Washington, D.C. 20549
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
ATRINSIC, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
ATRINSIC, INC. AND SUBSIDIARIES
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements
ATRINSIC, INC. AND SUBSIDIARIES
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts and the associated allowances for returnsrefunds and chargebacks,credits, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions.
In addition, the Company has an operating agreement with TBR whereby TBR provides billing services to the Company and its customers. The agreement reflects transactions in the normal course of business and was negotiated on an arm’s length basis. At September 30, 2009, TBR, its affiliated entities, and entities under common control are indebted to the Company $2.2 million which is included in the accompanying Condensed Consolidated Balance Sheet.
The table below represents the company’s concentration of business and credit risk by customers and aggregators.
The fair value of share-based awards granted is estimated on the date of grant using the Black-Scholes option pricing model or binominal option model, when appropriate. The key assumptions for these models are expected term, expected volatility, risk-free interest rate, dividend yield and strike price. Many of these assumptions are judgmental and the value of share-based awards is highly sensitive.sensitive to changes in these assumptions.
Financial instruments, which may be exchanged for equity securities are excluded in periods in which they are anti-dilutive. The following shares were excluded from the calculation of diluted earnings per share:
Anti Dilutive EPS Disclosure | | | | | | |
| | | | | | |
| | March 31, | |
| | 2010 | | | 2009 | |
| | | | | | |
Convertible note payable | | | - | | | | 322,878 | |
Options | | | 3,167,059 | | | | 2,773,372 | |
Warrants | | | 314,443 | | | | 314,443 | |
Restricted Shares | | | 9,171 | | | | 70,280 | |
Restricted Stock Units | | | 316,666 | | | | - | |
Anti Dilutive EPS Disclosure | | | | | | |
| | | | | | |
| | Three Months Ended | | | Nine Months Ended | |
| | September 30, | | | September 30, | |
| | 2009 | | | 2008 | | | 2009 | | | 2008 | |
| | | | | | | | | | | | |
Convertible note payable | | | - | | | | 322,878 | | | | - | | | | 322,878 | |
Options | | | 1,892,123 | | | | 3,252,812 | | | | 1,892,123 | | | | 2,662,649 | |
Warrants | | | 314,443 | | | | 314,443 | | | | 314,443 | | | | 290,909 | |
Restricted Shares | | | 61,969 | | | | 110,000 | | | | 61,969 | | | | - | |
Restricted Stock Units | | | 750,000 | | | | - | | | | 750,000 | | | | - | |
The per share exercise prices of the options were $0.48 - $14.00 for the ninethree months ended September 30, 2009March 31, 2010 and 2008.2009. The per share exercise prices of the warrants were $3.44 - $5.50 for the ninethree months ended September 30, 2009March 31, 2010 and 2008. The convertible note payable with a face value of $1,750,000, and a conversion price of $5.42, had a post conversion effect of 322,878 shares in 2008. The convertible note was paid in cash in 2009.
Note 810 - Income Taxes
The effectiveIncome tax rate for income (loss)expense (benefit) before noncontrolling interest and equity in loss on investee was 45% and 42%of for the ninethree months ended September 30,March 31, 2010 and 2009, was $64,000 and 2008,($0.7) million, respectively and reflects an effective tax rate of (2%) and 37%, respectively. The Company evaluated available information including estimated prospective operating result, the historical taxable income and the nature of the individual tax attributes presented on the Condensed Consolidated Balance Sheets as of September 30, 2009 when determining whether a valuation allowance for deferred taxes is necessary. The Company has not provided a valuation allowance against its deferred tax assets because it is more likely than not that such benefits will not be utilizedrealized by the Company.
Uncertain Tax Positions
The Company is subject to taxation in the United States for Federal and State, and certain foreign jurisdictions. The Company’s tax years for 2006, 2007, 2008 and 20082009 are subject to examination by the tax authorities. In addition, the tax returns for certain acquired entities are also subject to examination. As of September 30, 2009,March 31, 2010, an estimated liability of $42,000 for uncertain tax positions in Canada is recorded in our Condensed Consolidated Balance Sheets. Management believes that an adequate provision has been made for any adjustments that may result from tax examinations. The outcome of tax examinations however, cannot be predicted with certainty. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax to the extent such adjustments relate to acquired entities. Although the timing or the resolution and/or closure of the audits is highly uncertain, the Company does not believe that its unrecognized tax benefit will materially change in the next twelve months
Note 9-11- New Accounting Pronouncements
Adopted in 2010
In the third quarter ofJune 2009, the Company adoptedFASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded by the Financial Accounting Standards Board (“FASB”) Accounting StandardsFASB Codification (“ASC”). Theand included in ASC is810 to require an enterprise to perform an analysis to determine whether the sourceenterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of authoritative, nongovernmental GAAP, except for rulesa variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and interpretive releasesthe obligation to absorb losses of the Securitiesentity that could potentially be significant to the variable interest. These revisions to ASC 810 are effective as of January 1, 2010 and Exchange Commission (SEC). Thethe adoption of thethese revisions to ASC did not have an810 had no impact on the Company’sour interim results of operations or financial position.
Not Yet Adopted
In October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue 08-01, Revenue Arrangements with Multiple Deliverables (currently withinwhich has been superseded by the scope of FASB codification and included in ASC Subtopic 605-25).605-25. This statement provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. The EITF introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company is currently evaluating the impact of adopting this pronouncement.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which was superseded by the FASB Codification and included in ASC Topic 810 to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the variable interest. ASC Topic 810 will be effective as of the beginning of the annual reporting period commencing after November 15, 2009 and will be adopted by the Company in the first quarter of 2010. The Company is assessing the potential impact, if any, of the adoption of the revised guidance included in ASC Topic 810 on its consolidated financial statements.
In June 2009, the FASB issued ASC 855-10 (formerly SFAS No. 165), “Subsequent Events”. ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The effective date of ASC 855-10 is interim or annual financial periods ending after June 15, 2009. The adoption of ASC 855-10 did not have a material effect on the Company’s consolidated financial statements. Subsequent events have been evaluated through November 13, 2009.
In June 2008, the FASB issued ASC 260-10 (formerly FASB Staff Position No. EITF 03-6-1), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” ASC 260-10 gives guidance as to the circumstances when unvested share-based payment awards should be included in the computation of EPS. ASC 260-10 is effective for fiscal years beginning after December 15, 2008. The adoption of ASC 260-10 did not have an impact on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” which has been superseded ASC 810-10-65-1 and establishes requirements for ownership interests in subsidiaries held by parties other than us (minority interests) be clearly identified and disclosed in the consolidated statement of financial position within equity, but separate from the parent's equity. Any changes in the parent's ownership interests are required to be accounted for in a consistent manner as equity transactions and any noncontrolling equity investments in deconsolidated subsidiaries must be measured initially at fair value. ASC 810-10-65-1 is effective, on a prospective basis, for fiscal years beginning after December 15, 2008; however, presentation and disclosure requirements must be retrospectively applied to comparative financial statements. Except for presentation and disclosure requirements, the adoption of ASC 810-10-65-1 had no material impact on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” which has been superseded by ASC 805. ASC 805 establishes the principles and requirements for how an acquirer: (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. ASC 805 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008, with early adoption prohibited. Previously, any release of valuation allowances for certain deferred tax assets would serve to reduce goodwill, whereas under the new standard any release of the valuation allowance related to acquisitions currently or in prior periods will serve to reduce our income tax provision in the period in which the reserve is released. Additionally, under ASC 805 transaction-related expenses, which were previously capitalized, will be expensed as incurred. The adoption of ASC 805 did not have a material effect on our results of operations or financial position.
Note 1012 - Commitments and Contingencies
The Company is named inOn March 10, 2010, Atrinsic received final approval of its settlement to its Class Action Lawsuitsproceeding in Florida, California and Minnesota involving allegations concerning the Company's marketing practices associated with some of its services billed and delivered via wireless carriers. The Company pursued a variety of alternative resolutions to these claims including a national settlement pertaining to all related matters. On November 6, 2009, the Superior Court of the State of California in Allen v. Atrinsic, Inc. f/k/a New Motion, Inc., pending in Los Angeles County Superior Court. The settlement covers all of the Company’s mobile products, web sites and advertizing practices through December 2009. All costs of the settlement and defense were accrued for in 2008; therefore this settlement did not impact the Company’s results of operations in 2009 and is not expected to impact the Company’s results of operations in 2010. Subsequent to March 31, 2010, the Company paid the $1.0 million settlement for the County of Los Angeles granted preliminary approval of the settlement. Also in connection with these matters, as they relate to the Company and its business partners within the industry, there are potential secondary claims for which certain liabilities are not probable or estimable. The Company has accrued for all probable and estimable related costs including $1 million of attorney fees, any estimated costs, and refunds incurred related to the national settlement, which are included in Accrued Expenses in the Condensed Consolidated Balance Sheets.
On February 2, 2009 the Company filed a complaint against Mobile Messenger PTY LTD and its subsidiary Mobile Messenger Americas, Inc. (“Mobile Messenger”) to recover monies owed the Company in connection with transaction activity incurred in the ordinary and normal course and also included declaratory relief concerning demands made by Mobile Messenger for indemnification in Mobile Messenger's settlement in its Florida Class Action Matter which it settled in late 2008 (“Grey vs. Mobile Messenger”). Mobile Messenger brought upon the Company a cross complaint seeking injunctive relief, indemnification, and recoupment of attorney’s fees. The Company disputes the allegations and continues to vigorously defend itself in these matters considering, among other things, the specific facts surrounding the underlying claims against the Company, which we believe, are without merit.Action.
As a result of the State of California Settlement and final approval of the judgment, Atrinsic has filed stays, and will file dispositive motions, in the following actions, which it is either directly named in or has assumed the defense of the following cases: Baker v. Sprint Nextel Corp., Motricity, Inc., and New Motion, Inc. pending in Dade County Superior Court in Florida, Stewart v New Motion, Inc. and Motricity, Inc., pending in Hennepin County District Court in Minnesota, Rynearson v. Motricty, Inc, pending in King County Superior Court in Washington and Walker v. Motricity, Inc., pending in Alameda County Superior Court in California. Management has accrued for all probable and estimable related costs of these actions.
In the ordinary course of business, the Company is involved in various disputes, which are routine and incidental to the business and the industry in which it operates. In the opinion of management, the results of such disputes will not have a significant adverse effect on the financial position or the results of operations of the Company exceptCompany. Of approximately $9.0 million in total accrued expenses as otherwise disclosed.of March 31, 2010, $1.8 million is associated with the legal contingencies disclosed above.
In certain situations, the Company does have minimum fee obligations assuming the counterparty performs the required level of services. We feel that the level of business activity under normal and ordinary circumstances exceeds the minimum thresholds.
Note 1113 – Subsequent eventsEvents
On October 6, 2009, Burton Katz resigned from his position as Chief Executive OfficerWe have evaluated events subsequent to the balance sheet date through the date of the Company and also resigned from the Company’s Board of Directors. On October 20, 2009, the Company and Burton Katz, entered into a Separation and Mutual Release Agreement. This agreement provides that the Company will pay Mr. Katz an amount equal to $850,000 through 2011 in connection with his separation and that all 375,000 restricted stock units held by Mr. Katz and all rights of Mr. Katz to receive shares of common stock of the Company pursuant to such restricted stock units are terminated. In addition, the agreement provides that Mr. Katz will have until October 5, 2010 to exercise his 444,434 options to purchase common stock of the Company. All obligations of the Company relating to Mr. Katz’s resignation will be included as a component of operating expenses duringour Form10-Q filing for the quarter ended DecemberMarch 31, 2009. Subsequent2010 and determined there have not been any material events that have been evaluated through November 13, 2009.occurred that would require adjustment to or disclosure in our unaudited condensed consolidated financial statements.
CAUTIONARY STATEMENT
This discussion summarizes the significant factors affecting our condensed consolidated operating results, financial condition and liquidity and cash flows for the three and nine months ended September 30, 2009March 31, 2010 and 2008.2009. Except for historical information, the matters discussed in this “Management’s Discussion and Analysis” are forward-looking statements that involve risks and uncertainties and are based upon judgments concerning various factors that are beyond our control. Actual results could differ materially from those projected in the “ forward-looking“forward-looking statements” as a result of, among other things, the factors described under the “Cautionary Statements and Risk Factors” included elsewhere in this report. The information contained in this Form 10-Q, as at and for the three and nine months ended September 30,March 31, 2010 and 2009, and 2008, is intended to update the information contained in our Annual Report on Form 10-K for the year ended December 31, 20082009 of Atrinsic, Inc. (“we,” “our,” “us”, the “Company,” or “Atrinsic”) and presumes that readers have access to, and will have read, the “Management’s Discussion and Analysis” and other information contained in our Annual Report on Form 10-K.
A NOTE CONCERNING PRESENTATION
This Quarterly Report on Form 10-Q contains information concerning Atrinsic, Inc. as it pertains to the periods covered by this report - for the three and nine months ended September 30, 2009March 31, 2010 and 2008.2009.
Executive Overview
Atrinsic, Inc. isWe are a digital advertising andleading Internet focused marketing services company. Atrinsic has two main service offerings, Transactional services and Subscription services. Transactional services offers full service online marketing and distribution services which are targeted and measurable online campaigns and programs for marketing partners, corporate advertisers, or their agencies, generating qualified customer leads, online responses and activities, or increased brand recognition. Subscription services offer our portfolio of subscription based content applications direct to users working with wireless carriers and other distributors.
Atrinsic brings togetherWe combine the power of the Internet the latest in mobile technology,with traditional direct response marketing techniques to sell entertainment and traditional marketing/lifestyle subscription products directly to consumers. We also leverage our media network and marketing expertise to provide lead generation and search related marketing services to our corporate and advertising methodologies, creating a fully integrated multi platform vehicle for the advanced generationclients. We have developed our marketing media network, consisting of qualified leads monetized by the saleweb sites, proprietary content and distribution of subscription content, brand-based distributionlicensed media, to attract consumers, corporate partners and pay-for-performance advertising. Atrinsic’s service content is organized into four strategic content groups - digital music, casual games, interactive contests, and communities/lifestyles. The Atrinsic brands include GatorArcade, a premium online and mobile gaming site, Ringtone.com, a mobile music download service, and iMatchUp, one of the first integrated web-mobile dating services. Feature-rich Transactional advertising services include a mobile adadvertisers. We believe our marketing media network extensive search capabilities, email marketing, and one of the largest and growing publisher networks, and proprietary technology allows us to cost-effectively acquire consumers and provide targeted leads and marketing data to our corporate partners and advertisers.
As a direct to consumer Internet marketing company, our strategy is to maximize the value of each media impression by maximizing the revenue and profit from each visitor to our media network. We do this by using proprietary technology to match each consumer touch point (visit, registration or lead submission) with the highest value offer or series of offers. These offers are sourced from a large pool of advertisers or from our own portfolio of consumer subscription content. Services are providedproducts. We also engage in targeted performance marketing activities where we focus on a variety of pricing models including cost per action, fixed fee, or commission based arrangements.acquiring customers for an advertiser on an exclusive basis.
Our goal ispremium subscription products, which are marketed directly to optimize revenues from each of our qualified leads, regardlessconsumers, are an important component of the naturemaximization strategy. By maintaining alternatives to third party offers, we are able to make use of and derive more profit from a larger proportion of acquired Internet traffic and leads generated than would be the services wecase with only third party advertisers’ offerings, since our owned products typically provide to such parties. a higher effective value for each media impression.
Over an extended period of time, our ability to generate incremental revenues relies on our ability to increase the size and scope of our media network, our ability to target campaigns, and our ability to convert qualified leads into appropriate revenue generating opportunities, including into subscribers of our own products. Revenue growth also depends on our ability to market and sell our services, including search services and lead generation activities, to third parties.
We combine our direct response capability with an Internet-based customer acquisition model, which allows us to use proprietary lead generation, search and email marketing strategies, to generate a greater volume of Internet traffic at a lower effective cost of acquisition. Our success at acquiring qualified customers at a low effective cost is due, in part to our portfolio of attractive web properties, content and licensed media. This performance marketing media network ensures a continual base of subscribers to our subscription products, and also generates qualified traffic that is complementary to our third-party advertisers.
Our direct response marketing business principally serves two sets of customers. Corporate clients and third party advertisers use our products and services to enhance their online marketing programs (our transactional and marketing services). Consumers subscribe to our services to receive premium content on the Internet and on their mobile device (our subscription services). Each of these business activities – transactional and marketing services and subscriptions – may utilize the same originating media or derive a customer from the same source; the difference is reflected in the type of customer billing. In the case of transactional and marketing services, the billing is generally carried out on a service fee, percentage, or on a performance basis. For subscriptions, the end user (the consumer) is able to access premium content and in return is charged a recurring monthly fee to a credit card, mobile phone, or land-line phone.
In managing our business, we internally develop programming or partner with online content providers to match users with our service offerings and those of our advertising clients. Our continued success and prospects for growth are dependent on our ability to acquire content in a cost effective manner. Our results may also be impacted by overall economic conditions, trends in the online marketing and telecommunications industry, competition, and risks inherent in our customer database, including customer attrition.
There are a variety of factors that influence our revenues on a periodic basis including but not limited to: (1) economic conditions and the relative strengths and weakness of the U.S. economy; (2)economy, trends in the online marketing and telecommunications industry, including client spending patterns and their overall demand for our service offerings; (3) increases or decreases in our portfolio of service offerings; and (4)offerings, including the overall demand for such offerings, competitive and alternative programs and advertising mediums.mediums, and risks inherent in our customer database, including customer attrition.
Similar to other media based companies, our ability to specifically isolate the relative historical aggregate impact of price and volume regarding our revenue is not practical as the majority of our services are sold and managed on an order by order basis and our revenues are greatly impacted by our decisions regarding qualified lead monetization.ability to qualify, validate and enhance leads that we acquire. Factors impacting the pricing of our services include, but are not limited to: (1) the dollar value, length and breadth of the order; (2) the quality of the desired action; (3) the quantity of actions or services requested by our clients; (4) our ability to enhance the value of leads through validation and (4)traffic disaggregation; (5) matching leads to the highest relative value offer; and (6) the level of customization required by our clients.
The principal components of our operating expensesexpense are labor, media and media related expenses (including media content costs, lead validation and affiliate compensation,compensation), product or content development and royalties or licensing fees),fees, marketing and promotional expensesexpense (including sales commissions, customer service and customer acquisition and retention expenses)expense) and corporate general and administrative expenses.expense. We consider our operating cost structure to be predominantly variable in nature over a short time horizon, and as a result, we are immediately able to make modifications to our cost structure to what we believe to be increases or decreases in revenue and market trends. This factor is important in monitoring our performance in periods when revenues are increasing or decreasing. In periods where revenues are increasing as a result of improved market conditions, we will make every effort to best utilize existing resources, but there can be no guarantee that we will be able to increase revenues without incurring additional marketing or operating costs and expenses. Conversely, in a period of declining market conditions we are immediately able to reduce certain operating expenses and preserveto reduce operating income.losses. Furthermore, if we perceive a decline in market conditions to be temporary, we may choose to maintain or increase operating expenses for the future maximization of operating results.
STRATEGIC INITIATIVESAs a growing part of our direct-to-consumer business, the Kazaa music service is an important focus for management. The Kazaa digital music service is a collaborative arrangement that we have with Brilliant Digital Entertainment, Inc. (“BDE”), an online distributor of licensed digital content, and is not conducted in a separate legal entity. On March 26, 2010, we entered into a Marketing Services Agreement (the “Marketing Agreement”) and a Master Services Agreement (the “Services Agreement”) with BDE effective as of July 1, 2009 (collectively, the “Agreements”), relating to the operation and marketing of the Kazaa digital music service. The Agreements have a term of three years from the effective date, contain provisions for automatic one year renewals, subject to notice of non-renewal by either party, and may only be terminated generally upon a bankruptcy or liquidation event or in the event of an uncured material breach by either party. In accordance with the Agreements, Atrinsic and BDE will share equally in the “Net Profit” generated by the Kazaa music subscription service after all of our costs and expenses have first been recovered.
Our businessUnder the Marketing Agreement, we are responsible for marketing, promotional, and advertising services in respect of the Kazaa service. In exchange for these marketing services, we are entitled to full recoupment for all pre-approved costs and expenses incurred in connection with the provision of the services plus all other agreed budgeted amounts. Pursuant to the Services Agreement, we are to provide services related to the operation of the Kazaa website and service, including billing and collection services and the operation of the Kazaa online storefront. BDE is obligated to provide certain other services with respect to the service, including licensing the intellectual property underlying the Kazaa service to us, obtaining all licenses to the content offered as part of the service and delivering that content to the subscribers via the service interface.
As part of the Agreements, we are required to make advance payments and expenditures in respect of certain expenses incurred in order to provide the required services and operate the Kazaa music service. These advances and expenditures are recoverable on a dollar for dollar basis against future revenues. In addition, BDE has agreed to repay $2.5 million of these advances and expenditures which are not otherwise recovered from Kazaa generated revenues and this repayment obligation has been secured under separate agreement. All advances and expenditures that we make are fully recoupable from the cash flow generated by the Kazaa music service, although there can be no assurance that the future net cash flows from the Kazaa music service will be sufficient to allow us to fully recoup our expenditures. Similarly, we are not obligated to make additional expenditures if more than $5.0 million remains unrecovered or unrecouped by us from Kazaa revenues.
For the three months ended March 31, 2010, we have recorded Kazaa revenue of $2.9 million and expenses incurred for the Kazaa music service of $4.4 million, offset by $626,000 of reimbursements from BDE.
Business Strategy
To become a leading direct to consumer Internet marketing company, our strategy involves increasingis to continue to develop a broad marketing and media network that allows us to cost-efficiently acquire consumers for our overall scalesubscription-based services and profitability by offeringfor our third-party lead generation activities. To generate long term value for our stockholders and profitably grow our revenue over time, we are spending on media, product and distribution and marketing expense to acquire customers today so that we can build a large number of diversified products through a unique distribution networksubstantial subscriber base to generate subscription revenue in the most cost effective manner possible. To achieve this goal, we are pursuingfuture. We also must continually develop best in class service offerings for our clients in the following objectives.area of search related services.
Achieve Cross Media BenefitsExpand Online Distribution Capabilities. One: we consider our distribution capabilities as encompassing the various ways we generate Internet traffic by attracting users to various web properties and converting visitors into subscribers and third-party leads. We employ a multifaceted approach to generating traffic: (i) users may navigate directly to our web properties, (ii) users respond to our email marketing, (iii) we garner users of our strategic objectivespromotional and sweepstakes sites, (iv) we attract users to our content sites by offering valuable media and other content, (v) we utilize call center technology in the acquisition process, and (vi) we use search engine optimization and search marketing efforts which attract users to our sites and services on a Pay Per Click basis. Our strategy is to leverageincrease our volume of visitors, subscribers, and third-party leads by improving the cross media benefit derived primarily from the combinationreach and widening our breadth of Atrinsic and Traffix which was consummated on February 4, 2008. Our premium-billed subscriptions allow us to integrate and to leverage online and mobile distribution channels to deliver compelling media and entertainment. The advantage of the fixed Internet is that from a marketing expense standpoint, the cost of customer acquisitions is generally determinable. In addition, the Internet is full of free content that is advertisement supported. The Internet also allows for the delivery of rich media over broadband. The advantage of mobile media is that it already has a well established customer activation and customer retention capability and is accessible and portable for those using it to access content. Our cross media strategy seamlessly enables our subscriber to realize true convergence. Atrinsic enables subscribers to interact with our content at work, at home or on a remote basis.
Vertically Integrate and Expand Distribution Channels.distribution. We own a large library of wholly owned content, proprietary premium billed services, and our own media and distribution. By allocating a large proportion of the qualified leads acquired by our subscription properties to our owned marketing and distribution networks, we expect to generate cost savings through the eliminationdo this by increasing our portfolio of third-party margins. These cost savings are expectedweb properties and sites, and improving existing, or employing innovative techniques, to result insource traffic. We expect that by expanding our online distribution capability, we will lower our customer acquisition costs throughout our business. We also expect to continue to enhance our distribution channels by expanding existing channels to market and sell our products and services online and explore alternative marketing mediums. We also expect, with limited modification, to market and sell our existing online-only content directly to wireless customers. Finally, we expect to continue to drive a portion of our consumer traffic directly to our proprietary products and services without the use of third-party media outlets and media publishers.
Multiple Revenue Streams and Advertiser Network. Our merger with Traffix has allowed for a reduction in customer concentration and more diversification of the combined company’s revenue streams. We will continue to generate recurring revenue streams from a subscription -based model, which is targeted at end user mobile subscribers. We will also have the traditional revenue streams inherent in our online performance-based model, which is targeted to publishers and advertisers. Further revenue diversification is expected to result from our larger distribution reach, and our ability to generate ad revenue across the combined company’s portfolio of web properties.improving margins through greater scale.
Publish High-Quality, Branded Subscription ContentContent:. As a direct to consumer Internet marketing company, we are focused on partnering with companies, and developing proprietary sources of content, for our direct to consumer subscription products. We believe that publishing a diversified portfolio of the highest quality most innovative applicationscontent, like the Kazaa music service, is criticalimportant to our business. We intend to continue to develop innovative and sought-after content and intend to continue to devote significant resources to the development of high-quality and innovative products services and Internet storefronts. The U.S. consumer’s propensityservices. We will focus on subscription based products in the entertainment and lifestyle categories as these products correspond to use the fixed Internet to acquire, redeem and use mobile subscription products is unique. In this regard, we aim to provide complementary services between these two high-growthvisitor base in our media channels. We also expect to continue to create Atrinsic-branded applications, products and services, which typically generate higher margins.network.
Lead Generation Product Development: In order to enhancebe competitive in the Atrinsicperformance marketing areas, companies must de-commoditize the leads they generate. We are pursuing a number of value enhancing strategies to increase the marketability of our leads to third parties and to increase the conversion of leads into subscribers of our direct-to-consumer subscription services. These innovations include ad units designed to drive direct telephone calls, where a call center operator will respond instantly to a user’s request for information and, in some instances, transfer the consumer directly to an advertiser. We also actively increase the value of a consumer inquiry by validating the submission of online information through automated data lookups and validation, or through call center confirmation. All of these lead value enhancement techniques assist us in increasing the average sales price of leads sold to our advertisers, or improves the conversion of users into subscribers to our direct-to-consumer subscription services and the corresponding increases in Life Time Value that result from more highly qualified subscribers.
Multiple Billing Platforms: As a direct result of being proficient in multiple billing platforms, we are able to create customer acquisition efficiencies because we can acquire direct subscribers and generate third-party leads. This provides us with a competitive advantage over traditional direct response marketers, who may only offer a single billing modality – credit cards. We have agreements through multiple aggregators who have access to U.S. carriers – both wireless and landline – for billing. These relationships include our 36% interest in TBR, which is an aggregator of fixed-line billing. In addition to agreements with aggregators, we also have an agreement in place with AT&T Wireless to distribute and bill for our services directly to subscribers on their network. As a result of our multiple billing protocols, we are able to expand our potential customer base, attracting consumers who may prefer a different billing mechanism than is traditionally offered. Many of our new product initiatives leverage and expand upon our alternative billing capabilities.
Online Marketing Services: In order to be competitive in the area of online marketing services, particularly in search related marketing services, we must continue to expand our staff and technology capabilities. Our product offering will not remain competitive if we don’t offer our clients leading edge technology and strategies designed to drive their online sales efforts. Adding more services revenue will involve prospecting a targeted set of clients who are natural consumers of our services. Our initiatives include delivering an integrated suite of services, which include search engine marketing services, search engine optimization, display advertising, and affiliate marketing. Our ability to integrate brand protection and competitive intelligence is a source of differentiation and growth for our product brands,existing and new client base.
Technology: Through our use of technology, we planattempt to continue building brands through productdisplay the highest value offer to the consumer. On a real-time basis, our technology dynamically analyzes user data, media source, and service quality, subscriber, customerestimated offer values and carrier support, advertising campaigns, public relationsprogressions to gauge which offer maximizes the value of the media impression. If the user is “qualified,” we will expose one of our targeted consumer subscription offers. In the event that the user does not correspond to our internal targeting criteria, the most profitable third-party offers will be displayed. In every case, we are continually working on technology to improve targeting capability so as to maximize the value of each media impression. We also employ proprietary technology which measures, in real time, the effectiveness of our media buying by media source. This allows us to adjust marketing efforts immediately towards the most effective partners. These tools allow us to be more effective in our media buying, reducing our acquisition costs and other marketing efforts.improving convertibility and profitability.
Results of Operations for the three months ended September 30, 2009March 31, 2010 compared to the three months ended September 30, 2008.March 31, 2009.
Revenues presented by type of activity are as follows for the three month periods ending September 30, 2009March 31, 2010 and 2008:2009:
| | For the Three Months | | | Change | | | Change | | | For the Three Months Ended | | | Change | | | Change | |
| | September 30, | | | Inc.(Dec.) | | | Inc.(Dec.) | | | March 31, | | | Inc.(Dec.) | | | Inc.(Dec.) | |
| | 2009 | | | 2008 | | | $ | | | % | | | 2010 | | | 2009 | | | $ | | | % | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Subscription | | $ | 4,889 | | | $ | 15,362 | | | $ | (10,473 | ) | | | -68 | % | | $ | 5,982 | | | $ | 6,974 | | | $ | (992 | ) | | | -14 | % |
Transactional | | $ | 9,984 | | | $ | 15,457 | | | $ | (5,473 | ) | | | -35 | % | |
Transactional and Marketing Services | | | $ | 6,218 | | | $ | 16,574 | | | $ | (10,356 | ) | | | -62 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total Revenues (1) | | $ | 14,873 | | | $ | 30,819 | | | $ | (15,946 | ) | | | -52 | % | | $ | 12,200 | | | $ | 23,548 | | | $ | (11,348 | ) | | | -48 | % |
| (1) | As described above, the Company currently aggregates revenues based on the type of user activity monetized. The Company’s objective is to optimize total revenues from the user experience. Accordingly, this factor should be considered in evaluating the relative revenues generated from our Subscription and Transactional services. |
Revenues decreased approximately $15.9 million or 52%, to $14.9 million for the three months ended September 30, 2009, compared to $30.8 million for the three months ended September 30, 2008.
Subscription revenue decreased by approximately $10.5 million, or 68%, to $4.9 million for the three months ended September 30, 2009, compared to $15.4 million for the three months ended September 30, 2008. The decrease in subscription service revenue was principally attributable to a decrease in the average number of billable subscribers during the period. For the three months ended September 2009 the average number of subscribers was 280,000 compared to 800,000 for the three months ended September 30, 2008. The number of subscribers is largely, but not precisely, correlated to the periodic reported revenues as a result of inter-period volatility, varied monthly billing cycles, and specific transactions including acquisition of subscriber base, the rate of refunds and other adjustments.
Transactional revenue decreased by approximately $5.5 million or 35% to $10.0 million for the three months ended September 30, 2009 compared to $15.5 million for the three months ended September 30, 2008. The decrease was primarily attributable to the reduction in discretionary advertising expenditures by our clients.
Operating Expenses
| | For the Three Months | | | Change | | | Change | |
| | September 30, | | | Inc.(Dec.) | | | Inc.(Dec.) | |
| | 2009 | | | 2008 | | | $ | | | % | |
Operating Expenses | | | | | | | | | | | | | |
Cost of Media – 3rd party | | $ | 9,911 | | | $ | 20,853 | | | | (10,942 | ) | | | -52 | % |
Product and distribution | | | 3,651 | | | | 2,681 | | | | 970 | | | | 36 | % |
Selling and marketing | | | 2,168 | | | | 2,596 | | | | (428 | ) | | | -16 | % |
General, administrative and other operating | | | 3,659 | | | | 3,304 | | | | 355 | | | | 11 | % |
Depreciation and Amortization | | | 549 | | | | 1,336 | | | | (787 | ) | | | -59 | % |
| | | | | | | | | | | | | | | | |
Total Operating Expenses | | $ | 19,938 | | | $ | 30,770 | | | $ | (10,832 | ) | | | -35 | % |
Cost of Media
Cost of Media decreased by $11.0 million or 52% to $9.9 million for the three months ended September 30, 2009 from $20.9 million for the three months ended September 30, 2008. Cost of Media – 3 rd party includes media purchased for monetization of both transactional and subscription revenues. The decrease was proportionately correlated to the decline in the related revenue.
Product and Distribution
Product and distribution expense was $3.7 million for the three months ended September 30, 2009 as compared to $2.7 million for the three months ended September 30, 2008. Product and distribution expenses are costs necessary to develop and maintain proprietary content, support and maintain our websites, user data and technology platforms which drive both our transactional and subscription based revenues. During the third quarter of 2009, the Company had major ongoing initiatives to develop its subscription based music service, e-commerce ShopIt platform and other marketing and distribution technologies. Included in product and distribution cost is stock compensation expense of $32,000 and $(26,000) for the three months ended September 30, 2009 and 2008 respectively.
Selling and Marketing
Selling and marketing expense was $2.2 million in the three months ended September 30, 2009 as compared to $2.6 million for the three months ended September 30, 2008. The Company’s bad debt expense decreased by approximately $142,000 for the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Salaries and other marketing costs decreased for the three months ended September 30, 2009 in comparison to the three months ended September 30, 2008
General, Administrative and Other Operating
General and administrative expenses increased by approximately $355,000 to $3.7 million for the three months ended September 30, 2009 compared to $3.3 million for the three months ended September 30, 2008. The increase is primarily due to professional fees, Sarbanes Oxley consulting fees, legal and other compliance and governance related costs. The Company continues to make appropriate and modest investments in labor, facilities, and utilization of third party professional service providers to support growth, business development and corporate governance initiatives. Included in general and administrative expense is stock compensation expense of $226,000 and $(44,000) for the three months ended September 30, 2009 and 2008 respectively.
Depreciation and Amortization
Depreciation and amortization expense decreased $787,000 to $549,000 for the three months ended September 30, 2009 compared to $1.3 million for the three months ended September 30, 2008 principally as a result of the decrease in amortization expense due to circumstance that certain intangibles are fully amortized.
(Loss) Gain from Operations
Operating loss was approximately $5.1 million for the three months ended September 30, 2009, compared to an operating gain of $49,000 for the three months ended September 30, 2008. The Company’s revenue decreased by 52% with a corresponding decrease in operating expenses of 35%. The reduction of expenses did not keep pace with the degradation in revenue.
Management has reduced operating and strategic expenses, launched other operational and strategic initiatives, and continued to monitor the marketplace for additional opportunities. The nature, timing, and magnitude of future activities will depend on, among other things, operating performance and market conditions. Management continuously seeks to build long term shareholder value by prudently deploying capital with expectations for an anticipated risk adjusted return.
The Company continues to execute on its long term strategic plans amidst a business climate that is volatile and uncertain. Despite these challenges, management remains committed, if necessary, to reduce discretionary operating expenses and reevaluate new initiatives in order to preserve operating margins and generate positive cash flow.
Interest Income and Dividends
Interest and dividend income decreased $202,000 to $5,000 for the three months ended September 30, 2009, compared to $207,000 for the three months ended September 30, 2008. The reduction is mainly due to a decrease in the balances of cash and marketable securities at September 30, 2009 compared to September 30, 2008, as well as a reduction in market rate of return on cash and cash equivalents.
Interest Expense
Interest expense was $1,000 for the three months ended September 30, 2009 compared to $83,000 for the three months ended September 30, 2008. The decrease was due to the payment of the Ringtone.com note payable in the second quarter of 2009.
Income Taxes
Income tax benefit, before noncontrolling interest and Equity in loss of investee, for the three months ended September 30, 2009 and 2008 was ($2.7) million and ($77,000) respectively and reflects an effective tax rate of 54% and 79% respectively. The Company had a loss before taxes of $5.1 million for the three months ended September 30, 2009 compared to loss before taxes of $98,000 for the three months ended September 30, 2008. The Company has not provided a valuation allowance against its tax benefits because it is more likely than not that such benefits will be utilized by the Company.
Equity in (Earnings) Loss of Investee
Equity in loss of investee was $61,000, net of taxes and represents the Company’s 36% interest in The Billing Resource, LLC (TBR). The company acquired its interest in TBR in the 4th Quarter 2008 so there are no comparable earnings for the three months ended September 30, 2008.
Net Loss (Income) Attributable to Noncontrolling Interest
Net Loss (income) attributable to noncontrolling interest for the three months ended September 30, 2009 was $0 compared to net income of ($15,000) for the three months ended September 30, 2008. The investment in MECC was dissolved in June 2009.
Net Loss Attributable to Atrinsic, Inc.
Net loss increased by $2.4 million to $2.4 million for the three months ended September 30, 2009 as compared to a net loss of $6,000 for the three months ended September 30, 2008. This increase resulted from the factors described above.
Results of Operations for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008.
In terms of comparability, for the nine months ended September 30, 2008 total revenue and operating expenses include eight months of Traffix, Inc. activity and three months of Ringtone.com LLC activity whereas September 30, 2009 total revenue and operating expenses includes nine months of Traffix, Inc. and Ringtone.com LLC activity.
Revenues presented by type of activity are as follows for the nine month periods ending September 30, 2009 and 2008:
| | For the Nine Months | | | Change | | | Change | |
| | September 30, | | | Inc.(Dec.) | | | Inc.(Dec.) | |
| | 2009 | | | 2008 | | | $ | | | % | |
| | | | | | | | | | | | | |
Subscription | | $ | 15,099 | | | $ | 38,919 | | | $ | (23,820 | ) | | | -61 | % |
Transactional | | $ | 40,330 | | | $ | 52,089 | | | $ | (11,759 | ) | | | -23 | % |
| | | | | | | | | | | | | | | | |
Total Revenues (1) | | $ | 55,429 | | | $ | 91,008 | | | $ | (35,579 | ) | | | -39 | % |
| (1) | As described above, the Company currently aggregates revenues based on the type of user activity monetized. The Company’s objective is to optimize total revenues from the user experience. Accordingly, this factor should be considered in evaluating the relative revenues generated from our SubscriptionSubscriptions and from our Transactional services.and Marketing Services. |
Revenues decreased approximately $35.6$11.3 million or 39%48%, to $55.4$12.2 million for the ninethree months ended September 30, 2009,March 31, 2010, compared to $91.0$23.5 million for the ninethree months ended September 30, 2008.March 31, 2009.
Subscription revenue decreased by approximately $23.8$1.0 million, or 61%14%, to $15.1$6.0 million for the ninethree months ended September 30, 2009,March 31, 2010, compared to $38.9$7.0 million for the ninethree months ended September 30, 2008.March 31, 2009. Subscription revenue for the three months ended March 31, 2010 includes Kazaa revenue of $2.9 million, without which, our subscription revenue would have decreased by $3.9 million. The decrease in subscription service revenue was principally attributable to a decrease in the average number of billable subscribers during the period. Forfirst quarter of 2010, as compared to the nine months ended September 30, 2009 the average numberfirst quarter of 2009. The year-over-year decrease in subscribers was 362,000 compareddue primarily to 882,000 for the nine months ended September 30, 2008. The number of subscribers is largely, but not precisely, correlated to the periodic reported revenueslower customer acquisition rates as a result of inter-period volatility, varied monthly billing cycles,an uncertain regulatory environment and specific transactions including acquisitionchanging consumer tastes. As of subscriber base,March 31, 2010, the Company had approximately 330,000 subscribers across all of its entertainment and lifestyle subscription products, compared to approximately 340,000 subscribers as of December 31, 2009. During the first quarter of 2010, the Company added approximately 158,000 new subscribers. More than 50% of these new subscribers were new users of the Kazaa music subscription service. As of March 31, 2010, the Company estimates that it has approximately 100,000 Kazaa subscribers. During the first quarter of 2010, the Company estimates that its average revenue per user, or “ARPU,” was approximately $6.00, an increase of 27% when compared to the year ago period. This ARPU represents a blended rate across all of refunds and other adjustments.the Company’s subscription products. The Company expects that due to the higher price point for the Kazaa music service, that the Company’s blended ARPU will increase as the proportion of Kazaa subscribers to total subscribers increases.
Transactional and Marketing services revenue is derived from our online marketing and lead generation activities, which are targeted and measurable online campaigns and programs for marketing partners, corporate advertisers, or their agencies, generating qualified customer leads, online responses and activities, or increased brand recognition. Transactional and Marketing services revenue decreased by approximately $11.8$10.4 million or 23%62% to $40.3$6.2 million for the ninethree months ended September 30, 2009March 31, 2010 compared to $52.1$16.6 million for the ninethree months ended September 30, 2008.March 31, 2009. The decrease is principally attributedwas primarily attributable to the loss of accounts and a reduction in discretionary advertising spendingexpenditures by our search customers.clients.
Operating Expenses
| | For the Three Months Ended | | | Change | | | Change | |
| | March 31, | | | Inc.(Dec.) | | | Inc.(Dec.) | |
| | 2010 | | | 2009 | | | $ | | | % | |
Operating Expenses | | | | | | | | | | | | |
Cost of Media – 3rd party | | $ | 7,344 | | | $ | 15,475 | | | | (8,131 | ) | | | -53 | % |
Product and distribution | | | 4,362 | | | | 2,254 | | | | 2,108 | | | | 94 | % |
Selling and marketing | | | 950 | | | | 2,785 | | | | (1,835 | ) | | | -66 | % |
General, administrative and other operating | | | 2,440 | | | | 3,266 | | | | (826 | ) | | | -25 | % |
Depreciation and Amortization | | | 323 | | | | 1,555 | | | | (1,232 | ) | | | -79 | % |
| | | | | | | | | | | | | | | | |
Total Operating Expenses | | $ | 15,419 | | | $ | 25,335 | | | $ | (9,916 | ) | | | -39 | % |
Operating Expenses
| | For the Nine Months | | | Change | | | Change | |
| | September 30, | | | Inc.(Dec.) | | | Inc.(Dec.) | |
| | 2009 | | | 2008 | | | $ | | | % | |
Operating Expenses | | | | | | | | | | | | | |
Cost of Media – 3rd party | | $ | 35,859 | | | $ | 60,778 | | | | (24,919 | ) | | | -41 | % |
Product and distribution | | | 8,502 | | | | 7,634 | | | | 868 | | | | 11 | % |
Selling and marketing | | | 7,095 | | | | 6,757 | | | | 338 | | | | 5 | % |
General, administrative and other operating | | | 10,563 | | | | 12,345 | | | | (1,782 | ) | | | -14 | % |
Depreciation and Amortization | | | 3,111 | | | | 2,616 | | | | 495 | | | | 19 | % |
| | | | | | | | | | | | | | | | |
Total Operating Expenses | | $ | 65,130 | | | $ | 90,130 | | | $ | (25,000 | ) | | | -28 | % |
Cost of Media
Cost of Media – 3rd Party decreased by $25.0$8.1 million or 53% to $35.9$7.3 million for the ninethree months ended September 30, 2009March 31, 2010 from $60.8$15.5 million for the ninethree months ended September 30, 2008.March 31, 2009. Cost of Media – 3rd partyParty includes media purchased for monetization of both transactional and marketing services and subscription revenues. TheAlthough the decrease was proportionately correlateddue to the decline in the related revenue.revenue, the Company is actively spending media to acquire new customers to increase its base of subscribers, in particular Kazaa subscribers. The Company added approximately 158,000 new subscribers in the first quarter, over half of which were Kazaa subscribers. Cost of media for the three months ended March 31, 2010 includes Kazaa-related Cost of Media of $1.5 million. We expect to recoup these Kazaa cost of media expenses from the future cash flows of the Kazaa music service, although there can be no assurance in this regard.
During the first quarter of 2010, the Company estimates that its subscriber acquisition cost, or “SAC,” was approximately $12.80. This compares to SAC of approximately $13.30 in the year ago period. SAC is dependent on a number of factors, including prevailing market conditions, the type of media, and the ability of the Company to convert leads into subscribers. The Company expects that SAC will fluctuate from period to period based on all of these factors and that management will continue to monitor SAC closely to ensure that the Company acquires customers in a cost effective manner.
Product and Distribution
Product and distribution expense increased by $0.9$2.1 million or 94% to $8.5$4.4 million infor the ninethree months ended September 30, 2009March 31, 2010 as compared to $7.6$2.3 million for the ninethree months ended September 30, 2008.March 31, 2009. Product and distribution expenses are costs necessary to develop and maintain proprietary content and support and maintain our websites user data and technology platforms – which drive both our transactionalTransactional and subscriptionMarketing Services and Subscription based revenues. In 2009,Compared to the company had major ongoing initiativesyear ago period, in the first quarter of 2010, we experienced higher product and distribution expense of $2.3 million as a result of costs incurred to further develop its subscription basedthe Kazaa music service e-commerce ShopIt platform and other marketinggreater royalty and license expense payable to music labels, also associated with Kazaa. We expect to recoup these Kazaa product and distribution technologies.expenses from the future cash flows of the Kazaa music service, although there can be no assurance in this regard. Included in product and distribution cost is stock compensation expense of $138,000$16,000 and $110,000$45,000 for the ninethree months ended September 30,March 31, 2010 and 2009, and 2008 respectively.
Selling and Marketing
Selling and marketing expense increased by $338,000decreased $1.8 million or 66% to $7.1$1.0 million in the ninethree months ended September 30, 2009March 31, 2010 as compared to $6.8$2.8 million for the ninethree months ended September 30, 2008.March 31, 2009. The increase is primarily due to an increase inCompany’s bad debt expense of $994,000 partially offsetdecreased by approximately $0.9 million for the three months ended March 31, 2010 compared to the three months ended March 31, 2009. The decrease in selling and marketing was due mainly to a reductiondecrease in salaries and otheremployee related costs. Included in selling and marketing costs.cost is stock compensation expense of $4,000 and $0 for the three months ended March 31, 2010 and 2009 respectively.
General, Administrative and Other Operating
General and administrative expenses decreased by approximately $1.8$0.8 million to $10.5$2.4 million for the ninethree months ended September 30, 2009March 31, 2010 compared to $12.3$3.3 million for the ninethree months ended September 30, 2008.March 31, 2009. The decrease is primarily due to a reduction in laborworkforce and related costs, professional and consulting fees, facilities and related costs, partially offset by an increase in Sarbanes Oxley consulting fees, legal and related costs. The Company continues to make appropriate and modest investments in labor, facilities, and utilizationconsolidation of third party professional service providers to support its continued growth, business development and corporate governance initiativesoffice space. Included in general and administrative expense is stock compensation expense of $941,000$310,000 and $900,000$296,000 for the ninethree months ended September 30,March 31, 2010 and 2009 and 2008 respectively.
Depreciation and Amortization
Depreciation and amortization expense increased $495,000decreased $1.3 million to $3.1$0.3 million for the ninethree months ended September 30, 2009March 31, 2010 compared to $2.6$1.6 million for the ninethree months ended September 30, 2008March 31, 2009 principally as a result of the increasedecrease in amortization expense due to the full amortization of a major intangible assets as a result of the acquisitions of Traffix, Inc. on February 4, 2008 and Ringtone.com LLC on September 30, 2008, and an increase in leasehold improvements for the Company’s New York City headquarters. In addition, numerous assets were fully depreciated as a result of closing the California office.2009.
Loss from Operations
Operating loss increased by $1.4 million or 78% to approximately $9.7$3.2 million for the ninethree months ended September 30, 2009,March 31, 2010, compared to an operating gainloss of $878,000$1.8 million for the ninethree months ended September 30, 2008.March 31, 2009. The Company’s revenue decreased by 39%,48% with a corresponding decrease in operating expenses of 28%39%. The reduction of expenses did not keep pace with the degradation in revenue.
In addition, management has reduced operating and strategic expenses, has launched other operational initiatives, and has continued to monitor the marketplace for additional opportunities. The nature, timing, and magnitude of future activities will depend on, among other things, operating performance, and market conditions. Management continuously seeks to build long term shareholder value by prudently deploying capital with expectations for an anticipated risk adjusted return.
The Company continues to execute on its long term strategic plans amidst a business climate that is volatile and uncertain. Despite these challenges, management remains committed, if necessary, to reduce discretionary operating expenses and re-evaluate new initiatives in order to preserve operating margins and generate positive cash flow.
Interest Income and Dividends
Interest and dividend income decreased approximately $501,000$44,000 to $67,000$2,000 for the ninethree months ended September 30, 2009,March 31, 2010, compared to $568,000$46,000 for the ninethree months ended September 30, 2008.March 31, 2009. The reduction is mainly due to a decrease in the balances of cash and marketable securities at September 30, 2009March 31, 2010 compared to September 30, 2008,March 31, 2009, as well as a reduction in themarket rate of return on invested capital.cash and cash equivalents.
Interest Expense
Interest expense was $76,000$1,000 for the ninethree months ended September 30, 2009March 31, 2010 compared to $83,000$50,000 for the ninethree months ended September 30, 2008. The interest paid is primarily related to the note payable to Ringtone.com.March 31, 2009.
Income Taxes
Income tax expense (benefit) expense,, before noncontrolling interest and Equityequity in loss of investee, for the ninethree months ended September 30,March 31, 2010 and 2009 was $64,000 and 2008 was ($4.3)0.7) million and $517,000 respectively and reflects an effective tax rate of 45%(2%) and 42%37% respectively. The Company had a loss before taxes of $9.7$3.3 million for the ninethree months ended September 30, 2009March 31, 2010 compared to incomeloss before taxes of $1.2$1.8 million for the ninethree months ended September 30, 2008.March 31, 2009. The Company has not provided a valuation allowance against its tax benefits because it is more likely than not that such benefits will be utilized by the Company.
Equity in Loss of Investee
Equity in loss of investee was $113,000, net of taxes$110,000 for the ninethree months ended September 30, 2009 andMarch 31, 2010 compared to $85,000 for the three months ended March 31, 2009. The Equity represents the Company’s 36% interest in The Billing Resource, LLC.LLC (TBR). The company acquired its interest in TBR in the 4th Quarter 2008 so there are no comparable earnings for the nine months ended September 30, 2008.
Net Loss (Income)Income Attributable to Noncontrolling Interest
Net lossincome attributable to noncontrolling interest was $28,000 for the ninethree months ended September 30,March 31, 2009 comparedwas $18,000. This related to a net income of ($92,000) for the nine months ended September 30, 2008. Theour investment in MECC which was dissolved in June 2009.
Net (Loss) IncomeLoss Attributable to Atrinsic, Inc.Inc
Net loss increased by $6.3$2.2 million to ($5.5)$3.4 million for the ninethree months ended September 30, 2009March 31, 2010 as compared to a net incomeloss of $793,000$1.2 million for the ninethree months ended September 30, 2008.March 31, 2009. This increase in loss resulted from the factors described above.
Liquidity and Capital Resources
The CompanyWe continually projectsproject anticipated cash requirements, which may include business combinations, capital expenditures, and working capital requirements. As of September 30, 2009, the CompanyMarch 31, 2010, we had cash and cash equivalents of approximately $17.6$12.5 million and working capital of approximately $14.4$12.6 million. The CompanyWe used approximately $2.3$4.4 million in cash for operations for the ninethree months ended September 30, 2009March 31, 2010. This was the result of cash used to pay third party media suppliers, employees and contingent on prospective operating performance, may require reductionsconsultants, represented by a decrease in discretionary variable costsaccounts payable and accrued expenses, net of prepaid expenses, of approximately $1.0 million and cash used as a result of the increase in accounts receivable of approximately $1.6 million, which was offset by approximately $781,000 decrease in prepaid taxes (of which $727,000 was net cash refunded for taxes). We used $29,000 in investing activities. As a result, our cash and cash equivalents at March 31, 2010 decreased $4.4 million to approximately $12.5 million from approximately $16.9 million at December 31, 2009.
We believe that our existing cash, cash equivalents, together with cash flows from expected sales of our subscription and transactional marketing services, and other realignmentspotential sources of cash flows, including income tax refunds $3.6 million, expected to permanently reduce fixed operating costs. The Company generated $2.3 millionbe received in investing2010, will be sufficient to enable us to continue activities principallyfor at least 12 months. However, our projections of future cash needs and cash flows may differ from proceeds from sale of ARS securities and capital repayment from The Billing Resource, offset by the investment in ShopIt. Cash used in financing activities was $2.8 million and was principally attributable to payment of the Ringtone.com note payable of $1.8 million and stock repurchases of approximately $900,000.
The Company believes that its existingactual results. If current cash and cash equivalents, and anticipated cash flows from operating activities willthat may be sufficient to fund minimum working capital and capital expenditure needs for at least the next twelve months. The extent of the Company’s future capital requirements will depend on many factors, including its results of operations. If the Company’s cash flowsgenerated from operations, is less than anticipated or its working capitalare insufficient to satisfy our liquidity requirements, or capital expenditures are greater than expectations, or if the Company expands its business by acquiring or investing in additional products or technologies, itwe may needseek to secure additionalsell debt or equity securities or to obtain a line of credit. The sale of additional equity securities or convertible debt could result in dilution to our stockholders. We currently have no arrangements with respect to additional financing. The Company is continually evaluating various financing strategies to be used to expand its business and fund future growth. ThereWe can begive no assurance that additional debtwe will generate sufficient revenues in the future to satisfy our liquidity requirements or equity financingsustain future operations, that we will be able to acquire sufficient quantities of cost effective media, that other subscription and marketing services will not be provided by other companies that will render our services obsolete, or that other sources of funding would be available, if needed, on acceptablefavorable terms ifor at all. The potential inabilityIf we cannot obtain such funds if needed, we would need to obtain additional debtcurtail or equity financing, if required, could have a material adverse effect on the Company’scease some or all of our operations.
In conjunction with the Company’s objective of enhancing shareholder value, the Company’s Board of Directors authorized a share repurchase program which expired in May 2009. Under this share repurchase program, the Company purchased 832,392 shares of the Company’s common stock for an aggregate price of approximately $0.9 million.
The Company is continuously monitoring the marketplace and our operating performance and will make investments where necessary to accomplish our goals and objectives. The Company is committed to returning to profitability and generating positive cash flow.
In certain situations, the Company does have minimum fee obligations assuming the counterparty performs the required level of services. We feel that the level of business activity under normal and ordinary circumstances exceeds the minimum thresholds.
New Accounting Pronouncements
Adopted in 2010
In the third quarter ofJune 2009, the Company adoptedFASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded by the Financial Accounting Standards Board (“FASB”) Accounting StandardsFASB Codification (“ASC”). Theand included in ASC is810 to require an enterprise to perform an analysis to determine whether the sourceenterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of authoritative, nongovernmental GAAP, except for rulesa variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and interpretive releasesthe obligation to absorb losses of the Securitiesentity that could potentially be significant to the variable interest. These revisions to ASC 810 are effective as of January 1, 2010 and Exchange Commission (SEC). Thethe adoption of thethese revisions to ASC did not have an810 had no impact on the Company’sour interim results of operations or financial position.
Not Yet Adopted
In October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue 08-01, Revenue Arrangements with Multiple Deliverables (currently withinwhich has been superseded by the scope of FASB codification and included in ASC Subtopic 605-25).605-25. This statement provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. The EITF introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010. Alternatively, adoption may be on a retrospective basis, and early application is permitted. The Company is currently evaluating the impact of adopting this pronouncement.
In June 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which was superseded by the FASB Codification and included in ASC Topic 810 to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the variable interest. ASC Topic 810 will be effective as of the beginning of the annual reporting period commencing after November 15, 2009 and will be adopted by the Company in the first quarter of 2010. The Company is assessing the potential impact, if any, of the adoption of the revised guidance included in ASC Topic 810 on its consolidated financial statements.
In June 2009, the FASB issued ASC 855-10 (formerly SFAS No. 165), “Subsequent Events”. ASC 855-10 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued. The effective date of ASC 855-10 is interim or annual financial periods ending after June 15, 2009. The adoption of ASC 855-10 did not have a material effect on the Company’s consolidated financial statements. Subsequent events have been evaluated through November 13, 2009.
In June 2008, the FASB issued ASC 260-10 (formerly FASB Staff Position No. EITF 03-6-1), “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” ASC 260-10 gives guidance as to the circumstances when unvested share-based payment awards should be included in the computation of EPS. ASC 260-10 is effective for fiscal years beginning after December 15, 2008. The adoption of ASC 260-10 did not have an impact on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements,” which has been superseded ASC 810-10-65-1 and establishes requirements for ownership interests in subsidiaries held by parties other than us (minority interests) be clearly identified and disclosed in the consolidated statement of financial position within equity, but separate from the parent's equity. Any changes in the parent's ownership interests are required to be accounted for in a consistent manner as equity transactions and any noncontrolling equity investments in deconsolidated subsidiaries must be measured initially at fair value. ASC 810-10-65-1 is effective, on a prospective basis, for fiscal years beginning after December 15, 2008; however, presentation and disclosure requirements must be retrospectively applied to comparative financial statements. Except for presentation and disclosure requirements, the adoption of ASC 810-10-65-1 had no material impact on the Company’s financial statements.
In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” which has been superseded by ASC 805. ASC 805 establishes the principles and requirements for how an acquirer: (i) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any non-controlling interest in the acquiree; (ii) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and (iii) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. ASC 805 is to be applied prospectively to business combinations consummated on or after the beginning of the first annual reporting period on or after December 15, 2008, with early adoption prohibited. Previously, any release of valuation allowances for certain deferred tax assets would serve to reduce goodwill, whereas under the new standard any release of the valuation allowance related to acquisitions currently or in prior periods will serve to reduce our income tax provision in the period in which the reserve is released. Additionally, under ASC 805 transaction-related expenses, which were previously capitalized, will be expensed as incurred. The adoption of ASC 805 did not have a material effect on our results of operations or financial position.
Item 3. Quantitative and Qualitative Disclosures about Market Risk
None.Not required.
Item 4T. Disclosure Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Members of the our management, including our Interim Chief Executive Officer, Jeffrey Schwartz, and Interim Chief Financial Officer Andrew Zaref,Thomas Plotts, have evaluated the effectiveness of our disclosure controls and procedures, as defined by paragraph (e) of Exchange Act Rules 13a-15 or 15d-15, as of September 30, 2009,March 31, 2010, the end of the period covered by this report. Based upon that evaluation, Messrs. Schwartz and ZarefPlotts concluded that our disclosure controls and procedures were effective for the period ended September 30, 2009.March 31, 2010.
Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting or in other factors identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that occurred during the thirdfirst quarter ended September 30, 2009March 31, 2010 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II - OTHER INFORMATION
ItemITEM 1A. Risk FactorsRISK FACTORS
Investing in our common stock involves a high degree of risk. You should carefully consider the following risk factors and all other information contained in this report before purchasing our common stock. The risks and uncertainties described below are not the only ones we face.facing us. Additional risks and uncertainties that management is unaware of, or that it currently deems immaterial, also may become important factors that affect us. If any of the following risks occur, our business, financial condition, cash flows and/or results of operations could be materially and adversely affected. In that case, the trading price of our common stock could decline, and stockholders are at risk of losing some or all of the money invested in purchasing our common stock.
We have a limited operating history in an emerging market, which may make it difficult to evaluate our business.
Our wholly-owned subsidiary, New Motion Mobile, commenced offering subscription products and services directly to consumers in 2005. In addition, our merger with Traffix, which is responsible for generating the majority of our Transactional and Marketing revenues, was completed at the beginning of 2008. Accordingly, we have a limited history of generating revenues, and our future revenue and income generating potential is uncertain and unproven based on our limited operating history. As a result of our short operating history, we have limited financial data that can be used to develop trends and other historical based evaluation methods to project and forecast our business. Any evaluation of our business and the potential prospects derived from such evaluation must be considered in light of our limited operating history and discounted accordingly. Evaluations of our current business model and our future prospects must address the risks and uncertainties encountered by companies in early stages of development, that possess limited operating history, and that are conducting business in new and emerging markets.
The following is a list of some of the risks and uncertainties that exist in our operating, and competitive marketing environment. To be successful, we believe that we must:
| · | Maintain existing and develop new wireless carrier and billing aggregator relationships upon which a portion of our direct-to-consumer subscription business currently depends; |
| · | Maintain a compliance based control system to render our products and services compliant with carrier and aggregator demands, as well as marketing practices imposed by private marketing rule makers, such as the Mobile Marketing Association, (MMA), and to conform with the stringent marketing demands as imposed by various States’ Attorney Generals; |
| · | Respond effectively to competitive pressures in order to maintain our market position; |
| · | Increase brand awareness and consumer recognition to secure continued growth;grow our business; |
| · | Attract and retain qualified management and employees for the expansion of the operating platform; |
| · | Continue to upgrade our technology to process increased usage and remain competitive with message delivery; |
| · | Continue to upgrade our information processing systems to assess marketing results, andmeasure customer satisfaction ;and remain competitive; and |
| · | Continue to develop and source high-quality, direct-to-consumer subscription-worthy content that achieves significant market acceptance; |
| · | Maintain and continue to grow our distribution, including such distribution through our web sites and third-party direct-to-consumer distributors; |
| · | Execute our business and marketing strategies successfully. |
If we are unable to address these risks, and respond accordingly, our operating results may not meet our publicly forecasted expectations, and/or the expectations as derived by our investors, which could cause the price of our common stock to decline.
A portion of ourOur business relies on telecommunicationswireless and landline carriers and aggregators to facilitate billing and collections in connection with our subscription products sold and services rendered. The loss of, or a material change in, any of these relationships could materially and adversely affect our business, operating results and financial condition.
During the third quarter ended September 30, 2009, we generatedWe generate a significant portion of our revenues from the sale of our products and services directly to consumers which are billed through aggregators and telecommunicationstelephone carriers. We expect that we will continue to bill a significant portion of our revenues through a limited number of aggregators for the foreseeable future, although these aggregators may vary from period to period. In a risk diversification and cost saving effort, we have established a direct billing relationship with a carrier that mitigates a portion of our revenue generation risk as it relates to aggregator dependence; conversely this risk is replaced with internal performance risk regarding our ability to successfully process billable messages directly with the carrier. Moreover, in an effort to further mitigate such operational risk, we invested a 36% equity stake in a landline telephone aggregator, TBR, to give us more visibility in the billing and collection process associated with subscription services billed to customers of local exchange carriers.
Our aggregator agreements are not exclusive and generally have a limited term of less than three years with automatic renewal provisions upon expiration in the majority of the agreements. These agreements set out the terms of our relationships with the aggregator and carriers, and provide that either party to the contract can terminate such agreement prior to its expiration, and in some instances, terminate without cause.
Many other factors exist that are outside of our control and could impair our carrier relationships, including:
| · | a carrier’s decision to suspend delivery of our products and services to its customer base; |
| · | a carrier’s decision to offer its own competing subscription applications, products and services; |
| · | a carrier’s decision to offer similar subscription applications, products and services to its subscribers for price points less than our offered price points, or for free; |
| · | a network encountering technical problems that disrupt the delivery of, or billing for, our applications; |
| · | the potential for concentrations of credit risk embedded in the amounts receivable from the aggregator should any one, or group if aggregators encounter financial difficulties, directly or indirectly, as a result of the current period of slower economic growth currently affecting the United States; or |
| · | a carrier’s decision to increase the fees it charges to market and distribute our applications, thereby increasing its own revenue and decreasing our share of revenue. |
If one or more of these telecommunications carriers decidesdecide to suspend the offering of applications,our subscription services, we may be unable to replace such revenue source with an acceptable alternative, within an acceptable time frame. This could cause us to lose the capability to derive revenue from those subscribers, which could materially harm our business, operating results and financial condition.
We depend on third-party internetInternet and telecommunications providers, over whom we have no control, for the conduct of our subscription business and transactional and marketing business. Interruptions in or the discontinuance of the services provided by one of the providers could have an adverse effect on revenue; and securing alternate sources of these services could significantly increase expenses and cause significant interruption to both our transactional and marketing and subscription businesses.
We depend heavily on several third-party providers of Internet and related telecommunication services, including hosting and co-location facilities, in conducting our business. These companies may not continue to provide services to us without disruptions in service, at the current cost or at all. The costs associated with any transition to a new service provider would be substantial, requiring the reengineering of computer systems and telecommunications infrastructure to accommodate a new service provider to allow for a rapid replacement and return to normal network operations. This process would be both expensive and time-consuming. In addition, failure of the Internet and related telecommunications providers to provide the data communications capacity in the time frame required by us could cause interruptions in the services we provide across all of our business activities. In addition to service interruptions arising from third-party service providers, unanticipated problems affecting our proprietary internal computer and telecommunications systems have the potential to occur in future fiscal periods, and could cause interruptions in the delivery of services, causing a loss of revenue and related gross margins, and the potential loss of customers, all of which could materially and adversely affect our business, results of operations and financial condition.
We depend on partners and third-parties for our content and for the delivery of services underlying our subscriptions.
We depend heavily on partners and third-parties to provide us with licensed content including for the Kazaa music service. We are reliant on such companies to maintain licenses with content providers, including music labels, so that we can deliver services that we are contractually obligated to deliver to our customers. These companies may not continue to provide services to us without disruption, or maintain licenses with the owners of the delivered content. In addition to licensed content, we are also reliant on partners and third parties to provide services and to perform other activities which allow us to bill our subscribers. The costs associated with any transition to a new service or content provider would be substantial, even if a similar partner is available. Failure of our partners or other third parties to provide content or deliver services have the potential to cause interruptions in the delivery of services, causing a loss of revenue and related gross margins, and the potential loss of customers, all of which could materially and adversely affect our business, results of operations and financial condition.
We may not fully recoup the expenses and other costs we have expended with respect to the Kazaa music service
Under the Marketing Services Agreement and Master Services Agreement we entered into with Brilliant Digital, Inc. (“BDE”), relating to the operation and marketing of the Kazaa digital music service, we are responsible for making advance payments and expenditures in relation to certain expenses incurred in order to provide the required services and operate the Kazaa music service. The Company is entitled to full recoupment for all pre-approved costs and expenses incurred in connection with the provision of the services plus all other agreed budgeted amounts and these advances and expenditures are recoverable on a dollar for dollar basis against current and future revenues. We are dependent on the future net cash flow of the Kazaa music service to fully recoup the expenditures we have made although BDE has agreed to repay $2.5 million of these advances and expenditures which are not otherwise recovered from Kazaa generated revenues and this repayment obligation has been secured under separate agreement. There can be no assurance that the future net cash flows from the Kazaa music service will be sufficient to allow us to fully recoup our expenditures, which could materially and adversely affect our financial condition.
Our working capital requirements are significant and we may need to raise cash in the future to fund our working capital requirements.
Our working capital requirements are significant. If our cash flows from operations are less than anticipated or our working capital requirements or capital expenditures are greater than expectations, or if we expand our business by acquiring or investing in additional products or technologies, we may need to secure additional debt or equity financing. We are continually evaluating various financing strategies to be used to expand our business and fund future growth. There can be no assurance that additional debt or equity financing will be available on acceptable terms, if at all. The potential inability to obtain additional debt or equity financing, if required, could have a material adverse effect on our operations.
If advertising on the internet loses its appeal, our revenue could decline.
Companies doing business on the Internet must compete with traditional advertising media, including television, radio, cable and print, for a share of advertisers' total marketing budgets. Potential customers may be reluctant to devote a significant portion of their marketing budget to Internet advertising or digital marketing if they perceive the Internet to be trending towards a limited or ineffective marketing medium. Any shift in marketing budgets away from Internet advertising spending or digital marketing solutions, could directly, materially and adversely affect our transactional and marketing business, as well as our subscription business, with both having a materially negative impact on our results of operations and financial condition.
During the nine months ended September 30, 2009, allAll of our revenue wasis generated, directly or indirectly, through the Internet in part by delivering advertisements that generate leads, impressions, click-throughs, and other actions to our advertiser customers' websites as well as confirmation and management of mobile services. This business model may not continue to be effective in the future for various reasons, including the following reasons:following:
| · | click and conversion rates may decline as the number of advertisements and ad formats on the Web increases, making it less likely that a user will click on our advertisement; |
| · | the installation of "filter" software programs by web users which prevent advertisements from appearing on their computer screens or in their email boxes may reduce click-throughs; |
| · | companies may be reluctant or slow to adopt online advertising that replaces, limits or competes with their existing direct marketing efforts; |
| · | companies may prefer other forms of Internet advertising we do not offer, including certain forms of search engine placements; |
| · | companies may reject or discontinue the use of certain forms of online promotions that may conflict with their brand objectives; |
| · | companies may not utilize online advertising due to concerns of "click-fraud", particularly related to search engine placements; |
| · | regulatory actions may negatively impact certain business practices that we currently rely on to generate a portion of our revenue and profitability; and |
If the number of companies who purchase online advertising from us does not continue to grow, we may experience difficulty in attracting publishers, and our revenue could decline.
We no longer meet the minimum bid price requirement for continued listing on the NASDAQ Global Market and have until June 22, 2010 to correct it.
We received a notice from NASDAQ that we no longer meet the minimum bid price requirement for continued listing on the NASDAQ Global Market as set forth in NASDAQ’s Marketplace Rule 5450(a)(1), as a result of the bid price of our common stock closing below the required minimum $1.00 per share for 30 consecutive business days. We have been provided with a customary grace period of 180 calendar days in which to regain compliance with the minimum bid price rule. If at any time before June 22, 2010, the bid price of our stock closes at $1.00 per share or more for a minimum of 10 consecutive business days, NASDAQ will provide written confirmation to us that we have regained compliance. If we do not regain compliance with the bid price rule by June 22, 2010, NASDAQ will notify us that our common stock is subject to delisting from The NASDAQ Global Market. However, we may appeal the delisting determination to a NASDAQ hearing panel and the delisting will be stayed pending the panel's determination. Alternatively, we may apply to transfer the listing of our common stock to the NASDAQ Capital Market if we satisfy all criteria for initial listing on the NASDAQ Capital Market, other than compliance with the minimum bid price requirement. If such application to the NASDAQ Capital Market is approved, then we may be eligible for an additional grace period.
We intend to actively monitor the bid price for our common stock between now and June 22, 2010, and will consider available options to regain compliance with the NASDAQ minimum bid price requirements. If we are unable to regain compliance with the minimum bid rule and is delisted, or unable to qualify for listing on the NASDAQ Capital Market, market liquidity for our common stock could be severely affected, and our stockholders’ ability to sell securities in the secondary market could be limited. Delisting from NASDAQ would negatively affect the value of our common stock. Delisting could also have other negative results, including, but not limited to, the potential loss of confidence by employees, the loss of institutional investor interest and fewer business development opportunities.
Our revenue could decline if we fail to effectively monetize our content and our growth could be impeded if we fail to acquire or develop new contentcontent.
Our success depends in part on our ability to effectively manage our existing content. The Web publishers and email list owners that list their unsold leads, data or offers with us are not bound by long-term contracts that ensure us a consistent supply of same.such information. In addition, Web publishers or email list owners can change the amount of content they make available to us at any time. If a Web publisher or email list owner decides not to make content from its websites, newsletters or email lists available to us, we may not be able to replace this content with content from other Web publishers or email list owners that have comparable traffic patterns and user demographics quickly enough to fulfill our advertisers' requests. This would result in lost revenue.
If we are unable to successfully keep pace with the rapid technological changes that may occur in the wireless communication, internet and e-commerce arenas, we could lose customers or advertising inventory and our revenue and results of operations could decline.
To remain competitive, we must continually monitor, enhance and improve the responsiveness, functionality and features of our services, offered both in our subscription and transactional and marketing activities. Wireless network and mobile phone technologies, the Internet and the online commerce industry in general are characterized by rapid innovation and technological change, changes in user and customer requirements and preferences, frequent new product and service introductions requiring new technologies to facilitate commercial delivery, as well as the emergence of new industry standards and practices that could render existing technologies, systems, business methods and/or our products and services obsolete or unmarketable in future fiscal periods. Our success in our business activities will depend, in part, on our ability to license or internally develop leading technologies that address the increasingly sophisticated and varied needs of prospective consumers, and respond to technological advances and emerging industry standards and practices on a timely-cost-effective basis. Website and other proprietary technology development entails significant technical and business risks, including the significant cost and time to complete development, the successful implementation of the application once developed, and time period for which the application will be useful prior to obsolescence. There can be no assurance that we will use internally developed or acquired new technologies effectively or adapt existing websites and operational systems to customer requirements or emerging industry standards. If we are unable, for technical, legal, financial or other reasons, to adopt and implement new technologies on a timely basis in response to changing market conditions or customer requirements, our business, prospects, financial condition and results of operations could be materially adversely affected.
We could be subject to legal claims, government enforcement actions, and be held accountable for our or our customers' failure to comply with federal, state and foreign laws, regulations or policies, all of which could materially harm our business.
As a direct-to-consumer marketing company, we are subject to a variety of federal, state and local laws and regulations designed to protect consumers that govern certain of aspects of our business. For instance, recent growing public concern regarding privacy and the collection, distribution and use of information about Internet users has led to increased federal, state and foreign scrutiny and legislative and regulatory activity concerning data collection and use practices. Any failure by us to comply with applicable federal, state and foreign laws and the requirements of regulatory authorities may result in, among other things, indemnification liability to our customers and the advertising agencies we work with, administrative enforcement actions and fines, class action lawsuits, cease and desist orders, and civil and/orand criminal liability.
Our customers are also subject to various federal and state laws concerning the collection and use of information regarding individuals. These laws include the Children's Online Privacy Protection Act, the Federal CAN-SPAM Act of 2003, as well as other laws that govern the collection and use of consumer credit information. We cannot assure you that our customers are currently in compliance, or will remain in compliance, with these laws and their own privacy policies. We may be held liable if our customers use our technologies in a manner that is not in compliance with these laws or their own stated privacy policies, which would have an adverse impact on our operations.
Our success depends on our ability to continue forming relationships with other Internet and interactive media content, service and product providers.
The Internet includes an ever-increasing number of businesses that offer and market consumer products and services. These entities offer advertising space on their websites, as well as profit sharing arrangements for joint effort marketing programs. We expect that with the increasing number of entrants into the Internet commerce arena, advertising costs and joint effort marketing programs will become extremely competitive. This competitive environment might limit, or possibly prevent us from obtaining profit generating advertising or reduce our margins on such advertising, and reduce our ability to enter into joint marketing programs in the future. If we fail to continue establishing new, and maintain and expand existing, profitable advertising and joint marketing arrangements, we may suffer substantial adverse consequences to our financial condition and results of operations. WeAdditionally, we, as a result of our acquisition of Traffix, now have a significant economic dependence on the major search engine companies that conduct business on the Internet; such search engine companies maintain ever changing rules regarding scoring and indexing their customers marketing search terms. If we cannot effectively monitor the ever changing scoring and indexing criteria, and affectively adjust our search term applications to conform to such scoring and indexing, we could suffer a material decline in our search term generated acquisitions, correspondingly reducing our ability to fulfill our clients marketing needs. This would have an adverse impact on our company’s revenues and profitability.
The demand for a portion of our transactional and marketing services may decline due to the proliferation of “spam” and the expanded commercial adoption of software designed to prevent its delivery.
Our business may be adversely affected by the proliferation of "spam" or unwanted internet solicitations. In response to the proliferation of spam, Internet Service Providers ("ISP's") have been adopting technologies, and individual computer users are installing software on their computers that are designed to prevent the delivery of certain Internet advertising, including legitimate solicitations such as those delivered by us. We cannot assure you that the number of ISP's and individual computer users who employ these or other similar technologies and software will not increase, thereby diminishing the efficacy of our transactional and marketing, as well as our subscription service activities. In the case that one or more of these technologies, or software applications, realize continued and/or widely increased adoption, demand for our services could decline in response.
We have no intentiondo not intend to pay dividends on our equity securities.
It is our current and long-term intention that we will use all cash flows to fund operations and maintain excess cash requirements for the possibility of potential future acquisitions. Future dividend declarations, if any, will result from our reversal of our current intentions, and would depend on our performance, the level of our then current and retained earnings and other pertinent factors relating to our financial position. Prior dividend declarations should not be considered as an indication for the potential for any future dividend declarations.
We face intense competition in the marketingsale of our subscription services and the products of our transaction based clients.transactional and marketing services.
In both our subscription service business, which includes the Kazaa music service, and our transactional and marketing services and transaction services,business, we compete primarily on the basis of marketing acquisition cost, brand awareness, consumer penetration and carrier and distribution depth and breadth. We considerface numerous competitors, many of whom are much larger than us, who have greater financial and operating resources than we do and who have been operating in our primary subscription business competitors to be Buongiorno, Playphone, Dada Mobile, Acotel, Glu Mobile, Cellfish (Lagadere), Jamster (Fox), Hands on Mobile and Thumbplay. In our transactional business,target markets longer than we consider Azoogle, Value Click, Miva, Kowabunga! (Think Partnership), Right Media, iCrossing, 360i, iProspect, Publicis (Formerly Digitas), Omnicom and Blue Lithium to be our primary competitors.have. In the future, likely competitors may include other major media companies, traditional video game publishers, wirelesstelephone carriers, content aggregators, wireless software providers and other pure-play wireless subscription publishers,direct response marketers publishing content and media, and Internet affiliate and network companies.
If we are not as successful as our competitors in executing on our strategy in targeting new markets and increasing customer penetration in existing markets executing on marquee brand alignment, and/or effectively executing on business level accretive acquisition identification and successful closing and post acquisition integration, our sales could decline, our margins could be negatively impacted and we could lose market share, any and all of which could materially harm our business prospects, and potentially have a negative impact on our share price.
If we do not successfully execute our international strategy, our revenue, results of operations and the growth of our business could be harmed.
Our planned international expansion and the integration of international operations present unique challenges and risks to our company, and require management attention. Our foreign operations subject us to foreign currency exchange rate risks and we currently do not utilize hedging instruments to mitigate foreign currency exchange rate risks.
Our continued international expansion will subject us to additional foreign currency exchange rate risks and will require additional management attention and resources. We cannot assure you that we will be successful in our international expansion and operations efforts. Our international operations and expansion subject us to other inherent risks, including, but not limited to: the impact of recessions in economies outside of the United States; changes in and differences between regulatory requirements between countries; U.S. and foreign export restrictions, including export controls relating to encryption technologies; reduced protection for and enforcement of intellectual property rights in some countries; potentially adverse tax consequences; difficulties and costs of staffing and managing foreign operations; political and economic instability; tariffs and other trade barriers; and seasonal reductions in business activity.
Our failure to address these risks adequately could materially and adversely affect our business, revenue, results of operations and financial condition.
System failures could significantly disrupt our operations, which could cause us to lose customers or content.
Our success depends on the continuing and uninterrupted performance of our systems. Sustained or repeated system failures that interrupt our ability to provide services to customers, including failures affecting our ability to deliver advertisements quickly and accurately and to process visitors' responses to advertisements, and, validate mobile subscriptions, would reduce significantly the attractiveness of our solutions to advertisers and Web publishers. Our business, results of operations and financial condition could also be materially and adversely affected by any systems damage or failure that impacts data integrity or interrupts or delays our operations. Our computer systems are vulnerable to damage from a variety of sources, including telecommunications failures, power outages, malicious or accidental human acts, and natural disasters. We operate a data center in Canada and have a co-location agreement with a service provider to support our operations. Therefore, any of the above factors affecting any of these areas could substantially harm our business. Moreover, despite network security measures, our servers are potentially vulnerable to physical or electronic break-ins, computer viruses and similar disruptive problems in part because we cannot control the maintenance and operation of our third-party data centers. Despite the precautions taken, unanticipated problems affecting our systems could cause interruptions in the delivery of our solutions in the future and our ability to provide a record of past transactions. Our data centers and systems incorporate varying degrees of redundancy. All data centers and systems may not automatically switch over to their redundant counterpart. Our insurance policies may not adequately compensate us for any losses that may occur due to any failures in our systems.
We are dependent on our key personnel for managing our business affairs. The loss of their services could materially and adversely affect the conduct and the continuation of our business.
We are and will be highly dependent upon the efforts of the members of our management team, particularly those of our Interim Chief Executive Officer, Jeffrey Schwartz, our President, Andrew Stollman, our Executive Vice President, Corporate Development, Raymond Musci and our Chief Financial Officer, Andrew Zaref. The loss of the services of Messrs. Schwartz, Stollman, Musci or Zaref may impede the execution of our business strategy and the achievement of our business objectives. We can give you no assurance that we will be able to attract and retain the qualified personnel necessary for the development of our business. Our failure to recruit key personnel or our failure to adequately train, motivate and supervise our existing or future personnel will adversely affect our operations.
Decreased effectiveness of equity compensation could adversely affect our ability to attract and retain employees and harm our business.
We have historically used stock options as a key component of our employee compensation program in order to align employees' interests with the interests of our stockholders, encourage employee retention, and provide competitive compensation packages. Volatility or lack of positive performance in our stock price may adversely affect our ability to retain key employees, many of whom have been granted stock options, or to attract additional highly-qualified personnel. As of September 30, 2009, someMarch 31, 2010, many of our outstanding employee stock options have exercise prices in excess of the stock price on that date. To the extent this continues to occur, our ability to retain employees may be adversely affected. Moreover, applicable NASDAQ listing standards relating to obtaining stockholder approval of equity compensation plans could make it more difficult or expensive for us to grant stock options or other stock-based awards to employees in the future. As a result, we may incur increased compensation costs, change our equity compensation strategy or find it difficult to attract, retain and motivate employees, any of which could materially, adversely affect our business.
We have been named as a defendant in litigation, either directly, or indirectly, with the outcome of such litigation being unpredictable; a materially adverse decision in any such matter could have a material adverse affect on our financial position and results of operations.
As described below and as described under the heading "Legal Proceedings" in our periodic reports filed pursuant to the Securities Exchange Act of 1934, from time to time we are named as a defendant in litigation matters. The defense of these claims may divert financial and management resources that would otherwise be used to benefit our operations. Although we believe that we have meritorious defenses to the claims made in each and all of the litigation matters to which we have been a named party, whether directly or indirectly, and intend to contest each lawsuit vigorously, no assurances can be given that the results of these matters will be favorable to us. A materially adverse resolution of any of these lawsuits could have a material adverse affect on our financial position and results of operations.