Form 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q


		QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended: June 30, 2009

Commission File Number: 001-33667

DIGITALFX INTERNATIONAL, INC.

(Exact name of registrant as specified in its charter)


Florida		65-0358792
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)

3035 East Patrick Lane, Suite 9
Las Vegas, Nevada 89120
(Address of principal executive offices, including zip code)

(702) 938-9300
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer o	Accelerated filer o	Non-accelerated filer o	Smaller reporting company þ
		(Do not check if a smaller reporting company)

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

As of July 30, 2009, 33,831,748 shares of the registrant’s common stock were outstanding.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

DigitalFX International, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands, except share data)


	June 30,			December 31,
	2009			2008
	(unaudited)
Assets
Current assets:
Cash and cash equivalents	$	229		$	664
Accounts receivable		36			52
Inventories, net		104			295
Prepaid expenses and other assets		122			243

Total current assets		491			1,254

Investments, net		512			169
Assets held for exchange		—			402
Deferred financing costs		74			100
Property and equipment, net		305			486
Deposits, merchant processors		409			609
Other assets		—			12

Total assets	$	1,791		$	3,032


Liabilities and Stockholders’ Equity (Deficiency)

Current liabilities:
Accounts payable	$	174		$	99
Accrued expenses		718			629
Accrued commissions		1,126			1,243
Convertible notes payable, current, net		731			50
Derivative liabilities		177			—
Capital lease obligation, current		50			47


Total current liabilities		2,976			2,068

Capital lease obligation		56			81
Loan from shareholder		970			—
Convertible notes payable, net		—			826

Total liabilities		4,002			2,975


Commitments and Contingencies

Stockholders’ equity (deficiency):
Preferred stock, $0.01 par value, 5,000,000 shares authorized, 2,000,000 issued and outstanding		20			20
Common stock, $0.001 par value, 100,000,000 shares authorized, 33,831,748 and 31,937,998 shares issued and outstanding, respectively		25			25
Additional paid in capital		17,306			16,982
Other comprehensive income		—			8
Accumulated deficit		(19,562	)		(16,978	)

Total stockholders’ equity (deficiency)		(2,211	)		57

Total liabilities and stockholders’ equity (deficiency)	$	1,791		$	3,032

See Notes to Condensed Consolidated Financial Statements

DigitalFX International, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations

(In thousands, except share and per share data, unaudited)


	Three months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008

Revenues	$	1,301		$	3,804		$	3,028		$	8,621
Cost of revenues		576			693			1,393			1,693


Gross profit		725			3,111			1,635			6,928

Commission expenses		459			1,710			1,091			3,526
Other operating expenses		1,303			2,812			2,967			5,274


Operating loss		(1,037	)		(1,411	)		(2,423	)		(1,872	)


Other (income) expense:
Unrealized (gain) loss on investment		(17	)		51			59			490
Unrealized loss on investment in company owned by related party		—			325			—			325
Loss on modification of debt		—			—			—			1,920
Financing costs, net		77			127			175			428
(Gain) loss on derivative financial instruments		(341	)		—			46			—
Other (income) expense, net		—			1			—			(8	)


Other (income) expense, net		(281	)		504			280			3,155


Loss before provision for income taxes		(756	)		(1,915	)		(2,703	)		(5,027	)

Provision (benefit) for income taxes		—			27			(46	)		28


Net loss		(756	)		(1,942	)		(2,657	)		(5,055	)

Preferred stock dividend		60			—			120			—


Net loss available to common stockholders	$	(816	)	$	(1,942	)	$	(2,777	)	$	(5,055	)


Net loss per share available to common stockholders:
Basic and fully diluted	$	(0.02	)	$	(0.08	)	$	(0.08	)	$	(0.20	)


Weighted average shares outstanding:
Basic and fully diluted		33,502,581			24,927,710			32,953,623			24,923,710

See Notes to Condensed Consolidated Financial Statements

DigitalFX International, Inc. and Subsidiaries

Condensed Consolidated Statement of Stockholders’ Equity (Deficiency)

(In thousands, except share data)

Six Months Ended June 30, 2009 (unaudited)


	Preferred		Common		Preferred		Common		Additional			Other Comprehensive			Accumulated
	Shares		Shares		Stock		Stock		Paid-In Capital			Loss			Deficit			Total

Balance, December 31, 2008		2,000,000		31,937,998	$	20	$	25	$	16,982		$	8		$	(16,978	)	$	57

Cumulative effect of change in accounting principle- January 1, 2009 reclassification of embedded feature of equity based financial instruments to derivative liabilities		—		—		—		—		(65	)		—			193			128

Issuance of common stock for services		—		1,400,000		—		—		188			—			—			188

Issuance of common stock for acquisition of option		—		493,750		—		—		118			—			—			118

Preferred stock dividend		—		—		—		—		—			—			(120	)		(120	)

Fair value of vested options		—		—		—		—		83			—			—			83

Foreign currency translation adjustment		—		—		—		—		—			(8	)		—			(8	)

Net loss for the six months ended June 30, 2009		—		—		—		—		—			—			(2,657	)		(2,657	)

Balance, June 30, 2009		2,000,000		33,831,748	$	20	$	25	$	17,306		$	—		$	(19,562	)	$	(2,211	)

See Notes to Condensed Consolidated Financial Statements

DigitalFX International, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(In thousands, unaudited)


	Six Months Ended June 30
	2009			2008
Operating activities:

Net loss	$	(2,657	)	$	(5,055	)

Adjustment to reconcile net loss to net cash used in operating activities:

Depreciation and amortization		181			171
Equity based compensation expense		83			286
Common stock issued for services		306			279
Amortization of financing costs and debt discount		110			160
Unrealized loss on investment		59			490
Unrealized loss on investment in company owned by related party		—			325
Loss on modification of debt		—			1,920
Loss on derivative financial instrument		46			—
Deferred income taxes		—			29
Changes in assets and liabilities:
Accounts receivable		16			(255	)
Inventory		191			278
Prepaid expenses and other assets		334			(313	)
Accounts payable and accrued expenses		(43	)		(528	)


Net cash used in operating activities		(1,374	)		(2,213	)


Investing activities:
Exercise of warrants to acquire interest in company owned by related party		—			(100	)
Purchases of property and equipment		—			(204	)


Net cash used in investing activities		—			(304	)


Financing activities:
Proceeds from issuance of common stock, net		—			2
Advance from stockholder		970			—
Proceeds from capital lease obligation		—			149
Repayment of capital lease obligation		(23	)		—
Repayment of convertible notes		—			(2,025	)


Net cash provided by (used in) financing activities		947			(1,874	)


Foreign currency translation		(8	)		18


Change in cash and cash equivalents		(435	)		(4,373	)
Cash and cash equivalents, beginning of period		664			5,319


Cash and cash equivalents, end of period	$	229		$	946


Supplemental Cash Flow Information:
Cash paid for interest	$	4		$	229

Non-Cash Investing and Financing Activities:
Cumulative effect of accounting change	$	128		$	—

Preferred stock dividend	$	120		$	—

Reclassification of assets held for exchange to investments	$	402		$	—

Reclassification of accrued interest to convertible notes	$	30		$	—

Reduction of tax benefit related to stock options and warrants	$	—		$	904

Tax effect of loss on investment	$	—		$	140

Repayment of notes from restricted cash	$	—		$	2,000

See Notes to Condensed Consolidated Financial Statements

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Note 1. The Company and Basis of Presentation

Company

DigitalFX International, Inc. (the “Company”) a Florida corporation, is a Nevada based holding company for a direct selling corporate group offering an exclusive suite of internet marketing tools which include enhanced video and audio email service, live web casting, on demand video conferencing and a state-of- the-art e-marketing campaign manager.

Currently, these applications are offered to the Company’s Affiliate network through the website www.vmdirect.com, operated by its wholly-owned subsidiary VMdirect, LLC, a Nevada limited liability company (“VMdirect”), and VMdirect’s wholly-owned U.K. and Ireland subsidiaries, to the Company’s consumer retail base via the website www.helloWorld.com, operated by its wholly-owned subsidiary DigitalFX Networks, LLC, a Nevada limited liability company (“DigitalFX Networks”), and to the Company’s commercial user base via the website www.attainresponse.com.

The condensed consolidated financial statements include the accounts of the Company, VMdirect and its wholly-owned U.K. and Ireland subsidiaries, and the Company’s wholly-owned Nevada subsidiaries. Inter-company transactions and balances have been eliminated.

Going Concern

The accompanying condensed consolidated financial statements have been prepared assuming the company will continue as a going concern. The Company incurred a net loss of $2,657 and utilized cash in operating activities of $1,374 during the six months ended June 30, 2009, and as of June 30, 2009 the Company’s current liabilities exceeded current assets by $2,485. These matters raise substantial doubt about the Company’s ability to continue as a going concern.

During the six months ended June 30, 2009, the Company's Chairman and majority shareholder provided $970 of unsecured advances to help fund the current operating cash flow deficiency.

The Company believes that the recent change in management will result in the Company returning to profitable operations through its new product offerings and cost cutting practices. The Company may also continue to seek to finance future capital needs through various means and channels, such as issuance of long-term debt or sale of equity securities. However, there can be no assurances that the Company will be successful in this regard or will be able to eliminate its working capital deficit or operating losses. The accompanying financial statements do not contain any adjustments which may be required as a result of this uncertainty.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Note 2. Accounting Policies

Principles of consolidation

The consolidated financial statements include the accounts of DigitalFX International, Inc and its wholly-owned subsidiaries. Inter-company accounts and transactions have been eliminated.

Use of Estimates and Assumptions

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. Preparing financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. Examples of significant estimates used in preparing the accompanying financial statements include, but are not limited to: the carrying value of long-lived assets; useful lives of property and equipment; revenue recognition; and the valuation allowances for receivables, inventories and sales returns, the value of derivative instruments and the value of stock options issued for the purpose of determining stock-based compensation. Actual results and outcomes may materially differ from management’s estimates and assumptions.

Basis of Presentation

The condensed consolidated interim financial statements included herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission, and in the opinion of management include all adjustments which, except as described elsewhere herein, are of a normal recurring nature, necessary for a fair presentation of the financial position, results of operations, and cash flows for the period presented. The financial statements presented herein should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2008 filed with the Securities and Exchange Commission.

Cash and Cash Equivalents

The Company considers all highly liquid investments with remaining maturities of three months or less when acquired to be cash equivalents. The Company holds its cash in what it believes to be credit-worthy financial institutions.

At June 30, 2009 and December 31, 2008, the Company had $409 and $609, respectively, of funds held by banks as reserves against any possible charge backs and returns on credit card transactions related to customer disputes that are not offset against the Company’s daily sales deposit activity. These amounts are reflected as Deposit, Merchant Processors on the Company’s condensed consolidated balance sheets.

Investments

The Company accounts for its investments in equity securities under Statement of Financial Accounting Standards (“SFAS”) 115, “Accounting for Certain Investments in Debt and Equity Securities.” The Company has classified its investments as available for sale securities, and such securities are carried at fair value with the unrealized gains or losses, net of tax, included as a component of accumulated other comprehensive income in stockholders’ equity. Realized gains and losses and declines in value considered to be other than temporary on available for sale securities are included in other income (loss).

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The fair values for marketable equity securities are based on quoted market prices. The carrying value for non-marketable equity securities investments in private companies is based on cost, which approximates fair value. In determining whether a decline in value of non-marketable equity securities investments in private companies is other than temporary, the assessment is made by considering available evidence including the general market conditions in the investee’s industry, the investee’s product development status, the investee’s ability to meet business milestones and the financial condition of the investee. When a decline is considered other than temporary, the Company recognizes an impairment loss in the current period’s operating results in the period of decline.

Fair Value of Financial Instruments

The Company partially adopted SFAS 157, “Fair Value of Financial Instruments,” on January 1, 2008, delaying application for non-financial assets and non-financial liabilities as permitted. This statement establishes a framework for measuring fair value, and expands disclosures about fair value measurements.

SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels as follows:

Level 1: quoted prices (unadjusted) in active markets for identical asset or liabilities that the Company has the ability to access as of the measurement date. Financial assets and liabilities utilizing Level 1 inputs include active exchange-traded securities and exchange-based derivatives.

Level 2: inputs other than quoted prices included within Level 1 that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data. Financial assets and liabilities utilizing Level 2 inputs include fixed income securities, non-exchange-based derivatives, mutual funds, and fair-value hedges.

Level 3: unobservable inputs for the asset or liability only used when there is little, if any, market activity for the asset or liability at the measurement date. Financial assets and liabilities utilizing Level 3 inputs include infrequently-traded, non-exchange-based derivatives and commingled investment funds and are measured using present value pricing models.

In accordance with SFAS 157, the Company determines the level in the fair value hierarchy within which each fair value measurement in its entirety falls, based on the lowest level input that is significant to the fair value measurement in its entirety.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The following table represents certain financial instruments of the Company measured and recorded at fair value on the Company’s condensed consolidated balance sheets on a recurring basis and their level within the fair value hierarchy as of June 30, 2009:


	Level 1		Level 2		Level 3		Total
Assets:
Investments at fair value	$	110	$	—	$	402	$	512


	Level 1		Level 2		Level 3		Total
Liabilities:
Conversion feature derivative at fair value	$	—	$	—	$	143	$	143
Warrant derivative at fair value	$	—	$	—	$	34	$	34

	$	—	$	—	$	177	$	177

See Notes 5, 7 and 8 for more information on these financial instruments.

Derivative Financial Instruments

The Company does not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. The Company evaluates all of its financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the condensed consolidated statements of operations. For stock-based derivative financial instruments, the Company uses a probability weighted Black-Scholes-Merton valuation technique to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date.

Revenues

The Company generates revenue through (i) sales of affiliate business packages to Affiliates which include sales literature, training videos and other selling aids and the initial month’s subscription to its suite of internet marketing tools which include enhanced video and audio email service, live web casting, on demand video conferencing and a state of the art e-marketing campaign manager, (ii) sales of monthly subscriptions to retail and business customers and Affiliates of the suite of internet marketing tools which include enhanced video and audio email service, live web casting, on demand video conferencing and a state of the art e-marketing campaign manager, (iii) sales of branded apparel and merchandise, (iv) sales of electronic components and (v) hosting conferences and events.

Affiliate Business Packages

The Company recognizes revenue from the sales of the sales literature, training videos and selling aids within the business package, including shipping revenue, in accordance with SAB No. 104, when persuasive evidence of an order arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Generally, these criteria are met at the time the product is shipped to customers when title and risk of loss have transferred. Allowances for estimated subsequent customer returns are provided when revenues are recorded. Costs incurred for the shipping and handling of its products are recorded as cost of sales. Effective in May 2009, the Company has made its sales literature, training videos and selling aids available to its Affiliates online, and no longer physically “ships” out these items.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The Company recognizes revenue from sale of the Affiliate’s initial month’s subscription to the internet-based suite of products in accordance with generally accepted accounting principles and based on the fair value of such suite of products. Fair value is determinable because the subscription fee is thereafter billed monthly at a fixed rate based on the level of service selected. Access to the internet-based studio suite of the products is delivered together, and the individual products within the suite cannot be sold separately. Access is delivered immediately upon sign up and order acceptance.

Sales of the above products, ranging in price from $95 to $2,495 USD (pricing not in thousands), entail no post-customer support or delivery of any other items.

A monthly subscription is cancellable at any time and the relevant subscription fee is refundable if such cancellation is made in writing in accordance with and within the time frames specified by the Company’s policies and procedures guide. Allowances for estimated subsequent customer returns are provided when revenues are recorded.

Monthly Subscriptions

The Company recognizes revenue from sales of a month’s subscription to retail customers and sales to Affiliates for their recurring subscription to the internet-based suite of products in accordance with generally accepted accounting principles and based on the fair value of such suite of products. Fair value is determinable because the subscription fee is billed at a fixed rate based on the level of service selected. Funds collected in advance of the billing period are deferred. A monthly subscription is cancellable at any time and the relevant subscription fee is refundable if such cancellation is made in writing in accordance with and within the time frames specified by the Company’s policies and procedures guide.

The Company records an allowance for potential chargebacks on subscription fees based on an analysis of historical data for the four months preceding the date of measurement. The accuracy of these estimates is dependent on the rate of future chargebacks being consistent with the historical rate. Increases or decreases to the sales allowance are charged to revenue.

Apparel and Merchandise

The Company also sells select products to Affiliates to assist them in building their businesses and in selling subscriptions to the portal. Revenue for these sales including shipping revenue is recognized when all the criteria of SAB No. 104 described above are met, which is generally upon shipment.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Electronic Components

The Company recognizes revenue from the sales of electronic components in accordance with SAB No. 104, when persuasive evidence of an order arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Generally, these criteria are met at the time the product is shipped to customers when title and risk of loss have transferred. Sales of the above products entail no post-customer support or delivery of any other items.

Conferences and Events

The Company also earns fees for certain events it hosts such as sales and training conferences and seminars. Revenue is recognized when all of the criteria of SAB No. 104 described above are met, which is generally after the event has occurred. Amounts collected prior to the event are reflected as deferred revenue, and recognized after the event has occurred. As of June 30, 2009, there was no deferred revenue related to conferences and events.

Shipping and Handling Fees

Shipping and handling fees are billed to customers and included in revenue. The related costs are included in cost of goods sold. Shipping and handling costs are charged to expense as incurred. Total shipping and handling costs of $31, $79, $83, and $178 are included in cost of goods sold for the three and six months ended June 30, 2009 and 2008, respectively.

Stock-Based Compensation

The Company periodically issues stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. The Company adopted SFAS 123R, “Accounting for Stock-Based Compensation” effective January 1, 2006, and is using the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123R for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. The Company accounts for stock option and warrant grants issued and vesting to non-employees in accordance with EITF No. 96-18: “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and EITF 00-18 “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees” whereby the fair value of the stock compensation is based on the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instrument is complete.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Valuation Assumptions

The fair value of options and warrants were estimated on the date of grant using the Black-Scholes-Merton option pricing model with the following weighted-average assumptions for the six months ended June 30, 2009 and 2008:


	June 30,		June 30,
	2009		2008
Dividend yield		-0-		-0-
Risk-free interest rate		1.50% – 4.64%		4.50% – 4.64%
Expected volatility		42.00% – 101.54%		42.00% – 68.38%
Expected life of options		5 years		5 years

Earnings (Loss) Per Share

Statement of Financial Accounting Standards No. 128, “Earnings per Share,” requires presentation of basic earnings per share. Basic earnings (loss) per share is computed by dividing earnings (loss) available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution, using the treasury stock method, that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. In computing diluted earnings per share, the treasury stock method assumes that outstanding options and warrants are exercised and the proceeds are used to purchase common stock at the average market price during the period. Options and warrants will have a dilutive effect under the treasury stock method only when the average market price of the common stock during the period exceeds the exercise price of the options and warrants.

As of June 30, 2009 and 2008, potentially dilutive securities include options to purchase approximately 315,000 and 1,121,000 shares of common stock and warrants to purchase approximately 1,275,000 and 1,275,000 shares of common stock, respectively. In addition, at June 30, 2009, potentially dilutive securities include Series A Convertible Preferred Stock, which is convertible into 10,000,000 shares of common stock, Series A Warrants, which are convertible into 5,000,000 shares of common stock and convertible notes, which are convertible into approximately 4,037,000 shares of common stock.

Potentially dilutive securities were not included in the calculation of loss for the three and six months ended June 30, 2009 and 2008, because the Company incurred a loss during such periods and thus their effect would be anti-dilutive, and basic and diluted loss per share are the same.

Member Incentives

The Company’s commission structure is based on a multi-tiered affiliate program. Commissions are recorded for sales, including commissions based on bonus points assigned to products which are independent of the product’s price. Commissions totaled $459, $1,091, $1,710 and $3,526 for the three and six months ended June 30, 2009 and 2008 respectively, and are included in the accompanying condensed consolidated statements of operations.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Comprehensive Loss

SFAS 130, “Reporting Comprehensive Income,” established rules for the reporting and display of comprehensive income and its components. SFAS 130 requires unrealized gains or losses on the Company’s foreign currency translation adjustments to be reported as a separate component (comprehensive income/loss) of stockholders’ equity. The components of comprehensive loss are as follows:


	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
Net loss	$	(756	)	$	(1,942	)	$	$(2,657	)	$	(5,055	)

Foreign currency translation		(16	)		(1	)		(8	)		18

Fair value adjustment on investment		—			—			—			273


Comprehensive Loss	$	(772	)	$	(1,943	)	$	(2,665	)	$	(4,764	)

Recent Accounting Pronouncements

In December 2007, Financial Accounting Standards Board (“FASB”) SFAS 141R, “Business Combinations (revised 2007)” was issued. SFAS 141R replaces SFAS 141 “Business Combinations”. SFAS 141R requires the acquirer of a business to recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at fair value. SFAS 141R also requires transactions costs related to the business combination to be expensed as incurred. SFAS 141R applies prospectively to 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, 2008. The effective date, as well as the adoption date for the Company was January 1, 2009. Although SFAS 141R may impact its reporting in future financial periods, the Company has determined that the standard did not have any impact on its historical consolidated financial statements at the time of adoption.

In April 2008 the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets”, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. This pronouncement requires enhanced disclosures concerning a company’s treatment of costs incurred to renew or extend the term of a recognized intangible asset. FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The effective date, as well as the adoption date for the Company was January 1, 2009. Although FSP 142-3 may impact its reporting in future financial periods, the Company has determined that the standard did not have any impact on its historical consolidated financial statements at the time of adoption.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51.” SFAS 160 requires: (a) noncontrolling interests in subsidiaries to be separately presented within equity; (b) consolidated net income to be adjusted to include the net income attributable to a noncontrolling interest; (c) consolidated comprehensive income to be adjusted to include the comprehensive income attributed to a noncontrolling interest; (d) additional disclosures; and (e) a noncontrolling interest to continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance. SFAS 160 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The effective date, as well as the adoption date for the Company was January 1, 2009. Although SFAS 160 may impact its reporting in future financial periods, the Company has determined that the standard did not have any impact on its historical consolidated financial statements at the time of adoption.

In April 2009, the FASB issued FSP No. FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP No. FAS 141(R)-1 amends and clarifies SFAS 141(R), to address application issues raised on initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. FSP No. FAS 141(R)-1 is effective for the first annual reporting period on or after December 31, 2008. The impact of FSP No. FAS 141(R)-1 on the Company’s consolidated financial statements will depend on the number and size of acquisition transactions, if any, engaged in by the Company.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” SFAS 161 amends and expands the disclosure requirements for derivative instruments and hedging activities and is effective for fiscal years beginning after November 15, 2008. SFAS 161 became effective for the Company January 1, 2009. The additional disclosure requirements of SFAS 161 are incorporated in Note 8 of the Company’s condensed consolidated financial statements.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on the Company’s present or future consolidated financial statements.

Note 3. Product, Customer and Geographic Information

SFAS 131, “Disclosure about Segments of an Enterprise and Related Information,” establishes standards for the reporting of business enterprises of information about operating segments, products and services, geographic areas and major customers. The standard for determining what information to report is based on operating segments within the Company that are regularly reviewed and used by the chief operating decision-maker in evaluating financial performance and resource allocation.

The Company’s chief operating decision-maker is considered to be the chief executive officer (CEO). Based on the financial information reviewed by the CEO, the Company has determined that it operates in a single operating segment, specifically, digital web-based communications services.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The following table presents net revenue by category for the three and six months ended June 30, 2009 and 2008.


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2009		2008		2009		2008
Revenue:

Subscription fees for access plans and administrative tools	$	1,151	$	2,951	$	2,637	$	6,432
Affiliate business packages		106		651		286		1,420
Electronic components		—		13		—		346
Upgrades to business packages		39		118		87		262
Merchandise and Shipping fees		5		71		18		161

Total Revenue	$	1,301	$	3,804	$	3,028	$	8,621

The breakdown of revenues generated by geographic region for the three and six months ended June 30, 2009 and 2008 is as follows:


	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2009			2008			2009			2008

United States, Canada & Mexico		84	%		84	%		86	%		86	%
United Kingdom		4	%		3	%		4	%		3	%
Europe		4	%		6	%		3	%		5	%
Australia/New Zealand		8	%		7	%		7	%		6	%

		100	%		100	%		100	%		100	%

Assets and liabilities located in countries outside the United States were not material at June 30, 2009 or 2008.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The breakdown of revenues generated by customer type for the three and six months ended June 30, 2009 and 2008 is as follows:


	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2009			2008			2009			2008
Affiliates		82	%		86	%		82	%		87	%
Retail and other customers		18	%		14	%		18	%		13	%

		100	%		100	%		100	%		100	%

Note 4. Inventories

Inventories, net consisted of the following at June 30, 2009 and December 31, 2008:


	June 30,			December 31,
	2009			2008
Kits, cameras and merchandise	$	308		$	361
Less: Allowance for obsolete inventory		(204	)		(66	)

	$	104		$	295

Note 5. Investments

Investments consist of the following at June 30, 2009 and December 31, 2008:


	June 30, 2009							December 31, 2008
			Unrealized							Unrealized
	Cost		Loss			Net		Cost		Loss			Net
Fusion Telecommunications Int’l Inc.	$	700	$	(590	)	$	110	$	700	$	(531	)	$	169
STB TeleMedia, Inc.		402		—			402		—		—			—

	$	1,102	$	(590	)	$	512	$	700	$	(531	)	$	169

Fusion Telecommunications Int’l Inc.

On May 11, 2007, the Company entered into a Subscription and Rights Agreement with Fusion Telecommunications International, Inc. (“Fusion”) pursuant to which it purchased, for aggregate consideration of $700, 7 units consisting of an aggregate of 700 shares of Fusion’s Series A-2 Cumulative Convertible Preferred Stock (“Series A-2 Preferred Shares”) and warrants to purchase 421,687 shares of Fusion’s common stock. The 700 Series A-2 Preferred Shares are convertible into an aggregate of 843,374 shares of Fusion’s common stock. The warrants have a term of 7.5 years and are exercisable at the per share price of $0.83. Fusion has agreed to register the shares of Fusion’s common stock underlying the Series A-2 Preferred Shares and the warrants.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

At June 30, 2009 and December 31, 2008, the fair value of the Company’s common share equivalents in Fusion was $110 and $169, respectively.

STB TeleMedia, Inc.

In March 2009, the Company exchanged parts and electronic components inventory with a net book value of $402 related to the development of a set top box device and prepaid bandwidth charges paid to a related entity for 416,546 shares of common stock, or approximately 7 percent of the total common stock outstanding, of STB TeleMedia, Inc. (STB TeleMedia). At December 31, 2008, prior to the exchange, the Company classified its investment as assets held for exchange.

STB TeleMedia is a private multimedia communications, entertainment and social networking platform company that incorporated in October, 2008. STB TeleMedia, upon its inception, acquired technology and other assets from three other companies, including DigitalFX International, Inc. and RazorStream, LLC, a related entity (see Note 12), which had developed various elements of STB TeleMedia’s principal product, a unique video broadcasting and receiving device that can be embedded in a large number of products.

Other investors in STB TeleMedia include Richard Kall, the Company’s current CEO and Chairman of the Board.

At June 30, 2009, the Company’s investment in STB TeleMedia totaled $402, which approximates fair value based upon recent cash investments made by unrelated entities into STB TeleMedia.

Note 6. Property and Equipment

Property and equipment at June 30, 2009 and December 31, 2008 consists of the following:


	June 30,			December 31,
	2009			2008
Furniture and fixtures	$	47		$	47

Computers and equipment		441			441
Capital lease equipment		149			149
Purchased software		789			789

		1,426			1,426
Less: accumulated depreciation and amortization		(1,121	)		(940	)

	$	305		$	486

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

All property and equipment above is depreciated over a three year life. Depreciation and amortization expense for the three and six months ended June 30, 2009 and 2008 was $90, $181, $78 and $171, respectively.

Note 7. Convertible Notes Payable

As of June 30, 2009, convertible notes payable consist of the following:


	Loan		Loan			Current		Noncurrent
	Balance		Discount			portion		Portion
Amended and Restated Notes	$	606	$	(149	)	$	457	$	—
Amended and Restated Notes, related party		363		(89	)		274		—

	$	969	$	(238	)	$	731	$	—

As of December 31, 2008, convertible notes payable consist of the following:


	Loan		Loan			Current		Noncurrent
	Balance		discount			portion		Portion
Amended and Restated Notes	$	580	$	(63	)	$	44	$	473
Amended and Restated Notes, related party		359		—			6		353

	$	939	$	(63	)	$	50	$	826

In November 2007, the Company entered into a certain Securities Purchase Agreement, pursuant to which, among other things, the Investors purchased from the Company (i) senior secured convertible notes in the aggregate principal amount of $7,000 (the “Original Notes”), which are convertible into shares of the Company’s common stock, par value $0.001 per share, in accordance with the terms thereof, and (ii) warrants (the “Original Warrants”), which are exercisable into shares of common stock.

On March 24, 2008, the Company entered into an Amendment and Exchange Agreement with each of the above Investors that reduced the principal to $3,000 with each Investor receiving repayment of its pro-rata share of $4,000.

In October, 2008, Richard Kall, the Company’s Chief Executive Officer and majority shareholder, agreed to purchase an aggregate of $350 of the unpaid principal amount of the Amended and Restated Notes, Amended and Restated Warrants to purchase an aggregate of 90,517 shares of the Company’s common stock, and an aggregate of 120,000 shares of common stock previously issued to the Investors.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

On December 22, 2008, the Company, the Investors, and Richard Kall entered into a second restructuring of the Notes issued to the Investors and to Richard Kall whereby the remaining principal balance of the outstanding Notes was reduced by $2,050 to $922 through a combination of 1) a $650 cash payment; 2) transfer of the Company’s shares of common stock in WoozyFly, Inc. valued at $800; and 3) the Company’s issuance to the investors of shares of its common stock valued at $600. As of June 30, 2009, the balance of the Notes included $30 of accrued interest reclassified to the principal amount upon reissuance of the Notes on February 2009. The Amended and Restated Notes have a term expiring November 30, 2010, will carry interest at 7.50% per annum on the unpaid/unconverted principal balance, payable quarterly in arrears in cash beginning April 1, 2009, and will be secured on a senior basis against all of the assets of the Company. The Company will also be required to make aggregate monthly principal payments of $25 plus accrued interest thereon, beginning July 1, 2009. The Amended and Restated Notes will be convertible at the option of the holders thereof prior to their maturity into approximately 4,037,000 shares of Common Stock, based on a conversion price equal to $0.24 per share (subject to adjustment as provided in the Amended and Restated Notes, including pursuant to economic anti-dilution adjustments).

Additionally, if at any time after the date the Amended and Restated Notes are issued, the closing sale price of Common Stock equals or exceeds $0.288 for ten consecutive trading days (as adjusted for any stock splits, stock dividends, recapitalizations, combinations, reverse stock splits or other similar events during such period) and provided that the Company has complied with certain equity conditions, the Company will be able to require the holders to convert 50% of the remaining principal and accrued but unpaid interest of the Amended and Restated Notes into Common Stock. If at any time beginning at least 5 trading days from the date of the initial mandatory conversion, the closing sale price of Common Stock equals or exceeds $0.312 for ten consecutive trading days (as adjusted for any stock splits, stock dividends, recapitalizations, combinations, reverse stock splits or other similar events during such period) and provided that the Company has complied with certain equity conditions, the Company will be able to require the holders to convert the remaining principal and accrued but unpaid interest of the Amended and Restated Notes into Common Stock.

The holders of the Amended and Restated Notes will be entitled to accelerate the maturity in the event that there occurs an event of default under the Amended and Restated Notes, including, without limitation, if the Company fails to pay any amount under the Amended and Restated Notes when due, if a judgment is rendered against the Company in an amount set forth in the Amended and Restated Notes, if the Company breaches any representation or warranty under that certain Securities Purchase Agreement dated November 30, 2007, as amended, or other transaction documents, or if the Company fails to comply with the specified covenants set forth in the Amended and Restated Notes. Among other covenants, the Amended and Restated Notes contain financial covenants whereby the Company will be required to achieve specified EBITDA (earnings before interest, tax, depreciation and amortization) and revenue targets in each of the fiscal quarters during which the Amended and Restated Notes are outstanding. Any failure by the Company to achieve an EBITDA or revenue target will be considered a breach of the financial covenant. For the three months ended June 30, 2009, the Company determined that it was not in compliance with the specified EBITDA and revenue targets as set forth in the Amended and Restated Notes. The Company has not received notice from the holders of the Amended and Restated Notes about their intent to request that the Company redeem any or all of the outstanding notes. At June 30, 2009, the Company reflected the outstanding net principal balance of $731 as a current liability in the Company’s accompanying condensed consolidated balance sheets.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

As further described in Note 8, EITF 07-05 became effective January 1, 2009. In connection with its implementation, the Company was required to classify the conversion feature of the Amended and Restated Notes and the related warrants as derivative liabilities. The cumulative effect of adopting EITF 07-05 resulted in a decrease in the carrying value of the notes as of January 1, 2009 from $876 to $617. The Company recognized $77, $175, $127 and $428 in financing cost expense, which includes interest expense and the amortization of deferred financing costs and the note valuation discount, for the three and six months ended June 30, 2009 and 2008, respectively.

Note 8. Derivative Liability

In June 2008, the FASB finalized Emerging Issues Task Force (“EITF”) 07-05, “Determining Whether an Instrument (or Embedded Feature) is indexed to an Entity’s Own Stock.” Under EITF 07-05, instruments which do not have fixed settlement provisions are deemed to be derivative instruments. The conversion feature of the Company’s Amended and Restated Notes (described in Note 7), and the related warrants, do not have fixed settlement provisions because their conversion and exercise prices, respectively, may be lowered if the Company issues securities at lower prices in the future. The Company was required to include the reset provisions in order to protect the note holders from the potential dilution associated with future financings. In accordance with EITF 07-05, the conversion feature of the notes was separated from the host contract (i.e., the notes) and recognized as an embedded derivative instrument. Both the conversion feature of the notes and the warrants have been re-characterized as derivative liabilities. SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” requires that the fair value of these liabilities be re-measured at the end of every reporting period with the change in value reported in the statement of operations.

The derivative liabilities were valued using a probability weighted Black-Scholes-Merton valuation technique with the following weighted average assumptions:


	June 30,			December 31,			December 22,
	2009			2008			2008
Conversion feature:
Risk-free interest rate		1.58	%		1.58	%		1.58	%
Expected volatility		101.54	%		101.54	%		101.54	%
Expected life (in years)	1.50 years			2.0 years			2.0 years
Expected dividend yield		0			0			0

Warrants:
Risk-free interest rate		1.58	%		1.58	%		1.58	%
Expected volatility		101.54	%		101.54	%		101.54	%
Expected life (in years)	3.50 years			4.0 years			4.0 years
Expected dividend yield		0			0			0

Fair Value:
Conversion feature	$	143		$	104		$	259
Warrants	$	34		$	27		$	65

	$	177		$	131		$	324

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The risk-free interest rate was based on rates established by the Federal Reserve. The expected volatility is based on the Company’s historical volatility for its common stock. The expected life of the conversion feature of the notes was based on the term of the notes and the expected life of the warrants was determined by the expiration date of the warrants. The expected dividend yield was based on the fact that the Company has not paid dividends to common shareholders in the past and does not expect to pay dividends to common shareholders in the future.

EITF 07-05 was implemented in the first quarter of 2009 and is reported as a cumulative change in accounting principles. The cumulative effect on the accounting for the conversion feature of the notes and the warrants is as follows:


	Additional			Accumulated		Derivative		Convertible
	Paid-in Capital			Deficit		Liability		Notes
Derivative Instrument:
Conversion feature	$	—		$	155	$	104	$	(259	)
Warrants	$	(65	)	$	38	$	27	$	—

	$	(65	)	$	193	$	131	$	(259	)

The warrants were originally recorded at their relative fair value as an increase in additional paid-in capital. The change in the accumulated deficit includes gains resulting from decreases in the fair value of the derivative liabilities through December 31, 2008. The derivative liability amounts reflect the fair value of each derivative instrument as of the January 1, 2009 date of implementation. The convertible notes amounts represent the additional discount recorded upon adoption of EITF 07-05. This discount will be recognized on a monthly basis through the maturity date of the notes.

Note 9. Equity Transactions

Authorization and Issuance of Series A Preferred Stock

On December 18, 2008, the Company filed Articles of Amendment of its Articles of Incorporation with the Florida Secretary of State designating a new series of preferred stock consisting of 3,000,000 shares and known as Series A 12% Cumulative Convertible Preferred Stock (“Series A Preferred Stock”). Each share of Series A Preferred Stock accrues dividends at the rate of 12% per annum, paid quarterly, as permitted under State of Florida law, on the original purchase price of $1.00, is convertible into 5 shares of Common Stock (subject to adjustment as provided in the Articles of Amendment and the conversion cap), votes on all matters with the shares of Common Stock on an as-converted basis (subject to the voting cap), has an initial liquidation preference equal to the original purchase price plus accrued dividends, participates with the Common Stock on an as-converted basis in the event that the initial liquidation preference for the Series A Preferred Stock is fully paid, and is entitled to vote as a separate class on certain significant matters.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Prior to approval by the Company’s shareholders of the issuance of more than 19.9% of outstanding shares of Common Stock on December 19, 2008, the Series A Preferred Stock is not permitted to convert into (the “conversion cap”), nor permitted to vote shares representing (the “voting cap”), more than 19.9% of the outstanding shares of Common Stock on December 19, 2008.

On December 22, 2008, Richard Kall, the Company’s Chairman of the Board and Chief Executive Officer, and manager of the Company’s majority shareholder purchased from the Company, for an aggregate purchase price of $2,000, 2,000,000 shares of Series A Preferred Stock and a warrant to purchase 1,000,000 shares of Series A Preferred Stock (“Series A Warrant”), with a term of 5 years and an exercise price of $1.00 per share. Mr. Kall paid the aggregate purchase price through an advance on November 14, 2008 of $500 to the Company, an advance on December 18, 2008 of $200 to the Company, and a cash payment of $1,300 on December 22, 2008.

The fair value of the Series A Warrant, which was calculated using the Black-Sholes-Merton pricing model, which used the following assumptions: 5 year term, volatility of 101.54% and risk-free interest rate of 1.58%, totaled $240 and has been presented as a preferred stock dividend in the Company’s consolidated statements of operations and stockholders’ equity for the year ended December 31, 2008.

During the six months ended June 30, 2009, the Company accrued $120 of dividends due to Mr. Kall in accordance with the preferred stock agreement.

Other Equity Transactions

On April 1, 2009, the Company granted 500,000 shares of fully paid common stock to Abraham Sofer, the Company’s President, for services rendered and 250,000 shares of fully paid common stock to Tracy Sperry, the Company’s Chief Financial Officer for services rendered. In addition, during the six months ended June 30, 2009, the Company also granted 650,000 shares of common stock to consultants for services rendered. For the six months ended June 30, 2009, the Company recognized compensation expense for these grants of $188, as they represent compensation for past services, in the accompanying condensed consolidated statements of operations, which was the market value of the shares on the date of grant.

Note 10. Loan from Shareholder

In 2009, Richard Kall advanced the Company $970 for operating purposes. The terms of the financial instrument, which will include this advance and the $230 advanced to the Company in July 2009 as described in Note 15, are currently being negotiated. The requirements of the convertible notes payable described in Note 7 require that this instrument be subordinated to it, thus the Company has classified the advance as a non-current liability in its condensed consolidated balance sheets.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Note 11. Stock Options and Warrants

Options

The Company’s 2006 Stock Incentive Plan was adopted by its Board of Directors and became effective in August, 2006. The total number of shares reserved for issuance under this plan was 1,537,501. The number of shares reserved for issuance under the 2006 Stock Incentive Plan is subject to an annual increase on the first day of each fiscal year during the term of the 2006 Stock Incentive Plan, beginning January 1, 2007, in each case in an amount equal to the lesser of (i) 1,000,000 shares of common stock, (ii) 5% of the outstanding shares of common stock on the last day of the immediately preceding year, or (iii) an amount determined by the Company’s board of directors. Any shares of common stock subject to an award, which for any reason expires or terminates unexercised, are again available for issuance under the 2006 Stock Incentive Plan. On July 23, 2008, the Company’s board of directors and shareholders voted to increase the total number of shares reserved for issuance under the 2006 Stock Incentive Plan to 5,000,000.

The 2006 Stock Incentive Plan will terminate after 10 years from the effective date, unless it is terminated earlier by the Company’s board of directors. The plan authorizes the award of stock options, stock purchase grants, stock appreciation rights and stock units.

The 2006 Stock Incentive Plan provides for the grant of both incentive stock options that qualify under Section 422 of the Internal Revenue Code and nonqualified stock options. Incentive stock options may be granted only to the Company’s employees or to employees of any of the Company’s parents or subsidiaries. All awards other than incentive stock options may be granted to the Company’s employees, officers, directors, consultants, independent contractors and advisors or employees, officers, directors, consultants, independent contractors and advisors of any of the Company’s parents or subsidiaries. The exercise price of incentive stock options must be at least equal to the fair market value of the Company’s common stock on the date of grant. The exercise price of incentive stock options granted to 10% shareholders must be at least equal to 110% of that value. The exercise price of nonqualified stock options will be determined by the administrator of the plan when the options are granted. The term of options granted under the Company’s 2006 Stock Incentive Plan may not exceed 10 years and typically vest over four years, with 25% of the options vesting after 12 months and 75% vesting monthly over the remaining three years.

As of June 30, 2009, approximately 1,750,000 shares were available for grant under the 2006 Stock Incentive Plan.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The following is a summary of option activity (including plan and non-plan options) for the six months ended June 30, 2009 (in thousands, except per share data):


						Weighted
				Range of Exercise		Average
	Shares			Prices		Exercise Price
Outstanding at December 31, 2008		830,000		$	0.26-$1.21	$	0.91
Granted		—			—		—
Exercised		—			—		—
Cancelled		(515,000	)	$	0.55-$1.21	$	.99

Outstanding at June 30, 2009		315,000		$	0.26-$1.21	$	0.79

Exercisable at June 30, 2009		222,000		$	0.26-$1.21	$	0.65

The following table summarizes information regarding options outstanding at June 30, 2009:


							Weighted Average
					Weighted		Remaining
					Average		Contractual Term		Aggregate
	Shares		Exercise Price		Exercise Price		(months)		Intrinsic Value
Shares Granted Quarter Ended December 31, 2005		139,000	$	0.26	$	0.26		8		—
Shares Granted Quarter Ended June 30, 2008		176,000	$	1.21	$	1.21		60		—

Outstanding at June 30, 2009		315,000	$	0.26-$1.21	$	0.79		68	$	—

Exercisable at June 30, 2009		222,000	$	0.26-$1.21	$	0.65		55	$	—

The Company recognized compensation expense from vesting of stock options of $27, $83, $160 and $286 for the three and six months ended June 30, 2009 and 2008, respectively, and had estimated future compensation expense from these stock options of $127 at June 30, 2009 which will be recognized over the remaining estimated weighted useful life of the options.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Warrants

The following is a summary of common stock warrant activity for the six months ended June 30, 2009 (in thousands, except per share data):


					Weighted
			Range of Exercise		Average
	Shares		Prices		Exercise Price
Outstanding at December 31, 2008		1,275,000	$	0.26-$0.959	$	0.79
Granted		—		—		—
Exercised		—		—		—
Cancelled		—		—		—

Outstanding at June 30, 2009		1,275,000	$	0.26-$0.959	$	0.79

Exercisable at June 30, 2009		1,275,000	$	0.26-$0.959	$	0.79

The following table summarizes information regarding common stock warrants outstanding at June 30, 2009:


					Weighted Average
					Remaining
					Contractual Term		Aggregate
	Shares		Exercise Price		(months)		Intrinsic Value
Outstanding at June 30, 2009		1,275,000	$	0.26-$0.959		40	$	—


Exercisable at June 30, 2009		1,275,000	$	0.26-$0.959		40	$	—

In addition, as described in Note 10, in December 2008, the Series A Preferred Stock issued to Richard Kall included a warrant to purchase 1,000,000 shares of Series A Preferred Stock (“Series A Warrant”), with a term of 5 years and an exercise price of $1.00 per share. The Series A Warrants are convertible into 5,000,000 shares of common stock.

Note 12. Related Parties

RazorStream, LLC

On January 29, 2007, the Company entered into an Amended and Restated License, Hosting and Services Agreement (the “Amended Agreement”) with RazorStream, LLC (“RazorStream”). The Amended Agreement amends and restates the Licensing, Hosting and Services Agreement effective May 1, 2005, between the Company and RazorStream.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Pursuant to the terms of the Amended Agreement, RazorStream will provide hosting, maintenance and support services for each individual website operated by the Company or any third party authorized by the Company. While the initial term of the Amended Agreement ended on January 15, 2008, the Amended Agreement remains operative thereafter unless terminated by either party upon 60 days prior written notice. Under the terms of the Amended Agreement, for each individual website operated by the Company or any third party authorized by the Company, RazorStream (a) charges the Company $5 (not in thousands) per new subscriber account exceeding 20,000 accounts (purchasable in 20,000 account increments); (b) is entitled to (1) ten percent (10%) of the Company’s total gross revenue from all active subscriber accounts, with a minimum amount of $0.69 per each such subscriber account per month, and (2) some portion of revenue to be mutually agreed upon by the parties for all advertising-based “free” subscriber accounts (which the Company does not currently provide), provided, however that such terms will provide for a minimum amount of $0.25 (not in thousands) per each such subscriber account per month (which cost the Company will account for as marketing expense); and (c) effective February 1, 2007, is entitled to a minimum guarantee of $50 per month that is non-refundable but that will be credited against the above fees. The Company may, from time to time, engage RazorStream for non-recurring engineering services at a rate of $200 (not in thousands) per hour. The fees above apply independently to each individual website operated by the Company or any third party authorized by the Company, and no fees charged with respect to any individual website, and no subscriber account applied with respect to any individual website, shall be aggregated with any fees or subscriber accounts, respectively, applied to any other website.

Effective upon the change in control in October 2008, the Company further amended its agreements with RazorStream. Under the terms of the amended agreements, the Company agreed to pay a fixed fee of $105 in the aggregate for the above described services to all websites owed by the Company, payable in advance on the 1^st and 15^th of every month, until the agreements are terminated by either party upon 45 days notice. On March 13, 2009, the Company advised RazorStream of its intent to terminate the above agreements on April 30, 2009.

In connection with the services discussed above, the Company incurred expenses of $98, $418, $364, and $734 during the three and six months ended June 30, 2009 and 2008, respectively.

AttainResponse, LLC

On December 17, 2008, the Company acquired an option (the “Option”) to purchase up to 48% of the outstanding equity securities or other interests (the “Option Interest”) in AttainResponse LLC, a Colorado based company (“AttainResponse”) which engages in the development and management of content delivery applications to include text and video email hosting, email marketing and streaming video hosting, currently marketed under the brand “F5.”

The Option was acquired from the majority members of AttainResponse who together own and control over 70% of the company. The Option can be exercised by the Company during a period of 12 months starting December 17, 2008 (the “Option Term”), through the Company’s issuance of an aggregate of 4,375,000 shares of the Company’s common stock to the AttainResponse’s members participating in the Option.

In consideration for entering into the Option, the Company also agreed to assume up to $118 of debt owed by AttainResponse. In June 2009, the Company issued 493,750 shares of its common stock to stockholders of AttainResponse in satisfaction of this debt. The Company recognized this stock issuance as an expense of $118 in its condensed consolidated statements of operations for the three months ended June 30, 2009.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

The exercise of the Option is conditioned upon the completion of additional research and development tasks and a seamless integration of AttainResponse’s technology with the Company’s technology, as well as the entry into the license and service agreement. If the monthly revenues of the Company reach $1,500 during the Option Term, the Company will be obligated to exercise the Option.

Until the license and service agreement is finalized, the Company has agreed to pay AttainResponse $85 per month for licensing and service fees, on a month to month basis. For the three and six months ended June 30, 2009, the Company has paid AttainResponse $255 and $510, respectively.

Other Related Party Transactions

During the three and six months ended June 30, 2009 and 2008, the Company made payments to Vayan Marketing Group, LLC totaling $0, $5, $15 and $15, respectively under a month to month agreement to provide auto-responder services to the Company. An officer of Vayan Marketing Group, LLC is an immediate family member of the Company’s Chief Executive Officer and Chairman of the Board, Richard Kall.

In addition, the Company pays commissions to various family members of the current and previous management in the normal course of business as affiliates of VMdirect. For the three and six months ended June 30, 2009 and 2008, these payments totaled $63, $126, $173, and $345 respectively.

Note 13. Income Taxes

The provision (benefit) for income taxes consists of the following for the six months ended June 30, 2009 and 2008:


	Six Months Ended			Six Months Ended
	June 30,			June 30,
	2009			2008

Current tax provision — federal	$	—		$	—
- foreign		—			—
Deferred tax provision- federal		(46	)		28
- foreign		—			—

Income tax provision (benefit)	$	(46	)	$	28

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

A reconciliation of the statutory federal income tax rate to the effective tax rate is as follows for the six months ended June 30, 2009 and 2008:


	Six Months Ended			Six Months Ended
	June 30,			June 30,
	2009			2008
Income before income tax provision	$	(2,703	)	$	(5,027	)

Expected tax (federal statutory rate 34%)		(919	)		(1,709	)
Permanent differences		46			193
Change in valuation allowance		854			1,539
Other differences		(27	)		5

Income tax provision	$	(46	)	$	28

Effective January 1, 2007, the Company adopted Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”)—an interpretation of FASB Statement No. 109, Accounting for Income Taxes. The Interpretation addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under FIN 48, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. FIN 48 also provides guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures. At the date of adoption, and as of June 30, 2009, the Company does not have a liability for unrecognized tax benefits.

The Company files income tax returns in the U.S. federal jurisdiction. The Company is subject to U.S. federal income tax examinations by tax authorities for periods after June 16, 2006, the date at which the Company completed its reverse merger transaction. In addition, the Company files income tax returns in the United Kingdom and Ireland for the foreign subsidiaries located in these jurisdictions. The Company is subject to tax examinations by tax authorities in these jurisdictions. As of June 30, 2009, there are no open foreign income tax audits or related inquiries regarding the Company’s foreign subsidiaries.

The Company’s policy is to record interest and penalties on uncertain tax provisions as income tax expense. As of June 30, 2009, the Company has no accrued interest or penalties related to uncertain tax positions.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

Note 14. Commitments and Contingencies

Legal Proceedings

From time to time, the Company may be involved in litigation relating to claims arising out of its operations in the normal course of business. Except as is described below, the Company is not currently party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on its results of operations or financial position.

On February 7, 2007, VMdirect and DigitalFX Solutions, LLC, a Nevada limited liability company and wholly-owned subsidiary of the Company (“DigitalFX Solutions”) jointly filed a lawsuit in the Superior Court of the State of California for the County of Los Angeles against a former Affiliate of VMdirect alleging a number of complaints including unfair business practice, misappropriation of trade secrets, slander, intentional interference with contractual relationship, intentional interference with prospective economic advantage and breach of contract, and seeking compensatory and punitive damages in amounts to be proved at trial, injunctive relief and attorneys’ fees and costs. The defendant became an Affiliate of VMdirect in May 2006 and agreed to adhere to VMdirect’s Code of Ethics for Affiliates. Upon signing up as an Affiliate, defendant represented that he was capable of bringing a substantial number of new Affiliates to VMdirect, and in reliance on this representation, VMdirect agreed to provide certain privileges to defendant including posting of training materials on VMdirect’s website. VMdirect also agreed to work with defendant to develop training materials. Although VMdirect paid for all of the costs of developing the materials and its personnel actively participated in the development of such materials, defendant demanded aggregate compensation of $300 for creating the training and motivational materials after they were completed. After VMdirect did not pay this fee to defendant, defendant requested that VMdirect stop using the materials, began disparaging VMdirect and its officers, and engaged in cross-recruiting Affiliates from other VMdirect networks, a practice prohibited by VMdirect’s Code of Ethics for its Affiliates. VMdirect then terminated defendant’s distribution network and believes that defendant continues to use VMdirect’s proprietary trade secrets to recruit Affiliates to join other network marketing companies that compete with VMdirect.

On March 6, 2007, the Company, along with VMdirect and DigitalFX Solutions, was served with a cross complaint for damages filed in the Superior Court of California for the County of Los Angeles, by this same former Affiliate for alleged breach of contract, fraud-intentional misrepresentation, fraud-intentional concealment/omission, fraud-false promises, negligent misrepresentation and infringement of the rights of publicity and privacy, and seeking general, exemplary and punitive damages in amounts to be determined at trial and an order enjoining the Company’s use of his name, image, photograph and likeness for any purpose without his written consent. This former Affiliate alleges that the officers of VMdirect agreed to grant him 60,000 shares of the Company’s common stock, agreed to pay him a percentage of sales to small businesses and enterprises in connection with his creation of certain training materials, agreed to pay for the costs of all training materials created by him and agreed that all training materials which contained his likeness would remain his intellectual property. This former Affiliate also alleges that it was expressly agreed that a copy of such materials would be made available to him for posting as promotional materials on his own website and that his consent for VMdirect to use his image and likeness on its websites would be revocable at any time.

DigitalFX International, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements
(In Thousands, Except for Share and Per Share Data)
Six Months Ended June 30, 2009 and 2008 (unaudited)

On August 31, 2007, the former Affiliate unsuccessfully applied for a temporary restraining order (“TRO”) to enjoin VMdirect from using on its website the training materials featuring the former Affiliate. As a result of this unsuccessful application, the Court ordered VMdirect and DigitalFX Solutions to qualify to do business in California if they wished to proceed with their complaint against the former Affiliate. On December 10, 2007, DigitalFX Solutions qualified to do business in California. On December 14, 2007, VMdirect qualified to do business in California.

On November 20, 2008, VMdirect and DigitalFX Solutions dismissed their complaint against the former Affiliate and in April 2009, filed notices with the State of California informing the State of termination of business in that state. Trial on the former Affiliate’s cross-complaint was set for May 18, 2009. The trial date was vacated and the parties were ordered to mediation, presently set to occur on August 21, 2009. A new trial setting conference and post mediation status conference is set for September 10, 2009.

Management believes there exists no basis for the former Affiliate’s claims and intends to defend this matter vigorously. In the event the Company’s management’s assessment of the case is incorrect, or the former Affiliate actually obtains a favorable judgment for the claimed damages, the economic impact on us should not materially affect our operations.

Mr. Mickey Elfenbein served as the Company’s Chief Operating Officer from September 17, 2007 through October 17, 2008. Mr. Elfenbein was party to an employment agreement with the Company pursuant to which Mr. Elfenbein received base compensation at an annual rate of no less than $250. The employment agreement had a term of three years subject to automatic one-year renewals unless either party provided 120 days prior written notice to the other of non-renewal. If the Company were to terminate Mr. Elfenbein’s employment for any reason other than for cause (as defined in the employment agreement), his death or his permanent disability, or if Mr. Elfenbein terminates his employment due to a constructive termination (as defined in the employment agreement), the Company is required to pay Mr. Elfenbein his then current base salary for a period of 12 months, and to continue his benefits (covering Mr. Elfenbein and his family) for the same period, unless Mr. Elfenbein commences other employment pursuant to which he receives comparable benefits. On October 17, 2008, the Company terminated its relationship with Mr. Elfenbein, and the Company continues to negotiate the terms of Mr. Elfenbein’s separation. The Company believes the matter will be settled through arbitration. The Company believes that it had cause to terminate Mr. Elfenbein, and that no further amounts will be due or payable to him, and there is no accrual for severance or termination claims necessary as of June 30, 2009.

Note 15. Subsequent Events

In July 2009, Richard Kall advanced the Company an additional $230 for operating purposes. The terms of the financial instrument that will evidence these advances are currently being negotiated.


Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Statements made in this Form 10-Q (the “Quarterly Report”) that are not historical or current facts are “forward-looking statements” made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). We intend that such forward-looking statements be subject to the safe harbors for such statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. Any forward-looking statements represent management’s best judgment as to what may occur in the future. These forward-looking statements include the plans and objectives of management for our future growth, including plans and objectives related to the consummation of acquisitions and future private and public issuances of our equity and debt securities. The forward-looking statements included herein are based on current expectations that involve numerous risks and uncertainties. Assumptions relating to the foregoing involve judgments with respect to, among other things, future economic, competitive and market conditions and future business decisions, all of which are difficult or impossible to predict accurately and many of which are beyond our control. Although we believe that the assumptions underlying the forward-looking statements are reasonable, any of the assumptions could be inaccurate and, therefore, there can be no assurance that the forward-looking statements included in this Form 10-Q will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that our objectives and plans will be achieved. We disclaim any obligation subsequently to revise any forward-looking statements to reflect events or circumstances after the date of such statement or to reflect the occurrence of anticipated or unanticipated events.

References to the “Company” refer to DigitalFX International, Inc. The words or phrases “may,” “will,” “expect,” “believe,” “anticipate,” “estimate,” “approximate,” or “continue,” “would be,” “will allow,” “intends to,” “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” or similar expressions, or the negative thereof, are intended to identify “forward-looking statements.” Actual results could differ materially from those projected in the forward looking statements as a result of a number of risks and uncertainties, including but not limited to: (a) our failure to implement our business plan within the time period we originally planned to accomplish; and (b) other risks that are discussed in this Form 10-Q or included in our previous filings with the Securities and Exchange Commission (“SEC”).

Description of Business

Corporate History

DigitalFX International, Inc. was incorporated in the State of Florida on January 23, 1991. Prior to November 2001, we provided intelligent message communications services to enterprises in the travel and hospitality sectors. In November 2001, we sold substantially all of our assets to Avery Communications, Inc. after which we continued without material business assets, operations or revenues. On June 22, 2004, we consummated the transactions contemplated by a Securities Purchase Agreement (the “Purchase Agreement”) dated June 10, 2004, by and among our company, Keating Reverse Merger Fund, LLC (“KRM Fund”), Thurston Interests, LLC (“Thurston”) and certain other shareholders of our company. The transactions resulted in a change of control whereby KRM Fund became our majority shareholder. From November 2001 through June 15, 2006, we were a public “shell” company with nominal assets.

On May 23, 2006, we entered into an Exchange Agreement (the “Exchange Agreement”) with VMdirect, L.L.C., a Nevada limited liability company (“VMdirect”), the members of VMdirect holding a majority of its membership interests (together with all of the members of VMdirect, the “VMdirect Members”), and KRM Fund. The closing of the transactions contemplated by the Exchange Agreement occurred on June 15, 2006. At the closing, we acquired all of the outstanding membership interests of VMdirect (the “Interests”) from the VMdirect Members, and the VMdirect Members contributed all of their Interests to us. In exchange, we issued to the VMdirect Members 1,014,589 shares of our Series A Convertible Preferred Stock, par value $0.01 per share (the “Preferred Shares”), which, as a result of the approval by a substantial majority of our outstanding shareholders entitled to vote and the approval by our board of directors on June 22, 2006, of amendments to our articles of incorporation that (i) changed our name to DigitalFX International, Inc., (ii) increased our authorized number of shares of common stock to 100,000,000, and (iii) adopted a 1-for-50 reverse stock split, on August 1, 2006 converted into approximately 21,150,959 shares of our common stock on a post-reverse stock split basis.

At the closing, VMdirect became our wholly-owned subsidiary. The exchange transaction was accounted for as a reverse merger (recapitalization) with VMdirect deemed to be the accounting acquirer, and our company deemed to be the legal acquirer.

Business Overview

We are a direct selling company offering an exclusive suite of internet marketing tools which include enhanced video and audio email service, live webcasting, on demand video conferencing and a state-of-the-art e-marketing campaign manager. As such, we are the only company in the marketplace combining Web 2.0 applications as the products, and a multi-tiered system as the sales force. Based in Nevada, our distribution network spans over 17 countries, yet most of our revenues currently are derived from the U.S. market.

Starting in fiscal 2009, we shifted our product focus from social networking to internet marketing products for small business users, and launched the ComF5 Suite (“F5”) product line, which became available for sale in June. The F5 product enables our users to easily create and distribute email marketing campaigns at an affordable price. F5 is powered by technology provided by AttainResponse, LLC, a Colorado based company (“AttainResponse”). In December 2008, we acquired an option to purchase up to 48 percent of AttainResponse. AttainResponse’s technology will be sold exclusively through our company.

In 2006, VMdirect, the predecessor of our company and today one of our subsidiaries, went through a reverse merger to create DigitalFX International, Inc. as a publicly traded holding company for three business divisions (VMdirect—product subscriptions for Affiliates, helloWorld—retail social networking product; and AttainResponse—internet marketing tools for small and medium sized businesses, i.e., the F5 product, which replaced the FirstStream product in the second quarter of 2009). From 2003 through 2006 we attained a significant level of growth primarily because free online video postings (YouTube, MySpace, FaceBook, etc.) were not prevalent and video mail was a relatively new application. This growth pattern was reversed due to competition and to mismanaged product launches in late 2006, throughout 2007 and most of 2008. Our Affiliate and customer base continued to decline as we struggled to stabilize our product offerings. In an effort to turn revenues around, we went through a complete management and products overhaul during the fourth quarter of 2008.

Today we are headed by Richard Kall, an icon in the direct marketing industry, who has the support of a team of industry experts. Holding the positions of Chief Executive Officer and Chairman of our board of directors, Mr. Kall is also the manager of our majority shareholder and has recently invested a substantial amount of cash which enabled us to restructure our external debt.

Our new management team, having determined that we previously lacked the appropriate focus and execution and had missed out on various opportunities in our targeted markets, immediately put in place, and is now executing, a much more focused plan based on its many years of experience in direct marketing, internet video, technology, strategic alliances, financial markets, and Web 2.0 applications development.

Our plan to grow our business focuses on five key strategies:

•

Narrow focus on market niches where operations will generate positive cash flow and be economically feasible by setting attainable profitability targets;

•

Increase shareholder value;

•

Strengthen Affiliate compensation;

•

Provide unique and complete business tools to our Affiliates; and

•

Provide world class products.

In addition, in fiscal 2009 we ceased our marketing efforts to become a video based social network and shifted our focus to providing video enabled Web 2.0 communication tools to small businesses and organizations.

Results of Operations

Three and Six Months Ended June 30, 2009 Compared with Three and Six Months Ended June 30, 2008 (in thousands, except for customer base data)

As described above, during 2008 we experienced a reversal in the growth of our affiliate base due to increased competition in the marketplace and lack of focus on our product offerings. While we continue to cut costs and reduce overhead, our results correlate directly to the decline in our customer base further effected by significant non-cash, non-operating expenses related to the fair value adjustment required by recent accounting pronouncement EITF 07-05, which requires us to value through earnings the embedded conversion feature of our convertible notes and the related warrants, our stock-based compensation expense and unrealized losses on investments made prior to the change in control.

The new management team that took over in the fourth quarter of 2008 is committed to a complete turnaround of our business through renewed focus and exciting new products geared towards the burgeoning email marketing industry. We anticipate strong performance from the F5 launch and we believe we will see a marked improvement in our financial position and results of operations in the third and fourth quarters of 2009.

The following table presents revenue by category for the three and six ended June 30, 2009 and 2008.


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2009		2008		2009		2008
Revenue:

Subscription fees for access plans and administrative tools	$	1,151	$	2,951	$	2,637	$	6,432
Affiliate business packages		106		651		286		1,420
Electronic components		—		13		—		346
Upgrades to business packages		39		118		87		262
Merchandise and Shipping fees		5		71		18		161

Total Revenue	$	1,301	$	3,804	$	3,028	$	8,621

Net revenues decreased $2,503 or 66% and $5,593 or 65% from the three and six months ended June 30, 2008 to the corresponding periods in 2009. This decrease relates directly to the number of active customers.

The following is a breakdown of our active customer base as of June 30, 2009 and 2008:


	June 30,		June 30,
	2009		2008
Affiliates		3,520		9,455
Retail subscribers		5,139		12,258

Total active customers		8,659		21,713

We strongly believe that with our new management team in place and shift in focus to internet marketing products, we will see substantial growth in our customer base in 2009 and beyond.

Gross Profit

As a percentage of sales, gross profit decreased from 82% of sales to 56% of sales from the three months ended June 30, 2008 to the three months ended June 30, 2009, respectively and from 80% of sales to 54% of sales from the six months ended June 30, 2008 to the six months ended June 30, 2009. The decrease in gross profit in the current year relates to the fixed component of the costs associated with maintaining our websites. Additionally, during the first quarter of 2009, as we transitioned to the F5 product, we carried the cost of maintaining two platforms. We expect our gross profit to improve starting in the third quarter driven by growth in sales and a decrease in fixed costs as we completed the transition to the new F5 platform and no longer are carrying the cost of maintaining two platforms.

Commission Expenses

As a percentage of sales, commission expenses decreased from 45% of sales to 35% of sales for the three months ended June 30, 2008 to the three months ended June 30, 2009, respectively, and decreased from 41% of sales to 36% of sales for the six months ended June 30, 2008 to the six months ended June 30, 2009, respectively. Commission expenses for the three and six months ended June 30, 2008 included consulting fees related to our international sales. On an on-going basis, we expect commission expenses as a percentage of sales to stay in the range of 35%-38%.

Other Operating Expenses

The following table represents a breakdown of other operating expenses for the three and six months ended June 30, 2009 and 2008. These comparisons are not necessarily indicative of future spending.


	Three Months Ended				Six Months Ended
	June 30,		June 30,		June 30,		June 30,
	2009		2008		2009		2008
Salaries, benefits and other compensation	$	577	$	1,406	$	1,378	$	2,661
Corporate expenses		180		242		451		538
Product development		—		255		111		395
International deployment and administration		40		106		85		245
Merchant fees		47		148		110		336
Marketing expenses		5		187		26		261
General and administrative		454		468		806		838

Total Other Operating Expenses	$	1,303	$	2,812	$	2,967	$	5,274

In the three months ended June 30, 2009, while other operating expenses decreased by $1,509, or 54% from the quarter ended June 30, 2008, as a percentage of revenue, they represented 100% in the second quarter of 2009 versus 73% in the corresponding period in 2008. In the six months ended June 30, 2009, while other operating expenses decreased by $2,307, or 44% from the six months ended June 30, 2008, as a percentage of revenue, they represented 98% versus 61% in the corresponding period in 2008. We have taken significant steps to control costs and reduce overhead expenses. We have reprioritized a number of initiatives as we strive for simplification and product solidification as evidenced by our F5 product launch. As such, we recently revised our personnel structure by reducing resources in non-core areas and enhancing personnel focused on the delivery of our new product. We do not believe these revisions have inhibited growth or quality of services. In addition, we have decreased spending on other areas, including outside consultants, legal and international expansion. We expect that our other operating expenses will decrease as a percentage of revenue through these ongoing efforts.

Other expense, net decreased by $785 to $(281) in the three months ended June 30, 2009 from $504 in the corresponding period in 2008 and by $2,875 to $280 for the six months ending June 30, 2009 from $3,155 for the corresponding period in 2008. This decrease relates mainly to non-cash items incurred in the three and six months ended June 30, 2008, including the loss on modification of debt of $1,920, which occurred when our convertible notes were first restructured in March of 2008. As we recorded a $325 loss on our investment in a company owned by a former officer of the Company in the three months ended June 30, 2008, our unrealized losses on investments decreased from $376 in the three months ended June 30, 2008 to a gain of $17 in the same period in 2009. In addition, financing costs related to our convertible notes went from $127 and $428 in the three and six months ended June 30, 2008, respectively to $77 and $175 for the three and six months ended June 30, 2009 as a result of the restructuring of the notes in 2008 which lowered our principal balance in 2009.

Liquidity and Capital Resources (in thousands, except for share data)

Our cash requirements are principally for working capital. Historically, we have funded our working capital needs through operations, the sale of equity and debt interests and through capital contributions from related parties. We anticipate that we will continue to fund our working capital needs through these methods.

We will require additional external capital to fund our ongoing operations. While there are currently no definitive plans for debt or equity financing and we currently have no committed sources of external capital, we intend to vigorously pursue external financing options during the third and fourth quarters of 2009. There can be no assurance that external financing will be available to us, or if available, that it would be available on terms acceptable to us. If revenues do not increase to a level sufficient to operate our business of if we are unable to obtain acceptable external financing, we will have to make a determination as to how to continue our business.

The accompanying condensed consolidated financial statements (see Item 1) have been prepared assuming we will continue as a going concern. We incurred a net loss of $2,657 and utilized cash in operating activities of $1,374 during the six months ended June 30, 2009, and as of June 30, 2009 our current liabilities exceeded current assets by $2,485. These matters raise substantial doubt about our ability to continue as a going concern.

We believe that the recent change in the management will result in our return to profitable operations through our new product offerings and cost cutting practices. We will also continue to seek to finance future capital needs through various means and channels, such as issuance of long-term debt or sale of equity securities. However, there can be no assurances that we will be successful in this regard or will be able to eliminate our working capital deficit or operating losses. The accompanying financial statements do not contain any adjustments which may be required as a result of this uncertainty.

For the six months ended June 30, 2009, cash used by Operating Activities was $1,374 and consisted of net loss of $2,657 that was offset by substantial non-cash items totaling $785, including loss on derivative financial instruments of $46, unrealized losses on investments of $59, stock option expense of $83 and stock issued for services totaling $306 and by changes in operating assets and liabilities.

For the six months ended June 30, 2008, cash used by Operating Activities was $2,213 and consisted of net loss of $5,055 increased by non-cash items of $3,660, including $1,920 related to restructuring of debt and decreased by $818 due to changes in other operating assets and liabilities.

For the six months ended June 30, 2009, we had no Investing Activities.

For the six months ended June 30, 2008, net cash used in Investing Activities related to the exercise of warrants to acquire an interest in SaySwap of $100 and software licenses purchased totaling $204 (including $149 of anti-spam technology financed through a capital lease arrangement).

For the six months ended June 30, 2009, net cash provided by Financing Activities was $947 and consisted of the proceeds from advances from Richard Kall of $970 net of the repayment of capital lease financing for our anti-spam program of $23.

For the six months ended June 30, 2008, net cash used in Financing Activities included proceeds from the exercise of stock options of $2 offset by the cash repayment of $2,000 related to the restructuring of the convertible notes ($2,000 of restricted cash was also repaid as part of the restructuring of the convertible notes), $25 principal payment on the Amended and Restated Notes, and proceeds from capital lease financing of anti-spam technology of $149.

As fully described in Notes 7, 9 and 10 in the Notes to the condensed consolidated financial statements, we are party to the following recent financing transactions:

•

In November 2007, we received $7,000 from institutional investors in exchange for senior secured convertible notes (“Notes”). In March 2008, the terms of the Notes were restructured and we returned $4,000 of the funds. We also issued an aggregate of 1,000,000 shares of our common to the investors in connection with the March 2008 restructuring. In October 2008, Richard Kall, our Chief Executive Officer and Chairman, purchased $350 of the Notes from the investors.

•

In December 2008, the Notes were further restructured and the remaining principal balance was reduced by $2,050 through a combination of 1) a $650 cash payment; 2) transfer of our shares of common stock in WoozyFly, Inc. valued at $800; and 3) our issuance to the investors of shares of our common stock valued at $600.

•

In December 2008, we designated and issued 2,000,000 shares of Series A Preferred Stock to Mr. Kall in exchange for $2,000.

•

Through July 29, 2009, Mr. Kall has advanced a total of $1,200 to us for operating purposes. The terms of this financial instrument are currently being negotiated.

Our business benefits from low capital expenditure requirements. Our capital expenditures for 2009 are expected to primarily relate to enhancements for software applications.

Backlog

Backlog is currently only relevant to our merchandise sales, as all subscription services are delivered upon enrollment or at monthly renewal. Because merchandise sales are an insignificant part of our business, we do not believe that backlog is a meaningful indicator of future business prospects.

Geographic Information

The breakdown of revenues generated by geographic region for the three and six months ended June 30, 2009 and 2008 is as follows:


	Three Months Ended						Six Months Ended
	June 30,			June 30,			June 30,			June 30,
	2009			2008			2009			2008
United States, Canada & Mexico		84	%		84	%		86	%		86	%
United Kingdom		4	%		3	%		4	%		3	%
Europe		4	%		6	%		3	%		5	%
Australia/New Zealand		8	%		7	%		7	%		6	%

		100	%		100	%		100	%		100	%

Critical Accounting Policies

We prepare our Consolidated Financial Statements in conformity with accounting principles generally accepted in the United States, which require us to make estimates and assumptions that affect the reported amounts of assets and liabilities and revenue and expenses during the year. Actual results could differ from those estimates. We consider the following policies to be most critical in understanding the judgments that are involved in preparing our financial statements and the uncertainties that could impact our results of operations, financial condition and cash flows.

Revenue Recognition

We generate revenue through (i) sales of affiliate business packages to Affiliates which include sales literature, training videos, and other selling aids and the initial month’s subscription to our suite of internet marketing tools which include enhanced video and audio email service, live web casting, on demand video conferencing and a state of the art e-marketing campaign manager (ii) sales of monthly subscriptions to retail and business customers and Affiliates of the suite of internet marketing tools which include enhanced video and audio email service, live web casting, on demand video conferencing and a state of the art e-marketing campaign manager, (iii) sales of branded apparel and merchandise, (iv) sales of electronic components and (v) hosting conferences and events.

Affiliate Business Packages

We recognize revenue from the sales of the sales literature, training videos and selling aids within the business package, including shipping revenue, in accordance with SAB No. 104, when persuasive evidence of an order arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Generally, these criteria are met at the time the product is shipped to customers when title and risk of loss have transferred. Allowances for estimated subsequent customer returns are provided when revenues are recorded. Costs incurred for the shipping and handling of our products are recorded as cost of sales. Effective in May 2009, we have made our sales literature, training videos and selling aids available to our Affiliates online, and no longer physically “ship” out these items.

We recognize revenue from sale of the Affiliate’s initial month’s subscription to the internet-based suite of products in accordance with generally accepted accounting principles and based on the fair value of such suite of products. Fair value is determinable because the subscription fee is thereafter billed monthly at a fixed rate based on the level of service selected. Access to the internet-based studio suite of products is delivered together, and the individual products within the suite cannot be sold separately. Access is delivered immediately upon sign up and order acceptance.

Sales of the above products, ranging in price from $95 to $2,495 USD (pricing not in thousands), entail no post-customer support or delivery of any other items.

Monthly Subscriptions

We sell subscriptions for our internet-based studio suite of products to retail customers, business and Affiliates. We recognize revenue when all of the criteria of SAB No. 104 referred to above are met, which is when the subscription is initiated, and then monthly based on an automatic renewal. Our services are provided immediately upon enrollment and continue until cancelled. The recurring subscription can be cancelled at any time in writing. If cancelled within the first 7 days after enrollment (effective November 2008), 90% of the fee is refunded, pro-rated for the number of days not used during the month (subject to terms and conditions in VMdirect’s policies and procedures guide). If a subscription is cancelled after the first month of service, a full refund is issued for the month if the cancellation is received in writing within 48 hours prior to the renewal billing date. No refund is issued if a subscription is cancelled more than 48 hours prior to the renewal billing date for the month. We record an allowance for subscription cancellations based on an analysis of historical data for the four months preceding the date of measurement. We apply a cancellation percentage to subscription revenue that is subject to cancellation within the first 7 days of enrollment or 48 hours prior to the renewal billing date. The accuracy of these estimates is dependent on the rate of future cancellations being consistent with the historical rate. Increases or decreases to the sales allowance are charged to revenue.

Apparel and Merchandise

We also sell select products to Affiliates to assist them in building their businesses and in selling subscriptions to the portal. These products include cameras, branded apparel and other merchandise. Revenue for these sales, including shipping revenue, are recognized when all the criteria of SAB No. 104 described above are met, which is generally upon shipment.

Electronic Components

We recognize revenue from the sales of electronic components in accordance with SAB No. 104, when persuasive evidence of an order arrangement exists, delivery has occurred, the sales price is fixed or determinable and collectibility is reasonably assured. Generally, these criteria are met at the time the product is shipped to customers when title and risk of loss have transferred. Sales of the above products entail no post-customer support or delivery of any other items.

Conferences and Events

We also earn fees for certain events we host such as sales and training conferences and seminars. Revenue is recognized when all of the criteria of SAB No. 104 described above are met, which is generally after the event has occurred. Amounts collected prior to the event are reflected as deferred revenue, and recognized after the event has occurred.

Allowance for Doubtful Accounts

Our receivables consist entirely of receivables from credit card companies, arising from the sale of product and services to our customers. We do not record an allowance for doubtful accounts on these receivables, as monies processed by credit card processors are collected 100% within three to five days.

Inventories

Inventories are valued at the lower of cost or market. They are written down, as required, to provide for estimated obsolete or not salable inventory based on assumptions about future demand for our products and market conditions. If future demand and market conditions are less favorable than management’s assumptions, additional inventory write-downs could be required. Likewise, favorable future demand and market conditions could positively impact future operating results if written-off inventory is sold.

Derivative Financial Instruments

We do not use derivative instruments to hedge exposures to cash flow, market or foreign currency risks. We evaluate all of our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the condensed consolidated statements of operations. For stock-based derivative financial instruments, we use the Black-Scholes-Merton option pricing model to value the derivative instruments at inception and on subsequent valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12 months of the balance sheet date. For further information on our derivative instruments and the valuation assumptions used to determine their fair value, refer to Note 7 in the condensed consolidated financial statements.

Stock-Based Compensation

We periodically issue stock options and warrants to employees and non-employees in non-capital raising transactions for services and for financing costs. We adopted SFAS 123R, “Accounting for Stock-Based Compensation” effective January 1, 2006, and are using the modified prospective method in which compensation cost is recognized beginning with the effective date (a) based on the requirements of SFAS 123R for all share-based payments granted after the effective date and (b) based on the requirements of SFAS 123R for all awards granted to employees prior to the effective date of SFAS 123R that remain unvested on the effective date. We account for stock option and warrant grants issued and vesting to non-employees in accordance with EITF No. 96-18: “Accounting for Equity Instruments that are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and EITF 00-18 “Accounting Recognition for Certain Transactions involving Equity Instruments Granted to Other Than Employees” whereby the fair value of the stock compensation is based on the measurement date as determined at either a) the date at which a performance commitment is reached, or b) at the date at which the necessary performance to earn the equity instrument is complete.

We recognize compensation cost for equity-based compensation for all new or modified grants issued after December 31, 2005. In addition, commencing January 1, 2006, we recognized the unvested portion of the grant date fair value of awards issued prior to adoption of SFAS 123R based on the fair value previously calculated for disclosure purposes over the remaining vesting period of the outstanding stock options and warrants.

We estimate the fair value of stock options pursuant to SFAS 123R using the Black-Scholes-Merton option-pricing model, which was developed for use in estimating the fair value of options that have no vesting restrictions and are fully transferable. This model requires the input of subjective assumptions, including the expected price volatility of the underlying stock and the expected life of stock options. Projected data related to the expected volatility of stock options is based on the average volatility of the trading prices of comparable companies and the expected life of stock options is based upon the average term and vesting schedules of the options. Changes in these subjective assumptions can materially affect the fair value of the estimate, and therefore the existing valuation models do not provide a precise measure of the fair value of our employee stock options.

Recent Accounting Pronouncements

In December 2007, Financial Accounting Standards Board (FASB) SFAS 141R, “Business Combinations (revised 2007)” was issued. SFAS 141R replaces SFAS 141 “Business Combinations.” SFAS 141R requires the acquirer of a business to recognize and measure the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree at fair value. SFAS 141R also requires transactions costs related to the business combination to be expensed as incurred. SFAS 141R applies prospectively to 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, 2008. The effective date, as well as the adoption date for us was January 1, 2009. Although SFAS 141R may impact our reporting in future financial periods, we have determined that the standard did not have any impact on our historical consolidated financial statements at the time of adoption.

In April 2008 the FASB issued FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets,” which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS 142. This pronouncement requires enhanced disclosures concerning a company’s treatment of costs incurred to renew or extend the term of a recognized intangible asset. FSP 142-3 is effective for financial statements issued for fiscal years beginning after December 15, 2008. The effective date, as well as the adoption date for us was January 1, 2009. Although FSP 142-3 may impact our reporting in future financial periods, we have determined that the standard did not have any impact on our historical consolidated financial statements at the time of adoption.

In December 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51.” SFAS 160 requires: (a) noncontrolling interests in subsidiaries to be separately presented within equity; (b) consolidated net income to be adjusted to include the net income attributable to a noncontrolling interest; (c) consolidated comprehensive income to be adjusted to include the comprehensive income attributed to a noncontrolling interest; (d) additional disclosures; and (e) a noncontrolling interest to continue to be attributed its share of losses even if that attribution results in a deficit noncontrolling interest balance. SFAS 160 is effective for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. The effective date, as well as the adoption date for us was January 1, 2009. Although SFAS 160 may impact our reporting in future financial periods, we have determined that the standard did not have any impact on our historical consolidated financial statements at the time of adoption.

In April 2009, the FASB issued FSP No. FAS 141(R)-1,“Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP No. FAS 141(R)-1 amends and clarifies SFAS 141(R), to address application issues raised on initial recognition and measurement, subsequent measurement and accounting and disclosure of assets and liabilities arising from contingencies in a business combination. FSP No. FAS 141(R)-1 is effective for the first annual reporting period on or after December 31, 2008. The impact of FSP No. FAS 141(R)-1 on our consolidated financial statements will depend on the number and size of acquisition transactions, if any, engaged in by us.

In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133.” SFAS 161 amends and expands the disclosure requirements for derivative instruments and hedging activities and is effective for fiscal years beginning after November 15, 2008. SFAS 161 became effective for us January 1, 2009. The additional disclosure requirements of SFAS 161 are incorporated in Note 8 of our condensed consolidated financial statements.

Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the AICPA, and the SEC did not or are not believed by management to have a material impact on our present or future consolidated financial statements.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements or financing activities with special purpose entities.

RISK FACTORS

INVESTING IN OUR COMMON STOCK INVOLVES A HIGH DEGREE OF RISK. YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS AND ALL OTHER INFORMATION CONTAINED IN THIS REPORT BEFORE PURCHASING SHARES OF OUR COMMON STOCK. IF ANY OF THE FOLLOWING RISKS OCCUR, OUR BUSINESS, FINANCIAL CONDITION AND/OR RESULTS OF OPERATIONS COULD BE MATERIALLY AND ADVERSELY AFFECTED. IN THAT CASE, THE TRADING PRICE OF OUR COMMON STOCK COULD DECLINE, AND YOU MAY LOSE SOME OR ALL OF YOUR INVESTMENT.

RISKS RELATING TO OUR BUSINESS

We will need additional funding to support our operations and capital expenditures. Such funds may not be available to us, which lack of availability could reduce our operating income, product development and enhancement efforts and future business prospects.

While we have historically funded our working capital needs through operations, the sale of equity and debt interests and through capital contributions from related parties, we will need additional capital to fund our operations, pursue business opportunities (such as acquisitions of complementary businesses and the introduction of new products), react to unforeseen difficulties and/or respond to competitive pressures. If our capital resources prove insufficient, we will need to raise additional funds. We currently have no committed sources of additional capital, and there can be no assurance that any financing arrangements will be available in amounts or on terms acceptable to us, if at all. While Richard Kall, our Chairman and Chief Executive Officer, has recently advanced funds to us for operating purposes, there can be no assurance that Mr. Kall will continue to make such advances. Furthermore, the sale of additional equity or convertible debt securities may result in additional dilution to existing shareholders. If adequate additional funds are not available, we may be required to delay, reduce the scope of or eliminate material parts of the implementation of our business strategy or restructure our Company. This limitation would impede our growth and could result in a contraction of our operations, which would reduce our operating income, product development and enhancement efforts and future business prospects.

We may be unable to continue as a going concern if we do not successfully raise additional capital or if our revenues do not increase substantially.

If we are unable to successfully raise the capital we need, or experience significant reductions in sales, we may need to reduce the scope of our business to fully satisfy our future short-term liquidity requirements. If we cannot raise additional capital or reduce the scope of our business, we may be otherwise unable to achieve our goals or continue our operations. As discussed in Note 1 in the Notes to the Condensed Consolidated Financial Statements, we have incurred losses from operations in the prior two years and have a working capital deficiency. These factors raise substantial doubt about our ability to continue as a going concern. In addition, our auditors included in their report on our financial statements for the year ending December 31, 2008 an explanatory paragraph expressing substantial doubt about our ability to continue as a going concern. While we believe that the recent change in our management will result in our return to profitable operations through our new product offerings and cost cutting practices, there can be no assurances that we will be successful in these efforts or will be able to eliminate our working capital deficit or operating losses.

Our operating results may fluctuate significantly based on customer and Affiliate acceptance of our products.

Management expects that we will experience substantial variations in our net sales and operating results from quarter to quarter due to customer acceptance of our products. We rely on sales by our Affiliates to generate significant revenues for us. If customers don’t accept our products, our sales and revenues would decline, resulting in a reduction in our operating income.

Customer interest for our products could also be impacted by the timing of our introduction of new products. If our competitors introduce new products or free products around the same time that we issue new products, and if such competing products are superior to our own, customers’ desire for our products could decrease, resulting in a decrease in our sales and revenues. To the extent that we introduce new products and customers decide not to migrate to our new products from our older products, our revenues could be negatively impacted due to the loss of revenue from those customers. In the event that our newer products do not sell as well as our older products, we could also experience a reduction in our revenues and operating income. In addition, as a result of the soft economy, we may lose customers that have either exceeded their credit card limits or lost their available credit.

As a result of fluctuations in our revenue and operating expenses that may occur, management believes that period-to-period comparisons of our results of operations are not a good indication of our future performance.

If we do not successfully generate additional products and services, or if such products and services are developed but not successfully commercialized, we could lose revenue opportunities.

Starting in the second quarter of 2009, our primary business is the sale of our F5 suite of products to our Affiliates and to our end users. This is a new platform and our future success depends, in part, on our ability to promote this product and service offering. The process of identifying and commercializing new products is complex and uncertain, and if we fail to accurately predict customers’ changing needs and emerging technological trends, our business could be harmed. We may have to commit significant resources to commercializing F5 and other new products before knowing whether our investments will result in products the market will accept. Furthermore, we may not execute successfully on commercializing those products because of errors in product planning or timing, technical hurdles that we fail to overcome in a timely fashion, or a lack of appropriate resources. This could result in competitors providing those solutions before we do and a reduction in net sales and earnings.

The success of F5 and other new products depends on several factors, including proper new product definition, timely completion and introduction of these products, differentiation of new products from those of our competitors, and market acceptance of these products. There can be no assurance that we will successfully identify new product opportunities, develop and bring new products to market in a timely manner, or achieve market acceptance of our products or that products and technologies developed by others will not render our products or technologies obsolete or noncompetitive.

While we previously achieved an operating profit, we have a history of operating losses and there can be no assurance that we can achieve, maintain or increase profitability.

While we previously achieved operating profits, we did not achieve an operating profit for the three and six months ended June 30, 2009, and we have a history of operating losses. Given the competitive and evolving nature of the industry in which we operate, the technical challenges of moving from the RazorStream platform to the F5 platform, and potential technical difficulties we may encounter in the future, we may not be able to achieve, sustain or increase profitability and our failure to do so would adversely affect our business, including our ability to raise additional funds. In addition, to the extent we introduce new products that are not accepted by the market, we would continue to experience operating losses.

We may not be able to effectively manage our growth.

Our strategy envisions growing our business. To date, our growth has been derived primarily from the growth of our multi-tiered Affiliate base and we intend to continue to employ this growth strategy. To manage anticipated growth, we plan to expand our technology to handle increasing volume on our websites and to expand our administrative and marketing organizations to accommodate larger numbers of our Affiliates. We must also effectively manage our relationships with the increasing number of retail customers/users of our products. We will need to hire, train, supervise and manage new employees. These processes are time consuming and expensive, will increase management responsibilities and will divert management attention. In addition, we have gone through a complete restructuring of senior management and our new management is focused on turning our company around. Any growth in or expansion of our business is likely to continue to place a strain on our management and administrative resources, infrastructure and systems. We cannot assure you that we will be able to:

	•		sufficiently and timely improve our technology to handle increasing volume on our websites;

	•		handle all tech support matters relating to the transition to F5 in a timely fashion;

	•		expand our administrative and marketing systems effectively, efficiently or in a timely manner to accommodate increasing numbers of our Affiliates; or

	•		allocate our human resources optimally.

Our inability or failure to manage our growth and expansion effectively could result in strained Affiliate and customer relationships based on dissatisfaction with our service to these groups, our failure to meet demand for our products and/or increased expenses to us to resolve these issues, and a consequent significant decrease in the number of our Affiliates and end users. Any significant decrease in our Affiliate base or the number of retail customers, or the election of new Affiliates to sign on for lower level packages would result in a decrease in revenues.

If we continue to experience technological difficulties with our products our Affiliate base could shrink, customer growth could decrease and our business could suffer.

In November 2006, we released the 5.0 version of the DigitalFX Studio that included expanded functionality and features. The testing we conducted did not reveal various technical difficulties that remained with the product. In addition, the 5.0 version rolled out in November 2006 did not contain all of the enhancements that our Affiliates were expecting due to development delays. The result was a product with lower than expected functionality and operating difficulties. As a result of these issues, our Affiliate network has not marketed our products and the business opportunity as widely as projected in our plan. While we have taken steps to ameliorate these difficulties, to the extent that we continue to encounter technical difficulties, and to the extent that enhancements to the products we release or new products have technical difficulties, the reputation of our products could suffer, our Affiliate base could shrink and our ability to generate new customers, and consequently revenue, would be negatively impacted. Our ability to grow our business would also be negatively impacted.

We launched F5 to replace our core technology. We may experience interruptions in service while we are integrating the new service or a period of instability if the new technology cannot be scaled up.

Eighty-two percent of our revenues for the three months ended June 30, 2009 have been derived from sales of our products and services to our Affiliates, and our future success depends on our ability to grow our Affiliate base, as well as to expand our retail subscriptions and initiate advertising revenue.

To date, our revenue growth has been derived primarily from the growth of our multi-tiered Affiliate base. Rather than using traditional advertising and sales methods, we chose to create a multi-tiered affiliate program to develop new customers. Affiliates earn retail commissions on a monthly residual basis by acquiring new customers for us. Affiliates earn additional commissions from the sales activities of Affiliates who they personally enroll. These rewards are extended for up to eight generations of Affiliates, meaning that an Affiliate earns a commission on the sales of the Affiliates they have personally enrolled as well as on the sales of second-, third-, and fourth-generation Affiliates, potentially eight levels deep. Our Affiliate compensation plan is structured on a 3x8 matrix, meaning Affiliates can each enroll three Affiliates underneath themselves before they begin to build their next organizational level. The layers of three continue down a total of eight levels.

Our success and the planned growth and expansion of our business depend on us achieving greater and broader acceptance of our products and expanding our customer base. There can be no assurance that customers will subscribe to our product offerings or that we will continue to expand our customer base. Though we plan to continue to provide tools to our Affiliates to enable them to generate sales, we cannot guarantee that the time and resources we spend on these efforts will generate a commensurate increase in users of our product offerings. If we are unable to effectively market or expand our product offerings, and if our Affiliate enrollment does not continue to grow, we will be unable to grow and expand our business or implement our business strategy. This could materially impair our ability to increase sales and revenue and materially and adversely affect our margins, which could harm our business and cause our stock price to decline.

Our future success depends largely upon our ability to attract and retain a large active base of Affiliates who purchase and sell our products. We cannot give any assurances that the productivity of our Affiliates will continue at their current levels or increase in the future. Several factors affect our ability to attract and retain a significant number of Affiliates, including:

	•		on-going motivation of our Affiliates;

	•		general economic conditions;

	•		significant changes in the amount of commissions paid;

	•		public perception and acceptance of direct selling;

	•		public perception and acceptance of us and our products;

	•		the limited number of people interested in pursuing direct selling as a business;

	•		our ability to provide proprietary quality-driven products that the market demands; and

	•		competition in recruiting and retaining active Affiliates.

Our ability to conduct business, particularly in international markets, may be affected by political, economic, legal and regulatory risks, which could adversely affect the expansion of our business in those markets.

Our ability to capitalize on growth in new international markets and to maintain the current level of operations in our existing international markets is exposed to risks associated with international operations, including:

•

the possibility that a foreign government might ban or severely restrict our business method of selling through our Affiliates, or that local civil unrest, political instability or changes in diplomatic or trade relationships might disrupt our operations in an international market;

•

the possibility that a government authority might impose legal, tax or other financial burdens on Affiliates, as direct sellers, or on our company due, for example, to the structure of our operations in various markets;

•

the possibility that a government authority might challenge the status of our Affiliates as independent contractors or impose employment or social taxes on our Affiliates;

•

our ability to staff and manage international operations;

•

handling the various accounting, tax and legal complexities arising from our international operations; and

•

understanding cultural differences affecting non-U.S. customers.

We currently conduct activities in Australia, Ireland, Mexico, New Zealand, the United Kingdom, and Spain. We have not been affected in the past by any of the potential political, legal or regulatory risks identified above. While we do not consider these risks to be material in the foreign countries in which we currently operate, they may be material in other countries where we may expand our business.

We are also subject to the risk that due to legislative or regulatory changes in one or more of our present or future markets, our marketing system could be found not to comply with applicable laws and regulations or may be prohibited. Failure to comply with applicable laws and regulations could result in the imposition of legal fines and/or penalties which would increase our operating costs. We may also be required to comply with directives or orders from various courts or applicable regulatory bodies to conform to the requirements of new legislation or regulation, which would detract management’s attention from the operation of our business. Further we could be prohibited from distributing products through our marketing system or may be required to modify our marketing system.

Our services are currently priced in local currency in most foreign markets. As a result, our financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. We do not currently engage in hedging activities or other actions to decrease fluctuations in operating results due to changes in foreign currency exchange rates, although we may do so when the amount of revenue obtained from sources outside of the United States becomes significant.

We also face legal and regulatory risks in the United States, the affect of which could reduce our sales and revenues.

Our marketing program is subject to a number of federal and state regulations administered by the Federal Trade Commission and various state agencies in the United States, directed at preventing fraudulent or deceptive schemes by ensuring that product sales are made to consumers of the products and that compensation, recognition, and advancement within the marketing organization are based on the sale of products rather than investment in the organization or other non-sales-related criteria. These regulatory requirements do not include “bright line” rules and are inherently fact-based. Thus, even though we believe that our marketing program complies with applicable federal and state laws or regulations, we are subject to the risk that a governmental agency or court could determine that we have failed to meet these requirements in a particular case. Such an adverse determination could require us to make modifications to our marketing system, increasing our operating expenses. The negative publicity associated with such an adverse determination could also reduce Affiliate and end user demand for our products, which would consequently reduce our sales and revenues.

Starting 2003, all users and e mail service providers are also subject to the provisions of the CAN-SPAM Act which establishes requirements for commercial email and specifies penalties for commercial email that violates the CAN-SPAM Act. In the event that users of our F5 platform avertedly or inadvertently fail to meet our very strict mail transmission policy and such failure is subsequently determined to violate the CAN-SPAM Act, our business could be adversely affected through the reduction of sales and revenues and the resulting penalties would adversely affect our operating results.

If we incur substantial liability from litigation, complaints, or enforcement actions resulting from misconduct by our multi-level Affiliates, our financial condition could suffer.

Although we use various means to address misconduct by our multi-level Affiliates, including maintaining policies and procedures to govern the conduct of our Affiliates and conducting training seminars, it is still difficult to detect and correct all instances of misconduct. Violations of our policies and procedures by our Affiliates could lead to litigation, formal or informal complaints, enforcement actions, and inquiries by various federal, state, or foreign regulatory authorities against us and/or our Affiliates. Litigation, complaints, and enforcement actions involving us and our Affiliates could consume considerable amounts of financial and other corporate resources, which could have a negative impact on our sales, revenue, profitability and growth prospects.

We have not been, and are not currently, subject to any material litigation, complaint or enforcement action regarding Affiliate misconduct by any federal, state or foreign regulatory authority.

We may be unable to compete successfully against existing and future competitors, which could decrease our revenue and margins and harm our business.

The digital communications, email marketing and the multi tier industries are highly competitive. Our future growth and financial success depend on our ability to further penetrate and expand our user base, increase our affiliate base, recruit leaders to our program, as well as our ability to grow our revenue models. Our competitors, in several instances, possess greater resources than we do and in many cases are owned by companies with broader business lines. There can be no assurance that we will be able to maintain our growth rate or increase our market share in our industry at the expense of existing competitors.

We may not be able to adequately protect our intellectual property rights which would affect our ability to compete in our industry.

Our intellectual property relates to the initiation, receipt and management of digital communications and our dedicated body of affiliates who distribute our internet marketing products. We rely in part on trade secret, unfair competition, and trademark law to protect our rights to certain aspects of our intellectual property, including our software technologies, domain names and recognized trademarks, all of which we believe are important to the success of our products and our competitive position.

There can be no assurance that any of our trademark applications will result in the issuance of a registered trademark, or that any trademark granted will be effective in thwarting competition or be held valid if subsequently challenged. In addition, there can be no assurance that the actions taken by us to protect our proprietary rights will be adequate to prevent imitation of our products, that our proprietary information will not become known to competitors, that we can meaningfully protect our rights to unpatented proprietary information or that others will not independently develop substantially equivalent or better products that do not infringe on our intellectual property rights.

We could be required to devote substantial resources to enforce and protect our intellectual property, which could divert our resources from the conduct of our business and result in increased expenses. In addition, an adverse determination in litigation could subject us to the loss of our rights to particular intellectual property, could require us to grant licenses to third parties, could prevent us from selling or using certain aspects of our products or could subject us to substantial liability, any of which could reduce our sales and/or result in the entry of additional competitors into our industry.

There can be no assurance that we will be able to maintain the loyalty of our affiliates, or any size of an organization, or to avoid the attempts by other companies to raid our network. We are very protective of our proprietary systems and ideas and have acted swiftly to ensure that the integrity and secrets of our company are kept in confidence.

We or AttainResponse may become subject to litigation for infringing the intellectual property rights of others the affect of which could cause us to cease marketing and exploiting our products.

We are dependent on the technology platform created by AttainResponse. Others may initiate claims against us or AttainResponse for infringing on their intellectual property rights. We may be subject to costly litigation relating to such infringement claims and we may be required to pay compensatory and punitive damages or license fees if we settle or are found culpable in such litigation. In addition, we or AttainResponse may be precluded from offering products that rely on intellectual property that is found to have been infringed by us or AttainResponse. We also may be required to cease offering the affected products while a determination as to infringement is considered and could eventually be required to modify our products to cease the infringing activity. These developments could cause a decrease in our operating income and reduce our available cash flow, which could harm our business and cause our stock price to decline.

We or AttainResponse may have to expend significant resources developing alternative technologies in the event that third party licenses for intellectual property upon which our business depends are not available or are not available on terms acceptable to us.

We rely on certain intellectual property licensed from third parties and may be required to license additional products from third parties in the future. There can be no assurance that these third party licenses will be available or will continue to be available to us or AttainResponse on acceptable terms or at all. Our inability to enter into and maintain any license necessary for the conduct of our business could result in our expenditure of significant capital to develop or obtain alternate technologies and to integrate such alternate technologies into our current products, or could result in our cessation of the development or sales of products for which such licenses are necessary.

We may be unable to attract and retain qualified, experienced, highly skilled personnel, which could adversely affect the implementation of our business plan.

Our success depends to a significant degree upon our ability to attract, retain and motivate skilled and qualified personnel. In particular, we are heavily dependent on the continued services of Richard Kall and the other members of our senior management team. Mr. Kall has been widely recognized as a leader in the Network Marketing industry with over 30 years of experience. We do not have long-term employment agreements with most members of our senior management team, each of whom may voluntarily terminate his or her employment with us at any time. Following any termination of employment, those employees without employment agreements would not be subject to any non-competition covenants or non-solicitation covenants. The loss of any key employee, including members of our senior management team, could result in a decrease in the efficacy with which we implement our business plan due to the loss of our experienced managers, increased competition in our industry and could negatively impact our sales and marketing operations. The loss of Mr. Kall as a leader in our company could have a detrimental effect on the future of our company. Our inability to attract highly skilled personnel with sufficient experience in our industry could result in less innovation in our products and a consequent decrease in our competitive position, and a decrease in the quality of our service to our Affiliates and end users and a consequent decrease in our sales, revenue and operating income.

Our senior management had limited experience managing a publicly traded company prior to serving as our executive officers. This limited experience may divert our management’s attention from operations and harm our business.

Our management team had limited experience managing the reporting requirements of the federal securities laws prior to serving as our executive officers. Management will be required to implement appropriate programs and policies to comply with existing disclosure requirements and to respond to increased reporting requirements pursuant to Section 404 of the Sarbanes-Oxley Act. These increased requirements include the preparation of an internal report which states the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting and containing an assessment, as of the end of each fiscal year, of the effectiveness of the internal control structure and procedures for financial reporting. Management’s efforts to familiarize itself with and to implement appropriate procedures to comply with the disclosure requirements of the federal securities laws could divert its attention from the operation of our business. Management’s failure to comply with the disclosure requirements of the federal securities laws could lead to the imposition of fines and penalties by the SEC.

If we are not able to respond to the adoption of technological innovation in our industry and changes in consumer demand, our products will cease to be competitive, which could result in a decrease in revenue and harm our business.

Our future success will depend, in part, on our ability to keep up with changes in consumer tastes and offer seamless compatibility with other systems or applications offered by industry leaders, and our continued ability to differentiate our products through implementation of new technologies. We may not, however, be able to successfully do so, and our competitors may be able to implement new technologies at a much lower cost. These types of developments could render our products less competitive and possibly eliminate any differentiating advantage that we might hold at the present time.

RISKS RELATING TO OUR COMMON STOCK

There is limited trading, and consequently limited liquidity, of our common stock.

Prior to August 23, 2007, bid and ask prices for shares of our common stock were quoted on the OTC Bulletin Board under the symbol “DFXN.” From August 23, 2007 through February 12, 2009, our common stock was traded on AMEX under the symbol “DXN.” On February 13, 2009 our common stock resumed quotation on the OTC Bulletin Board under the symbol “DGFX.” Although our common stock is quoted on the OTC Bulletin Board, there is limited trading of our common stock and our common stock is not broadly followed by securities analysts. The average daily volume of our common stock as reported on AMEX and the OTC Bulletin Board for the three months ended June 30, 2009 was approximately 27,108 shares. Consequently, shareholders may find it difficult to sell shares of our common stock.

While we are hopeful that we will command the interest of a greater number of investors and analysts, more active trading of our common stock may never develop or be maintained. More active trading generally results in lower price volatility and more efficient execution of buy and sell orders. The absence of active trading reduces the liquidity of our common stock. As a result of the lack of trading activity, the quoted price for our common stock on the OTC Bulletin Board or the AMEX is not necessarily a reliable indicator of its fair market value. Further, if our common stock ceases to be quoted, holders of our common stock would find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, our common stock, and the market value of our common stock would likely decline.

The market price of our common stock is likely to be highly volatile and subject to wide fluctuations, and you may be unable to resell your shares at or above the price at which you purchased such shares.

The market price of our common stock is likely to be highly volatile and could be subject to wide fluctuations in response to a number of factors that are beyond our control, including announcements of new products or services by our competitors. In addition, the market price of our common stock could be subject to wide fluctuations in response to a variety of factors, including:

•

quarterly variations in our revenues and operating expenses;

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developments in the financial markets, and the worldwide or regional economies;

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announcements of innovations or new products or services by us or our competitors;

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fluctuations in merchant credit card interest rates;

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significant sales of our common stock or other securities in the open market; and

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changes in accounting principles.

In the past, shareholders have often instituted securities class action litigation after periods of volatility in the market price of a company’s securities. If a shareholder were to file any such class action suit against us, we would incur substantial legal fees and our management’s attention and resources would be diverted from operating our business to respond to the litigation, which could impact our productivity and profitability.

Substantial future sales of our common stock in the public market could cause our stock price to fall.

Upon the effectiveness of any registration statement that we may file with respect to the resale of shares held by our shareholders, a significant number of our shares of common stock may become eligible for sale, or, as specified below, these shares could be sold without any restrictions pursuant to other exemptions under the securities laws. The sale of these shares could depress the market price of our common stock. Sales of a significant number of shares of our common stock in the open market could harm the market price of our common stock. A reduced market price for our shares could make it more difficult to raise funds through future offerings of common stock.

On November 30, 2007, upon the expiration of the lock up agreements restricting sales by the selling shareholders listed in the prospectus included on the post-effective amendment to the registration statement on Form SB-2 we filed with the SEC on May 22, 2007, additional shares of our common stock became eligible for unrestricted resale. As additional shares of our common stock become available for resale in the open market (including shares issued upon the exercise of our outstanding options and warrants), the supply of our publicly traded shares will increase, which could decrease its price.

Some of our shares may also be offered from time to time in the open market pursuant to Rule 144, and these sales may have a depressive effect on the market price of our shares. In general, a non-affiliate who has held restricted shares for a period of six months may sell an unrestricted number of shares of our common stock into the market.

Economic and market conditions affecting certain of the large equity funds which purchased securities in our company upon and following the November 30, 2007 PIPE transaction could result in large blocks of shares of our common stock being sold into the market, thereby causing decreasing stock prices.

The sale of securities by us in any equity or debt financing could result in dilution to our existing shareholders and have a material adverse effect on our earnings.

Any sale of common stock or convertible preferred stock by us in a future private placement offering could result in dilution to the existing shareholders as a direct result of our issuance of additional shares of our capital stock. In addition, our business strategy may include expansion through internal growth, by acquiring complementary businesses, by acquiring or licensing additional brands, or by establishing strategic relationships with targeted customers and suppliers. In order to do so, or to finance the cost of our other activities, we may issue additional equity securities that could dilute our shareholders’ stock ownership. We may also assume additional debt and incur impairment losses related to goodwill and other tangible assets if we acquire another company and this could negatively impact our earnings and results of operations.

We have not paid dividends in the past and do not expect to pay dividends on our common stock for the foreseeable future, and any return on investment may be limited to potential future appreciation on the value of our common stock.

We currently intend to retain any future earnings to support the development and expansion of our business and do not anticipate paying cash dividends to our common stockholders in the foreseeable future. In addition we are not permitted to pay dividends on our common stock unless full cumulative dividends have been or contemporaneously are declared and paid on our Series A 12% Cumulative Convertible Preferred Stock. The holders of Series A 12% Cumulative Convertible Preferred Stock are also entitled to receive dividends, on a pari passu basis with the holders of our common stock, with the amount of such dividends to be distributed to the holders of Series A 12% Cumulative Convertible Preferred stock based on the number of shares of our common stock into which their shares of Series A 12% Cumulative Convertible Preferred Stock are then convertible. We intend to pay quarterly dividends on the Series A 12% Cumulative Convertible Preferred Stock as permitted under Florida Law.

Our payment of any future dividends to common stockholders will be at the discretion of our board of directors after taking into account various factors, including without limitation, our financial condition, operating results, cash needs, growth plans, senior dividend preferences and the terms of any credit agreements that we may be a party to at the time. To the extent we do not pay dividends, our common stock may be less valuable because a return on investment will only occur if and to the extent our common stock price appreciates, which may never occur. In addition, investors must rely on sales of their common stock after price appreciation as the only way to realize their investment, and if the price of our common stock does not appreciate, then there will be no return on investment. Investors seeking cash dividends should not purchase our common stock.

Our officers, directors and principal shareholders, controlling approximately 53% of our outstanding common stock, and 100% of our Series A 12% Cumulative Convertible Preferred Stock, can exert significant influence over us and may make decisions that are not in the best interests of all shareholders.

Our officers, directors and principal shareholders collectively control approximately 53% of our outstanding common stock and 100% of our Series A 12% Cumulative Convertible Preferred Stock. As a result, these shareholders will be able to affect the outcome of, or exert significant influence over, all matters requiring shareholder approval, including the election and removal of directors and any change in control. In particular, this concentration of ownership of our common stock and Series A 12% Cumulative Convertible Preferred Stock could have the effect of delaying or preventing a change of control of us or otherwise discouraging or preventing a potential acquirer from attempting to obtain control of us. This, in turn, could have a negative effect on the market price of our common stock. It could also prevent our shareholders from realizing a premium over the market prices for their shares of common stock. Moreover, the interests of this concentration of ownership may not always coincide with our interests or the interests of other shareholders, and accordingly, they could cause us to enter into transactions or agreements that we would not otherwise consider.

Anti-takeover provisions may limit the ability of another party to acquire us, which could cause our stock price to decline.

Our articles of incorporation, as amended, our bylaws and Florida law contain provisions that could discourage, delay or prevent a third party from acquiring us, even if doing so may be beneficial to our shareholders. In addition, these provisions could limit the price investors would be willing to pay in the future for shares of our common stock.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. Except as is described below, we are not currently party to any legal proceedings, the adverse outcome of which, in management’s opinion, individually or in the aggregate, would have a material adverse effect on our results of operations or financial position.

On February 7, 2007, VMdirect and DigitalFX Solutions jointly filed a lawsuit in the Superior Court of the State of California for the County of Los Angeles against a former Affiliate of VMdirect alleging a number of complaints including unfair business practice, misappropriation of trade secrets, slander, intentional interference with contractual relationship, intentional interference with prospective economic advantage and breach of contract, and seeking compensatory and punitive damages in amounts to be proved at trial, injunctive relief and attorneys’ fees and costs. Reference is made to the disclosure of this proceeding included in our Annual Report on Form 10-K (File Number 001-33667) filed with the Securities and Exchange Commission on March 23, 2009.

Since the filing of our Annual Report on Form 10-K (File Number 001-33667) filed with the Securities and Exchange Commission on March 23, 2009, the trial date (previously set for May 18, 2009) was vacated and the parties were ordered to mediation, presently set to occur on August 21, 2009. A new trial setting conference and post mediation status conference is set for September 10, 2009.

Management believes there exists no basis for the former Affiliate’s claims and intends to defend this matter vigorously. In the event management’s assessment of the case is incorrect, or the former Affiliate actually obtains a favorable judgment for the claimed damages, the economic impact on us should not materially affect our operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On June 5, 2009, our board of directors authorized the issuance of 493,750 shares of our common stock to Wade Weston and Funmark Advertising, Inc. pursuant to our entry into a debt settlement agreement to fulfill our obligations under our Term Sheet with Attain Response, LLC. The shares issued to Mr. Weston and Funmark Advertising, Inc. had an aggregate value of approximately $39,500 based on the closing sale price of our common stock on June 5, 2009 of $0.08 per share. We did not pay any underwriting discounts or commissions in connection with the above stock issuance. In making the issuance without registration under the Securities Act, we relied upon the exemption from registration contained in Section 4(2) of the Securities Act.

Item 6. Exhibits

See attached Exhibit Index.


Exhibit
Number		Exhibit Title

	31.1	Certification by Chief Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended.

	31.2	Certification by Chief Financial Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended.

	32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

	32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


PART I — FINANCIAL INFORMATION			2

Item 1. Financial Statements			2

Condensed Consolidated Balance Sheets			2

Condensed Consolidated Statements of Operations			3

Condensed Consolidated Statement of Stockholders’ Equity (Deficiency)			4

Condensed Consolidated Statements of Cash Flows			5

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			31

Item 3. Quantitative and Qualitative Disclosures About Market Risk			52

Item 4. Controls And Procedures			53

PART II — OTHER INFORMATION			54

Item 1. Legal Proceedings.			54

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			54

Item 6. Exhibits			54

Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2


	DIGITALFX INTERNATIONAL, INC.
Date: July 31, 2009	By:	/s/ Tracy Sperry
		Tracy Sperry
		Chief Financial Officer