31, 2011, the Company applied the full principal balance of the Demand Note, along with accrued interest, against Brilliant Digital’s purchase of Convertible Promissory Notes and warrants for $2.2 million and the Demand Note was cancelled.
 
           Brilliant Digital is the owner of the Kazaa digital music service, which is jointly operated with the Company.  See Note 4 – Kazaa, for details of the agreements in effect between the Company and Brilliant Digital.  Brilliant Digital is also the holder of 1,040,358 shares of the Company’s common stock, representing approximately 16.4% of the Company’s issued and outstanding shares.

 
[18]

 

Note 18 – Subsequent Events
 
Subsequent to September 30, 2011, the Company delisted its shares from the NASDAQ Capital Market, based in part, on the Company’s continued non-compliance with the minimum stockholders’ equity requirement for continued listing on The NASDAQ Capital Market.
 
The decision to delist its shares from NASDAQ was also made in view of the Company’s contractual obligations to the Buyers of the Company’s Notes and Warrants – see Note 5.  On October 27, 2011, the Company and each of the Buyers entered into separate Letter Agreements which modified certain terms of the transaction documents entered into with the Buyers.  Pursuant to the terms of the Notes, as amended, the Company was contractually obligated to delist its shares of common stock from the Nasdaq Capital Market and simultaneously list or designate for quotation its common stock on another eligible market by November 4, 2011, to avoid an event of default under the Notes and to regain compliance with various other terms of the transaction documents. The result of these modifications will result in a fourth quarter mark-to-market adjustment to the warrants and derivative liabilities increasing the value of the derivative liability by approximately $0.5 million with an offsetting increase to interest expense.
 
We have evaluated events subsequent to the balance sheet date through the date of our Form 10-Q filing for the quarter ended September 30, 2011 and determined there have not been any other material events that have occurred that would require adjustment to or disclosure in our unaudited condensed consolidated financial statements.
 
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations

CAUTIONARY STATEMENT

This discussion summarizes the significant factors affecting our condensed consolidated operating results, financial condition and liquidity and cash flows for the three and nine months ended September 30, 2011 and 2010. 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. Actual results could differ materially from those projected in the “forward-looking statements” as a result of, among other things, the factors described under the “Cautionary Statements and Risk Factors” included elsewhere in this report. The information contained in this Form 10-Q, as at and for the three and nine months ended September 30, 2011 and 2010, is intended to update the information contained in our Annual Report on Form 10-K for the year ended December 31, 2010 of Atrinsic, Inc. (“we,” “our,” “us”, the “Company,” or “Atrinsic”) and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other information contained in our Annual Report on Form 10-K.
 
 
[19]

 
 
Executive Overview

Our business is focused on two key segments:
 
 
·
Direct to consumer subscriptions, built around the Kazaa brand, and
 
·
Transactional services, built around search and affiliate marketing, within the Atrinsic Interactive brand.

Our Subscription business is built around a recurring-revenue business model. We are focused on digital music in the rapidly growing mobile space, and our lead offering, Kazaa, is a recognizable brand in this market. Our core strategic focus for our Kazaa music service is to build and sustain a large and profitable subscriber base and a growing and engaged audience and to deliver entertainment content to our customers anywhere, anytime and on any device, in a manner our customers choose.

Transactional Services is built around Atrinsic Interactive, our affiliate network and search marketing agency.  Atrinsic Interactive is a leading search agency and a top-tier affiliate network. We offer advertisers an integrated service offering across paid search, or search engine marketing (“SEM”), search engine optimization (“SEO”), display advertising, affiliate marketing, as well as offering business intelligence and brand protection services to our clients. We work with all types and sizes of advertisers on a performance basis to assist them in acquiring customers at an attractive return on investment. Our core strategic focus for Atrinsic Interactive is to build a leading independent search marketing agency and a top-five affiliate network.

Our business principally serves two sets of customers – consumers and advertisers. Consumers subscribe to our entertainment services, like Kazaa, to receive premium content on the internet and on their mobile device (Subscriptions). Advertisers use our products and services to enhance their online marketing programs (Transactional).  Each of these business activities – Subscriptions and Transactional Services – may utilize the same originating media or derive a customer from the same source (e.g. search); the difference is reflected in the type of customer billing and in the service that is provided. In the case of Transactional revenue, which is primarily generated from our search marketing agency business, the billing is generally carried out on a service fee, percentage, or on a performance basis. For Subscriptions, the end user (the consumer) is able to access premium content and in return is charged a recurring monthly fee to a credit card, or mobile phone. In managing our business, we internally develop marketing programs to match users with our service offerings or with those of our advertising clients.

For Subscriptions, our prospects for growth are dependent on our ability to acquire subscribers in a cost effective manner, have those customers stay as paying subscribers and to provide content and services to those subscribers in a cost effective manner. For our Transactional Services, our prospects for growth are dependent on our ability to sell our services to new advertisers, expand our existing customer relationships and to improve our margins. Results may also be impacted by economic conditions and the relative strengths and weakness of the U.S. economy, trends in the online marketing and telecommunications industry, including client spending patterns and increases or decreases in our portfolio of service offerings, including the overall demand for such offerings, competitive and alternative programs and advertising mediums, and risks inherent in our customer database, including customer attrition.

The principal components of our operating expense are labor, media and media related expenses, royalty and licensing fees, product or content development, marketing and promotional expenses (including sales commissions, customer service and customer retention expense) and corporate general and administrative expenses. We consider our third party media cost and a portion of 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 this portion of our cost structure to what we believe to be increases or decreases in revenue and market trends. Conversely, a significant portion of our operating cost structure is considered to be predominantly fixed in nature over a short time horizon, making it more difficult to make modifications to this portion of our cost structure in response to increases or decreases in revenue and market trends. These factors are important in monitoring our performance in periods when revenues are increasing or decreasing.

In addition to the two operating segments; Subscription Services and Transactional Services, there is an additional component of expenditures for Administrative Overhead.  Some of the costs related to this area are rent, insurance, technology systems and compensation related to finance, human resources, information technology and executive personnel.  These expenditures do not relate directly to the generation of revenue and as such are not considered to be an operating segment.  
 
 
[20]

 
 
Kazaa Music Service

Atrinsic and Brilliant Digital Entertainment, Inc. (“Brilliant Digital”) jointly offer the Kazaa digital music service pursuant to a Marketing Services Agreement and a Master Services Agreement between the two companies. Under the Marketing Services Agreement, we are responsible for marketing, promotional, and advertising services in respect of the Kazaa business. Pursuant to the Master Services Agreement, Atrinsic provides services related to the operation of the Kazaa business, including billing and collection services and the operation of the Kazaa online storefront. Brilliant Digital is obligated to provide certain other services with respect to the Kazaa business, including licensing the intellectual property underlying the Kazaa business to us, obtaining all licenses to the content offered as part of the Kazaa business and delivering that content to subscribers. As part of the agreements, we are required to make advance payments and expenditures in respect of certain expenses incurred in order to operate the Kazaa business. Since inception on July 1, 2009, and through September 30, 2011, we have made advance payments and expenditures related to Kazaa of $17.4 million in excess of revenue and recouped funds.
 
Also in accordance with the original Marketing Service Agreement and Master Service Agreement, Atrinsic and Brilliant Digital were to share equally in the “Net Profit” generated by the Kazaa music subscription service after all of our costs and expenses have been recouped. For the nine months ended September 30, 2011 and 2010, the Company has included in its statement of operations Kazaa revenue of $7.1 million, net of deferred revenue and $8.4 million, respectively, and expenses incurred for the Kazaa music service of $12.7 million and $11.5 million, net of reimbursements from Brilliant Digital.  Kazaa revenue and expenses are recorded as part of our subscription segment.

On October 13, 2010, we entered into amendments to our existing Marketing Services Agreement and Master Services Agreement with Brilliant Digital and entered into an agreement with Brilliant Digital to acquire all of the assets of Brilliant Digital that relate to its Kazaa subscription based music service business.
 
Among other things, the amendments extend the term of each of the Marketing Services Agreement and Master Services Agreement from three years to thirty years, provide us with an exclusive license to the Kazaa trademark in connection with our services under the agreements, and modify the Kazaa digital music service profit share payable to us under the agreements from 50% to 80%. In addition, the amendments remove Brilliant Digital’s obligation to repay up to $2.5 million of Atrinsic’s advances and expenditures which are not otherwise recovered from Kazaa generated revenues and remove the $5.0 million cap on expenditures that we are required to advance in relation to the operation of the Kazaa business. As consideration for entering into the amendments, we issued 1,040,358 unregistered shares of our common stock to Brilliant Digital.

The amendments to the Marketing Services Agreement and Master Services Agreement are part of a broader transaction between us and Brilliant Digital pursuant to which we will acquire all of the assets of Brilliant Digital that relate to its Kazaa digital music service business in accordance with the terms of an asset purchase agreement entered into between the parties. The purchase price for the acquired assets includes the issuance by us of an additional 1,781,416 unregistered shares of our common stock at the closing of the transactions contemplated by the asset purchase agreement as well as the assumption of certain liabilities related to the Kazaa business. The closing of the transactions contemplated by the asset purchase agreement will occur when all of the assets associated with the Kazaa business, including the Kazaa trademark and associated intellectual property, as well as Brilliant Digital’s content management, delivery and customer service platforms, and licenses with third parties, have been transferred to us. The closing of the transactions contemplated by the asset purchase agreement is subject to receipt of all necessary third party consents as well as other customary closing conditions. There is no guarantee that such conditions will be satisfied. At the closing of the transactions contemplated by the asset purchase agreement, we have agreed to appoint two individuals to be selected by Brilliant Digital to serve on our Board of Directors. In addition, at the closing, each of the Marketing Services Agreement and Master Services Agreement will terminate.

Ability to Continue as Going Concern

Our consolidated financial statements are prepared using accounting principles generally accepted in the United States applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The accompanying historical consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.

            The assessment of our ability to continue as a going concern was made by management considering, among other factors: (i) our current levels of expenditures, including subscriber acquisition costs, operating expense, including product development, and overhead, (ii) our ongoing working capital needs, (iii) the uncertainty concerning the outcome of future financings, (iv) our history of losses and use of cash for operating activities (v) outstanding balance of cash and cash equivalents of $2.0 million at the end of the quarter, and (vi) our budgets and financial projections of future operations, including the likelihood of achieving operating profitability without the need for additional financing.

 
[21]

 

For periods subsequent to September 30, 2011, we expect losses if we continue to incur expenditures to develop the Kazaa digital music service, acquire subscribers for the Kazaa service, and if we are not able to reduce other operating expenses and overhead sufficiently to a level in line with our level of revenues.  If we are unable to increase revenues sufficiently or decrease our expenditures to a sustainable level, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about our ability to continue as a going concern.

Based on current financial projections, we believe the continuation of our Company as a going concern is primarily dependent on our ability to, among other factors: (i) consummate a suitable financing, or obtain cash from the sale of our assets or lines of business, (ii) scale our Kazaa subscriber base to a level where the monthly revenue generated from our subscriber base exceeds subscriber acquisition costs, net of expenses required to operate Kazaa, (iii) eliminate or reduce operating and overhead expenditures to a level more in line with our revenue, (iv) improve utilization of the Kazaa digital music service and improve LTVs of subscribers to that service (v) acquire profitable subscribers to the Kazaa digital music service at cost effective rates, (vi) grow our search marketing agency revenue base through the addition of new customers or expansion of business with existing customers and, (vii) expand margins in our search marketing agency and on our affiliate platform.

While we address these operating matters, we must continue to meet expected near-term obligations, including normal course operating cash requirements and costs associated with developing and operating the Kazaa digital music service, as well as funding overhead and the working capital needs of our other businesses.  If we are not able to obtain sufficient funds through a financing, or if we experience adverse outcomes with respect to our operational forecasts, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected.

 Anticipated Financing

In order to carry out our business strategy and to fund our Kazaa music service, we intend to make an offering of securities not registered under the Securities Act of 1933, as amended (the “Securities Act”). The securities to be offered will not be registered under the Securities Act and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements. At this time, the title, amount and basic terms of the securities to be offered and the amount and timing of the offering are not known, but the Company anticipates that the terms of the offering may be substantially similar to the financing transaction the Company completed on May 31, 2011, as reported in the Company’s Current Reports on Form 8-K filed with the Securities and Exchange Commission on June 1, 2011 and October 27, 2011. The proceeds of the offering will be used for general working capital purposes, including to fund Atrinsic’s Kazaa digital music subscription business. 

Results of Operations for the three months ended September 30, 2011 compared to the three months ended September 30, 2010.

Detailed segment operating results for the three months ended September 30, 2011 and 2010 are summarized below:
 
   
For the Three Months Ended
   
Change
   
Change
 
   
September 30,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
(dollars in thousands)
 
2011
   
2010
   
$
   
%
 
Segment Revenues:
                       
Subscription Services
  $ 2,496     $ 4,261     $ (1,765 )     -41 %
Transactional Services
    9,830       4,916       4,914       100 %
Total Revenues
    12,326       9,177       3,149       34 %
                                 
Segment Operating Expenses:
                               
Subscription Services
    4,100       4,727       (627 )     -13 %
Transactional Services
    9,814       5,355       4,459       83 %
Administrative Overhead
    3,430       2,763       667       24 %
Total Operating Expenses
    17,344       12,845       4,499       35 %
                                 
Segement Operating Income/(Loss):
                               
Subscription Services
    (1,604 )     (466 )     (1,138 )     244 %
Transactional Sevices
    16       (439 )     455       -104 %
Administrative Overhead
    (3,430 )     (2,763 )     (667 )     24 %
Total Operating Loss
  $ (5,018 )   $ (3,668 )   $ (1,350 )     37 %
 
 
[22]

 

Total revenue increased $3.1 million, or 34%, to $12.3 million for the three months ended September 30, 2011 compared to $9.2 million for the three months ended September 30, 2010 due to the reasons discussed in the below analyses of segment operations.

           Total operating expenses increased $4.5 million, or 35%, to $17.3 million for the three months ended September 30, 2011 compared to $12.8 million for the three months ended September 30, 2010 due to the reasons discussed in the below analyses of segment operations.

Subscription Services Segment
 
   
For the Three Months Ended
   
Change
   
Change
 
   
September 30,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
(dollars in thousands)
 
2011
   
2010
   
$
   
%
 
                         
Segment Revenue
  $ 2,496     $ 4,261     $ (1,765 )     -41 %
                                 
Segment Operating Expenses
                               
Cost of media – 3rd party
    392       848       (456 )     -54 %
Content costs
    1,997       1,831       166       9 %
Product and distribution
    1,563       1,877       (314 )     -17 %
Selling and marketing
    111       21       90       429 %
General, administrative and other operating
    37       150       (113 )     -75 %
Total Segment Operating Expenses
    4,100       4,727       (627 )     -13 %
Subscriptions services Segment Operating Income (Loss)
  $ (1,604 )   $ (466 )   $ (1,138 )     244 %

Subscription segment revenues decreased $1.8 million or 41% to $2.5 million for the three months ended September 30, 2011 from $4.3 million for the three months ended September 30, 2010.  This reduction was the result of a lower number of billable subscribers in the third quarter of 2011, compared to the year ago period, offset partly by an increase in average revenue per user (“ARPU”).  As of September 30, 2011, the Company had approximately 78,000 total subscribers, compared to 217,000 as of September 30, 2010, representing a reduction of 64% in the total number of billable subscribers.  Across all of our subscription products, our ARPU was approximately $5.95 for the third quarter of 2011, compared to $5.74 in the year ago period.  As of September 30, 2011, the Company has approximately 55,000 Kazaa subscribers (representing September 2011 net billing transactions), compared to approximately 64,000 as of September 30, 2010 and 77,000 at December 31, 2010.  Our rate of customer acquisition in the third quarter did not exceed the pace of customer attrition, and as a result, we lost approximately 16,000 net Kazaa subscribers (new subscriber additions, net of attrition) in the third quarter of 2011, compared to 71,000 Kazaa subscribers as of June 30, 2011.
 
As the Kazaa business becomes the central focus of our subscription segment, management expects that it will continue to evaluate the operating metrics it communicates to the public, including, number of subscribers, ARPU and other key metrics.

Cost of media -3rd party decreased $0.5 million, or 54%, to $0.4 million for the three months ended September 30, 2011 from $0.9 million for the three months ended September 30, 2010.  This decrease in Cost of media -3rd party was due to a conscious effort to moderate marketing spends, resulting in a lower rate of Kazaa customer acquisitions, which we also see continuing into the fourth quarter as management more closely monitors and evaluates prevailing market conditions, the type of media, and the cost effectiveness of its various marketing programs.  Cost of media -3rd party did not decrease in proportion to the decline in subscription services revenue because most of the revenue decline was the result of fewer non-Kazaa legacy subscribers - which account for a relatively smaller proportion of cost of media -3rd party.

Content costs, which are costs necessary to provide licensed content, principally for Kazaa, increased $0.2 million or 9% to $2.0 million for the three months ended September 30, 2011from $1.8 million for the three months ended September 30, 2010. The content costs reflect the actual royalties and license fees incurred from music labels and publishers of licensed music in the period.

Product and distribution expenses decreased by $0.3 million, or 17%, to $1.6 million for the three months ended September 30, 2011 from $1.9 million for the three months ended September 30, 2010, due to a decrease in labor related costs, as a result of the Company’s restructuring during 2010.  

 
[23]

 
 
Transactional Services Segment
 
   
For the Three Months Ended
   
Change
   
Change
 
   
September 30,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
(dollars in thousands)
 
2011
   
2010
   
$
   
%
 
                         
Segment Revenue
  $ 9,830     $ 4,916     $ 4,914       100 %
                                 
Segment Operating Expenses
                               
Cost of media – 3rd party
    8,816       3,742       5,074       136 %
Product and distribution
    236       688       (452 )     -66 %
Selling and marketing
    682       918       (236 )     -26 %
General, administrative and other operating
    80       7       73       1043 %
Total Segment Operating Expenses
    9,814       5,355       4,459       83 %
Transactional services Segment Operating Income (Loss)
  $ 16     $ (439 )   $ 455       -104 %
 
Transactional Service segment revenues increased $4.9 million, or 100%, to $9.8 million for the three months ended September 30, 2011 from $4.9 million for the three months ended September 30, 2010.  Transactional revenue is principally derived from our search marketing agency business, which consists of targeted and measurable online campaigns and programs for advertisers to generate qualified customer leads, sales transactions, or increased brand recognition.  The increase in revenue was primarily related to sales volume improvement from existing clients as well as new client acquisitions during the third quarter. The increase was offset by the restructuring of our lead generation business in which we eliminated a number of unprofitable (on a gross margin basis) revenue lines.  As a result of this restructuring, the bulk of our Transactional revenue now consists of revenue generated from our search marketing agency business, together with higher yielding marketing campaigns.

Transactional Service segment expenses increased by $4.4 million, or 83%, to $9.8 million for the three months ended September 30, 2011 from $5.4 million for the three months ended September 30, 2010. This increase in expenditures was primarily due an increase in Cost of media-3rd party (principally search costs), which is correlated to the corresponding increase in revenue.  During the three months ended September 30, 2011 Cost of media – 3rd party increased $5.1 million or 136% to $8.8 million from $3.7 million for the three months ended September 30, 2011 due to the increase in Transactional related revenue, which resulted in a corresponding increase in purchased media.

Product and distribution expenses decreased $0.5 million or 66% to $0.2 million for the three months ended September 30, 2011 from $0.7 million for the three months ended September 30, 2010.  This reduction resulted from the termination of several unprofitable or marginally profitable transactional services lines of business during the Company’s restructuring during 2010.

Selling and marketing expenses decreased $0.2 million or 26% to $0.7 million for the three months ended September 30, 2011 from $0.9 million for the three months ended September 30, 2010.  This reduction resulted from the termination of several unprofitable or marginally profitable transactional services lines of business during the Company’s restructuring during 2010.

Administrative Overhead
 
   
For the Three Months Ended
   
Change
   
Change
 
   
September 30,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
(dollars in thousands)
 
2011
   
2010
    $     %  
                           
Segment Operating Expenses
                         
General, administrative and other operating
  $ 1,776     $ 2,438     $ (662 )     -27 %
Depreciation & amortization
    233       325       (92 )     -28 %
Impairment of intangible assets
    1,421       -     $ 1,421       100 %
Administrative overhead Expense
  $ 3,430     $ 2,763     $ 667       24 %

General, administrative and other operating expenses decreased $0.6 million, or 27%, to $1.8 million for the three months ended September 30, 2011 from $2.4 million for the three months ended September 30, 2010 due to the decrease in expenditures for salaries and technological costs as part of the Company’s restructuring that took place in the second half of 2010, including the closing of our technological facility in Canada during the fourth quarter of 2010.

 
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Depreciation and amortization decreased $0.1 million, or 28%, to $0.2 million for the three months ended September 30, 2011 from $0.3 million for the three months ended September 30, 2010 due primarily to a reduction in amortization for intangibles, due to the $3.4 million impairment charge to reduce the carrying value of our amortizable intangibles at the end of 2010. Depreciation decreased due to a reduction in property, plant and equipment related to the decision to shut down the Canada facility in the second half of 2010.

An impairment charge of $1.4 million was recorded by the Company during the third quarter of 2011, as a result of the carrying value of the intangible assets of $2.8 million exceeding their fair market value of $1.4 million. No such charge was recorded during the comparative period in the prior year.

Loss from Operations

Operating loss increased by $1.3 million, or 37%, to $5.0 million for the three months ended September 30, 2011, compared to an operating loss of $3.7 million for the three months ended September 30, 2010. As described above, the increase in operating loss was driven by declining revenue related to the Subscription Services Segment along with the 2011 impairment charge.
 
Interest Expense, net

Interest expense decreased $0.6 million to ($0.6 million) for the three months ended September 30, 2011from $0.0 million for the three months ended September 30, 2010 due to the discount amortization partly offset by the mark-to-market gain on the derivatives. The interest income in the third quarter is a non-cash item.
 
Income Taxes

Income tax expense, before equity in loss of investee, for the three months ended September 30, 2011 and 2010 was $45,000 and $35,000 respectively and reflects an effective tax rate of (1%)  and (1%) respectively. The Company had a loss before taxes of $4.5 million for the three months ended September 30, 2011 compared to loss before taxes of $3.6 million for the three months ended September 30, 2010. 
 
Equity in Loss (Earnings) of Investee

Equity in loss of investee was $9,000 for the three months ended September 30, 2011 compared to a loss of $13,000 for the three months ended September 30, 2010. The equity represents the Company’s 36% interest in The Billing Resource, LLC (TBR). The company acquired its interest in TBR in the 4th quarter of 2008.

Net Loss Attributable to Atrinsic, Inc.

Net loss increased by $0.9 million to $4.5 million for the three months ended September 30, 2011 as compared to a net loss of $3.6 million for the three months ended September 30, 2010. This increase in loss resulted from the factors described above.

 
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Results of Operations for the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010.

Detailed segment operating results for the nine months ended September 30, 2011 and 2010 are summarized below:
 
   
For the Nine Months Ended
   
Change
   
Change
 
   
September 30,
   
Inc.(Dec.)
   
Inc.(Dec.)
 
(dollars in thousands)
 
2011
   
2010
   
$
   
%
 
Segment Revenues:
                       
Subscription Services
  $ 9,495     $ 15,234     $ (5,739 )     -38 %
Transactional Services
    16,157       16,956       (799 )     -5 %
Total Revenues
    25,652       32,190       (6,538 )     -20 %
                                 
Segment Operating Expenses:
                               
Subscription Services
    15,294       15,500       (206 )     -1 %
Transactional Services
    16,882       20,115       (3,233 )     -16 %
Administrative Overhead
    7,371       7,949       (578 )     -7 %
Total Operating Expenses
    39,547       43,564       (4,017 )     -9 %
                                 
Segement Operating Income/(Loss):
                               
Subscription Services
    (5,799 )     (266 )     (5,533 )