Loan Portfolio

Although loans may be classified as non-performing, some pay on a regular basis, and many continue to pay interest irregularly or at less than original contractual rates.  Interest income that would have been recorded under the original terms of these loans would have aggregated $272 thousand for 2020, $193 for 2019 and $99 thousand for 2018. Any collections of interest on nonaccrual loans are included in interest income when collected unless it is on an impaired loan with a specific allocation.  A collection of interest on an impaired loan with a specific allocation is applied to the loan balance to decrease the allocation. Total interest collections, whether on an accrued or cash basis, amounted to $269 thousand for 2020, $117 thousand for 2019 and $69 thousand for 2018. Loans are placed on nonaccrual status in the event that the loan is in past due status for more than 90 days or payment in full of principal and interest is not expected.  The Bank had nonaccrual loan balances of $9.4 million at December 31, 2020 compared to balances of $3.4 million and $542.0 thousand as of year-end 2019 and 2018. All of the balances of nonaccrual loans for the past three years were collaterally secured. As of December 31, 2020, the Bank had $56.3 million of loans which it considers to be “potential problem loans” in that the borrowers are experiencing financial difficulties which are not reflected in the table above. At December 31, 2019, the Bank had $60.2 million of these loans. At December 31, 2018, the Bank had $7.9 million of these loans.  These loans are subject to constant management attention and are reviewed at least monthly. The amount of the potential problem loans was considered in management’s review of the loan loss reserve at December 31, 2020 and 2019.In extending credit to families, businesses and governments, banks accept a measure of risk against which an allowance for possible loan loss is established by way of expense charges to earnings. This expense is determined by management based on a detailed monthly review of the risk factors affecting the loan portfolio, including general economic conditions, changes in the portfolio mix, past due loan-loss experience and the financial condition of the bank’s borrowers.As of December 31, 2020, the Bank had loans outstanding to individuals and firms engaged in the various fields of agriculture in the amount of $94.4 million with an additional $189.2 million in agricultural real estate loans which compared to $111.8 and $199.1 million respectively as of December 31, 2019.  The ratio of this segment of loans to the total loan portfolio is not considered unusual for a bank engaged in and servicing rural communities.Interest rate modification to reflect a decrease in market interest rates or maintain a relationship with the debtor, where the debtor is not experiencing financial difficulty and can obtain funding from other sources, is not considered a troubled debt restructuring. As of December 31, 2020, the Bank had $6.5 million of its loans that were classified as troubled debt restructurings, of which $5.6 million are included in non-accrual loans.  This compares to $956.3 thousand of troubled debt restructurings, of which $50.3 thousand are included in non-accrual loans for 2019 and $178.1 thousand of troubled debt restructuring, of which $74.4 thousand are included in non-accrual loans for 2018. Updated appraisals are required on all collateral dependent loans once they are deemed impaired.  The Bank may also require an updated appraisal of a watch list loan which the Bank monitors under their loan policy. On a quarterly basis, Bank management reviews properties supporting asset dependent loans to consider market events that may indicate a change in value has occurred.To determine observable market value, collateral asset values securing an impaired loan are periodically evaluated. Maximum time of re-evaluation is every 12 months for chattels and titled vehicles and every two years for real estate.  In this process, third party evaluations are obtained and heavily relied upon. Until such time that updated appraisals are received, the Bank may discount the existing collateral value used.Performing “non-watch list” loans secured in whole or in part by real estate, do not require an updated appraisal unless the loan is rewritten and additional funds advanced.  Watch List loans secured in whole or in part by real estate require updated appraisals every two years.  All loans are subject to loan to values as found in the Bank’s loan policies irrespective of their grade.  The Bank’s watch list is reviewed on a quarterly basis by management and any questions to value are addressed at that time. The majority of the Bank’s loans are made in the market by lenders who live and work in the market.  Thus, their evaluation of the independent valuation is also valuable and serves as a double check.  On extremely rare occasions, the Bank will make adjustments to the recorded values of collateral securing commercial real estate loans without acquiring an updated appraisal for the subject property. The Bank has no formalized policy for determining when collateral value adjustments between regularly scheduled appraisals are necessary, nor does it use any specific methodology for applying such adjustments. However, on a quarterly basis as part of its normal operations, the Bank’s senior management and the Loan Review Committee will meet to review all commercial credits either deemed to be impaired or on the Bank’s watch list. In addition to analyzing the recent performance of these loans, management and the Enterprise Risk Management Committee will also consider any general market conditions that might warrant adjustments to the value of particular real estate collateralizing commercial loans. In addition, management conducts annual reviews of all commercial loans exceeding certain outstanding balance thresholds. In each of these situations, any information available to management regarding market conditions impacting a specific property or other relevant factors are considered, and lenders familiar with a particular commercial real estate loan and the underlying collateral may be present to provide their opinion on such factors. If the available information leads management to conclude a valuation adjustment is warranted, such an adjustment may be applied on the basis of the information available. If management concludes that an adjustment is warranted but lacks the specific information needed to reasonably quantify the adjustment, management will order a new appraisal on the subject property even though one may not be required under the Bank’s general policies for updating appraisal. Note 4 of the Consolidated Financial Statements may also be reviewed for additional tables dealing with the Bank’s loans and ALLL. ALLL is evaluated based on an assessment of the losses inherent in the loan portfolio.  This assessment results in an allowance consisting of two components, allocated and unallocated. Management considers several different risk assessments in determining ALLL. The allocated component of ALLL reflects expected losses resulting from an analysis of individual loans, developed through specific credit allocations for individual loans and historical loss experience for each loan category.  For those loans where the internal credit rating is at or below a predetermined classification and management can reasonably estimate the loss that will be sustained based upon collateral, the borrowers operating activity and economic conditions in which the borrower operates, a specific allocation is made.  For those borrowers that are not currently behind in their payment, but for which management believes, based on economic conditions and operating activities of the borrower, the possibility exists for future collection problems, a reserve is established.  The amount of reserve allocated to each loan portfolio is based on past loss experiences and the different levels of risk within each loan portfolio.  The historical loan loss portion is determined using a historical loss analysis by loan category.The unallocated portion of the reserve for loan losses is determined based on management’s assessment of general economic conditions as well as specific economic factors in the Bank’s marketing area.  This assessment inherently involves a higher degree of uncertainty.  It represents estimated inherent but undetected losses within the portfolio that are probable due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition and other current risk factors that may not have yet manifested themselves in the Bank’s historical loss factors used to determine the allocated component of the allowance.Actual charge-off of loan balances is based upon periodic evaluations of the loan portfolio by management.  These evaluations consider several factors, including, but not limited to, general economic conditions, financial condition of the borrower, and collateral.As presented in the table on the next page, charge-offs decreased to $720 thousand for 2020. 52.8% of the charge-offs stemmed from the consumer related portfolios. Charge-offs were $841 thousand for 2019, $580 thousand for 2018, preceded by $288 thousand for 2017 and $550 thousand for 2016.  Recoveries were $183 thousand in 2020 compared to $156, $163, $150 and $156 thousand for 2019, 2018, 2017 and 2016, respectively. The net charge-offs for the last five years were all under $700 thousand. 2017 was the lowest at $138 thousand. Higher provision expense was used to fund the ALLL for loan growth in 2016 and 2019. 2020 had higher provision expense due to the uncertainty surrounding COVID-19 and its impact on individuals and businesses. For 2017 and 2018, the provision was used to replenish the balance decreased by the net charge-off activity. Overall, the ALLL increased from $6.8 million at year-end 2016 to $13.7 million at year-end 2020. After adding the allowance for unfunded loan commitments, the ACL ended 2020 at $14.3 million. As the ratios on the bottom of the following table show, the trends for each have improved or remained constant over the five years shown. Asset quality and the ACL are both strong and emphasize the level of credit quality. In reviewing the bigger picture of the allowance for credit loss, the years with the higher percentage of ACL to total nonperforming loans ratio account for the lower level of nonaccrual and watch list loans. This demonstrates the extended time period with which it has taken to achieve resolution and/or collection of these loans. The ratio of ACL to nonperforming loans increased beginning in 2016 with a significant drop in 2019 followed by a slight drop in 2020. 2020’s provision expense was the highest of the five years shown largely due to the uncertainty surrounding COVID-19.  Loan growth occurred in 2020 and 2019 reaching a double-digit percentage increase like 2016. The ACL to nonperforming loans for all years remained more than adequate and emphasizes the existing strong level of credit quality.  The following table presents a reconciliation of the allowance for credit losses for the years ended December 31, 2020, 2019, 2018, 2017 and 2016:


Loan Portfolio

*Nonperforming loans are defined as all loans on nonaccrual, plus any loans past due 90 days not on nonaccrual.Allocation of ALLL per Loan Category in terms of dollars and percentage of loans in each category to total loans is as follows:


22

*We
have already paid $172,000 toward this total.If
we are able to successfully develop our drug, PT00114, and obtain FDA approval, we could then begin marketing and selling it in
the United States and generate revenue. FDA approval to begin commercial sales is the singular gating item that will allow us
to begin generating sales revenue in the U.S., so it will have an enormous impact on our business plan and our financial condition.
It is anticipated that the sale of our drug will allow the Company to generate enough sales revenue to support all of our operations
and to generate a profit. However, given the stage of development, even if FDA Approval is obtained, we do not anticipate generating
any revenue from sales prior to 2024.Development
Milestones (upcoming developmental milestones)Upcoming
development milestones include confirming efficacy of our lead drug candidate in an animal model in a CRO, conducting toxicology
testing in two animal species, and filing an IND application to begin human clinical trials.Human
Resources (current state of employees and future plans towards employeesThe
Company has two part-time employees: Garo H. Armen, PhD, the Executive Chairman, and Alexander K. Arrow, MD, the Chief Financial
Officer. The Company also has three paid consultants: Andrew Slee, PhD, Development Advisor, Dalia Barsyte, PhD, Chief Technology
Advisor, David Lovejoy, PhD, Chief Scientific Advisor, and Christina Fam Faragalla, Director of Project Management.Financing
– Capital NeedsIn
addition to the working capital being generated via the Note Private Offering, the Company anticipates that it will need to raise
additional capital in the next year or so to support its research and development activities as it prepares to commence and commences
human clinical trials. The Company does not have any commitments for such additional capital.Over
the next two years, we anticipate conducting the following research and development activities at the following estimated costs
and expense:

|  |  | Estimated Cost | |  |
| --- | --- | --- | --- | --- |
| 2Q 2020 |  |  |  |  |
| Final Dosing work for Phase I |  | $ | 55,000 |  |
| Final Safety and Toxicology Animal studies |  | $ | 421,000 | \* |
|  |  |  |  |  |
| 3Q 2020 |  |  |  |  |
| Complete Stability and Formulation |  | $ | 85,000 |  |
| IND application write-up and filing |  | $ | 120,000 |  |
|  |  |  |  |  |
| 4Q 2020 |  |  |  |  |
| Site selection, patient enrollment |  | $ | 850,000 | \* |
|  |  |  |  |  |
| 1H 2021 |  |  |  |  |
| Human Safety Data generated from Phase I trial |  | $ | 450,000 |  |
|  |  |  |  |  |
| 2H 2021 |  |  |  |  |
| Human Efficacy Data generated from Phase II trial |  | $ | 600,000 |  |


ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS

(1)

As described above, we currently
      aggregate revenues based on the type of user activity monetized. Our
      objective is to optimize total revenues from the user experiences.
      Accordingly, this factor should be considered in evaluating the relative
      revenues generated from our Subscription and Transactional
      Services.

Revenues
decreased approximately $44.8 million, or 39%, to $69.1 million for the year
ended December 31, 2009, compared to $113.9 million for the year ended December
31, 2008.Subscription
revenue consists of content applications billed direct to consumers via mobile
or land based telephone lines or credit card.  These services are
delivered through the Internet to PCs, or mobile phones, or through other
Internet-connected devices.  Subscription revenue decreased by
approximately $22.0 million, or 50%, to $22.2 million for the year ended
December 31, 2009, compared to $44.2 million for the year ended December 31,
2008. The decrease in subscription service revenue was principally attributable
to a decrease in the number of billable subscribers during the period. At
December 31, 2009 the number of subscribers was 338,000 compared to 501,000 at
December 31, 2008.  This also compares to 346,000 subscribers at
September 30, 2009.  The decrease in billable subscribers from a year ago
was due primarily to a significant reduction in mobile customer acquisition
rates, offset by approximately 70,000 net billable additions from the
introduction of the Kazaa music subscription service.  Net billable
additions refers to the number of subscribers added during the period, less
attrition.  During 2009, we reduced our mobile marketing spends, which
directly impacted customer acquisition rates. We elected to cut our mobile
marketing spends because of the uncertain regulatory and legal environment
associated with marketing mobile subscription services and due to the less
profitable economics – a result of higher customer acquisition costs – of our
mobile subscription service offerings.Transactional
revenue is derived from our online marketing and lead generation activities,
which are targeted and measurable online campaigns and programs for marketing
partners, corporate advertisers, or their agencies, generating qualified
customer leads, online responses and activities, or increased brand recognition.
Transactional revenue decreased by approximately $22.9 million or 33% to $46.8
million for the year ended December 31, 2009 compared to $69.7 million for the
year ended December 31, 2008. The decrease is principally attributed to the
reduction in discretionary advertising spending by our search
customers.We also
experienced weakness in our marketing services and lead generation business,
including a reduction in page views, site visits, and registrations, which
manifested itself in lower revenue for these service lines on a year-over-year
basis.  As a result of the slow-down in economic activity in the
United States during 2009, spending on advertising decreased markedly, leading
to increased competition in the Internet marketing and lead generation markets
which, in turn, created significant downward pricing pressure on our offerings
and resulted in a lower volume of registrations and leads that could be sourced
at an attractive price.Operating
Expenses


Cost
of MediaCost of
Media – 3rd party
decreased by $31.2 million to $43.3 million for the year ended December 31, 2009
from $74.5 million for the year ended December 31, 2008. Cost of Media – 3 rd party
includes media purchased for monetization of both transactional and subscription
revenues. Because of its strictly variable nature, this decrease was
proportionately correlated to the decline in the related revenue.  As
a percentage of revenue, Cost of Media -3rd party
improved to 63% for the year ended December 31, 2009 from 65% for the year ended
December 31, 2008.  This improvement in Cost of Media -3rd party
margin is attributable to reductions in the pace of mobile customer acquisition,
partially offset by increased search marketing spend associated with the Kazaa
music subscription service. It is to be expected that for businesses with a
significant recurring revenue component, if direct marketing expense is
significantly curtailed, the business, as a result of the recurring nature of
revenue generated by the subscription service, will exhibit a short term period
of improved Cost of Media – 3 rd party
margins.Product
and DistributionProduct
and distribution expense increased by $0.8 million to $10.5 million in the year
ended December 31, 2009 as compared to $9.7 million for the year ended December
31, 2008. Product and distribution expenses are costs necessary to develop and
maintain proprietary content and support and maintain our websites and
technology platforms – which drive both our transactional and subscription based
revenues.  In 2009, we experienced higher product and distribution
expense as a result of costs incurred to further develop the Kazaa music
service, greater royalty and license expense, also associated with Kazaa, and
other general marketing and distribution technology-related
expense.  These higher technology and royalty costs were offset by a
reduction in product and distribution salary expense. Included in product and
distribution cost is stock compensation expense of $111,000 and $7,000 for the
year ended December 31, 2009 and 2008, respectively.Selling
and marketingSelling
and marketing expense decreased by $1.6 million to $8.4 million in the year
ended December 31, 2009 as compared to $10.0 million for the year ended December
31, 2008. The decrease is primarily due to a reduction in salaries and other
marketing costs, in accordance with the decrease in our revenue over the same
period.  This decrease in selling and marketing expense was partially
offset by higher customer service expense as a result of new service offerings
and call center activity.General,
Administrative and Other OperatingGeneral
and administrative expenses decreased by approximately $1.4 million to $14.7
million for the year ended December 31, 2009 compared to $16.1 million for the
year ended December 31, 2008. The decrease is due primarily due to a reduction
in labor and related costs, professional and consulting fees, facilities and
related costs, partially offset by an increase in Sarbanes Oxley consulting
fees, legal expense and severance payments and accruals to former executives.
While we consider it important to make appropriate and modest investments in
labor, facilities, and utilization of third party professional service providers
to support our continued growth, business development, and corporate governance
initiatives, management has also made steps to reduce our overall cost structure
as a result of the challenging and competitive business environment, and the
associated decrease in revenue and unfavorable operating results we have
experienced over the last year.  We continue to look for opportunities
to leverage our existing infrastructure or to generate appropriate cost savings
without affecting employee morale or jeopardizing business development
opportunities. Included in general and administrative expense is severance of
$1.1 million for the year ended December 31, 2009 and stock compensation expense
of $0.7 million and $1.3 million for the year ended December 31, 2009 and 2008,
respectively.Depreciation
and amortizationDepreciation
and amortization expense decreased $2.2 million to $3.7 million for the year
ended December 31, 2009 compared to $5.9 million for the year ended December 31,
2008 principally as a result of a reduction in capital expenditure and a
decrease of $1.4 million of Ringtone subscriber database amortization expense
from 2008 to 2009. The database was fully amortized by the second quarter of
2009.Impairment
of Goodwill and Intangible AssetsThe
Company conducts its annual impairment test in the fourth quarter of the year,
unless an event occurs prior to the fourth quarter that would more likely than
not reduce the fair value of the Company below its carrying amount. In
connection with our annual goodwill impairment testing conducted in the fourth
quarter, and for the year ended December 31, 2009, we determined there was
impairment of the carrying value of goodwill and intangible assets and recorded
a non-cash charge of $17.3 million compared to an impairment charge of $114.8
million in 2008. The goodwill and intangibles impairment, the majority of which
is not deductible for income tax purposes, is primarily due to our declining
market price, reduced expectations for future operating results and reduced
valuation multiples. Such negative factors are reflected in our stock price and
market capitalization.Loss
from OperationsOperating
loss decreased to approximately $28.9 million for the year ended December 31,
2009 compared to $117.1 million for the year ended December 31, 2008. Excluding
the effect of goodwill and intangibles impairment in 2009 and 2008, operating
loss increased to approximately $11.6 million for the year ended December 31,
2009, compared to $2.3 million for the year ended December 31, 2008. The higher
operating loss is the result of the revenue decrease, together with
proportionately higher product and distribution expense, selling and marketing
expense and general and administrative expense, offset by an improvement in the
Cost of Media – 3rd party
margin.Interest
income and dividends Interest
and dividend income decreased approximately $676,000 to $72,000 for the year
ended December 31, 2009, compared to $748,000 for the year ended December 31,
2008. The reduction is mainly due to a decrease in the balances of cash and
marketable securities at December 31, 2009 compared to December 31, 2008, as
well as a reduction in the rate of return on invested capital.Interest
expenseInterest
expense was $76,000 for the year ended December 31, 2009 compared to $147,000
for the year ended December 31, 2008. The interest paid is primarily related to
the note payable to Ringtone which was paid in January 2009.Other
Income (Expense)Other
income was $5,000 for the year ended December 31, 2009 compared to other expense
of ($153,000) for the year ended December 31, 2008. The 2008 expense was due to
a loss on sale of marketable securities.Income
Taxes Income
tax expense (benefit), before noncontrolling interest and equity in income of
investee, for the year ended December 31, 2009 and 2008 was $0.6 million and
($0.9) million, respectively and reflects an effective tax rate of 2.2% and 0.7%
respectively. The effective tax rates were computed taking into consideration
non-deductible impairment charges of $12.1 million and $114.8 million for 2009
and 2008, respectively, and the establishment of an income tax valuation
allowance of $11.0 million for 2009.Equity
in Loss of InvesteeEquity in
income of investee was $59,000, net of taxes at December 31, 2009 and represents
our 36% interest in The Billing Resource, LLC (TBR). We acquired the interest in
TBR in the 4th Quarter
2008 and  the operating results were de minimis.Net Loss (Income) Attributable to Noncontrolling
InterestNet loss attributable to noncontrolling
interest was $28,000 for the year ended December 31, 2009 as compared to net
income of ($24,000) for the year ended December 31, 2008. This related to our
investment in MECC which was dissolved in June 2009.Net
Loss Attributable to Atrinsic, Inc.Net loss attributable to Atrinsic Inc., decreased by
$86.3 million to $29.5 million for the year ended December 31, 2009 as compared
$115.8 million for the year ended December 31, 2008. This decrease resulted from
the factors described above.Liquidity
and Capital ResourcesWe
continually project anticipated cash requirements, which may include business
combinations, capital expenditures, and working capital requirements. As of
December 31, 2009, we had cash and cash equivalents of approximately $16.9
million and working capital of approximately $15.3 million. We used
approximately $3.0 million in cash for operations for the year ended December
31, 2009 and, contingent on prospective operating performance, may require
reductions in discretionary variable costs and other realignments to permanently
reduce fixed operating costs. We generated $2.4 million in cash from investing
activities, principally from proceeds from sale of marketable securities and a
distribution from The Billing Resource, offset by the investment in ShopIt. Cash
used in financing activities was $2.8 million and was principally attributable
to repayment of the Ringtone note payable of $1.8 million and stock repurchases.
Our Board of Directors authorized a share repurchase program which expired in
May 2009. Under this share repurchase program we purchased 832,392 shares of our
common stock for an aggregate price of $939,000.We
believe that our existing cash and cash equivalents and anticipated cash flows
from operating activities will be sufficient to fund minimum working capital and
capital expenditure needs for at least the next twelve months. The extent of our
future capital requirements will depend on many factors, including our results
of operations. If our cash flows from operations is less than anticipated or our
working capital requirements or capital expenditures are greater than
expectations, or if we expand our business by acquiring or investing in
additional products or technologies, we may need to secure additional debt or
equity financing. We are continually evaluating various financing strategies to
be used to expand our business and fund future growth. There can be no assurance
that additional debt or equity financing will be available on acceptable terms,
if at all. The potential inability to obtain additional debt or equity
financing, if required, could have a material adverse effect on our
operations.Critical
Accounting Policies and EstimatesPrinciples
of ConsolidationThe
consolidated financial statements include the accounts of all majority and
wholly-owned subsidiaries and significant intercompany balances and transactions
have been eliminated.The
equity method is used to account for investments in entities in which we have an
ownership of less than 50% and have significant influence over the operating and
financial policies of the affiliate.Use
of EstimatesThe
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenue and expenses as well
as the disclosure of contingent assets and liabilities. Management continually
evaluates its estimates and judgments including those related to allowances for
doubtful accounts, useful lives of property, plant and equipment and intangible
assets, fair value of stock options granted, forfeiture rate of equity based
compensation grants, probable losses associated with pre-acquisition
contingencies, income taxes and other contingencies. Management bases its
estimates and judgments on historical experience and other factors that are
believed to be reasonable in the circumstances. Actual results may differ from
those estimates. Macroeconomic conditions may directly, or indirectly through
our business partners and vendors, impact our financial performance and
available resources. Such conditions may, in turn, impact the aforementioned
estimates and assumptions. Management has discussed the development, selection
and disclosure of these estimates and assumptions with the Audit Committee of
the Board of Directors.  Accounts
Receivable and Related AllowancesThe
Company maintains allowances for doubtful accounts for estimated losses which
may result from the inability of its customers to make required payments. The
Company bases its allowances on the likelihood of recoverability of
accounts receivable by customer, based on past experience, the age of the
accounts receivable balance, the credit quality of the Company’s customers, and,
taking into account current collection trends. If specific customer
circumstances change or industry trends worsen beyond the Company’s estimates,
the Company would be required to increase its allowances for doubtful accounts.
Alternatively, if trends improve beyond the Company’s estimates, the Company
would be required to decrease its allowance for doubtful accounts. The Company’s
estimates are reviewed periodically, and adjustments are reflected through bad
debt expense in the period they become known. Changes in the Company’s bad debt
experience can materially affect its results of operations.The
Company also makes estimates for refunds and provides for these probable
uncollectible amounts through a reduction of recorded revenues in the period for
which the sale occurs, based on analyses of previous rates and
trends.Due to
the payment terms of the carriers requiring in excess of 60 days from the date
of billing or sale, at its sole discretion, the Company can elect to use trade
discounts in order to facilitate quicker payment. This discount or fee allows
for payments of approximately 80% of the prior month’s billings 15 to 20 days
after the end of the month. The Company records revenue net of that fee, if
incurred, which is 3.5% to 5% of the associated revenue.Goodwill
and Intangible AssetsGoodwill
represents the excess of cost over fair value of net assets of businesses
acquired. In accordance with ASC 350 formerly Statement of Financial Accounting
Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”,
the value assigned to goodwill and indefinite lived intangible assets is not
amortized to expense, but rather it is evaluated at least on an annual basis to
determine if there is a potential impairment. If the fair value of the reporting
unit is less than its carrying value, an impairment loss is recorded to the
extent that the implied fair value of the reporting unit goodwill is less than
the carrying value. If the fair value of an indefinite lived intangible is less
than its carrying amount, an impairment loss is recorded. Fair value is
determined based on discounted cash flows, market multiples or appraised values
as appropriate. Discounted cash flow analysis requires assumptions about the
timing and amount of future cash inflows and outflows, risk, the cost of
capital, and terminal values. Each of these factors can significantly affect the
value of the intangible asset. The estimates of future cash flows, based on
reasonable and supportable assumptions and projections, require management’s
judgment. Any changes in key assumptions about the Company’s businesses and
their prospects, or changes in market conditions, could result in an impairment
charge. Some of the more significant estimates and assumptions inherent in the
intangible asset valuation process include: the timing and amount of projected
future cash flows; the discount rate selected to measure the risks inherent in
the future cash flows; and the assessment of the asset’s life cycle and the
competitive trends impacting the asset, including consideration of any
technical, legal or regulatory trends.The
Company has determined that there was an impairment of the carrying value
of  goodwill and non-amortizable intangible assets as a result of
completing its annual impairment analysis as of December 31, 2009. In
performing the related valuation analysis the company used various valuation
methodologies including probability weighted discounted cash flows, comparable
transaction analysis, and market capitalization and comparable company multiple
comparison. The results of this review and impact of the impairment are more
fully described in Note 7 - “Goodwill and Intangible
Assets”.Intangible
assets subject to amortization primarily consist of customer lists, trade names
and trademarks, and restrictive covenants that were acquired.  The
intangible asset values assigned to the identified assets for each acquisition
were generally determined based upon the expected discounted aggregate cash
flows to be derived over the estimated useful life. The method of amortizing the
intangible asset values reflects, based upon the Company’s historical
experience, an accelerated rate of attrition in the subscriber database based
over the expected life of the underlying subscriber database after considering
turnover.  Accordingly, the Company amortizes the value assigned to
subscriber database based on the actual depletion of the acquired subscriber
database. The Company reviews the recoverability of its finite-lived intangible
assets for recoverability whenever events or circumstances indicated that the
carrying amount of an asset may not be recoverable. Recoverability is assessed
by comparison to associated undiscounted cash flows. In the fourth quarter of
2009, and prior to ASC 350 evaluation, the Company recognized an impairment of
$2.1 million under ASC 360.Stock-Based
CompensationThe
Company records stock based compensation in accordance with ASC 718 formerly
Financial Accounting Standard Board Statement of Financial Accounting Standards
No. 123 (revised 2004). In estimating the grant date fair value at stock option
awards and performance based restricted stock, we use the Black Scholes option
pricing model and other binomial pricing models where appropriate. The key
assumptions for these models to derive fair value include expected term, rate of
risk free returns and volatility. If different assumptions and estimates were
used, the amounts charged to compensation expense would be
different.Revenue
RecognitionThe
Company monetizes a portion of its user activities through subscription based
sources by providing on-going monthly access to and usage of premium products
and services.  In general, customers are billed at standard rates, at
the beginning of the month, and revenues are recognized upon receipt of
information confirming an arrangement. The Company estimates a provision for
refunds and credits which is recorded as a reduction to revenues. In determining
the estimate for refunds and credits, the Company relies upon historical data,
contract information and other factors. The estimated provision for refunds can
vary from actual results.The
Company effectuates its subscription revenues through a carrier or distributors
who are paid a transaction fee for their services.  In accordance with
ASC 605 formerly Emerging Issues Task Force (“EITF” No 99-19) “Reporting
Revenues Gross as Principal Versus Net as an Agent”, the Company recognizes as
revenues the net amount received from the carrier or distributor, net of their
fee.  The
Company monetizes a portion of its user activities through transactional based
services generated primarily from (a) fees earned, primarily on a Cost Per Click
basis, from search syndication services; (b) fees earned for the Company's
search engine marketing ("SEM") services; and (c) other fees for marketing
services including data and list management services, which can be either
periodic or transactional. Commission fee revenue is recognized in the period
that the Company's advertiser customer generates a sale or other agreed-upon
action on the Company's affiliate marketing networks or as a result of the
Company's SEM services, provided that no significant Company obligations remain,
collection of the resulting receivable is reasonably assured, and the fees are
fixed or determinable. All transaction services revenues are recognized on a
gross basis in accordance with the provisions of EITF 99-19, due to the
fact that the Company is the primary obligor and bears all credit risk to its
customer, and publisher expenses that are directly related to a
revenue-generating event are recorded as a component of 3rd part Media
Cost.Income
TaxesThe
Company uses the asset and liability method of financial accounting and
reporting for income taxes required by ASC 740 formerly Statement of Financial
Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”.
Under ASC 740, deferred income taxes reflect the tax impact of temporary
differences between the amount of assets and liabilities recognized for
financial reporting purposes and the amounts recognized for tax
purposes.We
maintain valuation allowances where it is more likely than not that all or a
portion of  a deferred tax asset will not be realized.Effective
January 1, 2007, the Company adopted FIN No. 48, “Accounting for
Uncertainty in Income Taxes” subsequently codified under ASC 740-10-25 which
resulted in no material adjustment in the liability for unrecognized tax
benefits. The Company classifies interest expense and penalties related to
unrecognized tax benefits as income tax expense. ASC 740 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements in accordance with ASC 740 and prescribes a recognition
threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The
evaluation of a tax position in accordance with this Interpretation is a
two-step process. The first step is recognition, in which the enterprise
determines whether it is more likely than not that a tax position will be
sustained upon examination, including resolution of any related appeals or
litigation processes, based on the technical merits of the position. The second
step is measurement. A tax position that meets the more-likely-than-not
recognition threshold is measured to determine the amount of benefit to
recognize in the financial statements.The
Company and its subsidiaries file income tax returns in the U.S and Canada. The
Company is subject to federal,  state and Canadian examinations. The
statute of limitations for 2008 and 2009 in all jurisdictions remains open and
are subject to examination by tax authorities.Contractual
Obligations and Off-Balance Sheet ArrangementsAt
December 31, 2009, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or other contractually narrow or limited purposes. As such, the Company is not
exposed to any financing, liquidity, market or credit risk that could arise if
it had engaged in such relationships.The
following table shows the Company’s future commitments for future minimum lease
payments required under operating leases that have remaining non cancellable
lease terms in excess of one year, future commitments under investment and
marketing agreements and future commitments under employment agreements as of
December 31, 2009:


Recent
Accounting PronouncementsAdopted
in 2009In August
2009, the FASB issued ASU 2009-05 “Measuring Liabilities at Fair Value” (“ASC
820-10”). ASC 820-10 is effective for interim and annual reporting periods
beginning after August 27, 2009.  It clarifies the application of
certain valuation techniques in circumstances in which a quoted price in an
active market for the identical liability is not available and clarifies that
when estimating the fair value of a liability, the fair value is not adjusted to
reflect the impact of contractual restrictions that prevent its transfer.
 We adopted ASC 820-10 for the year ended December 31, 2009 and it did not
have a material impact on our consolidated financial statements.In the
third quarter of 2009, the Company adopted the Financial Accounting Standards
Board (“FASB”) Accounting Standards Codification (“ASC”). The ASC is the source
of authoritative, nongovernmental GAAP, except for rules and interpretive
releases of the Securities and Exchange Commission (SEC).  The
adoption of the ASC did not have an impact on the Company’s results of
operations or financial position.In June
2009, the FASB issued SFAS No. 165, “Subsequent Events”, which has been
superseded by the FASB codification and included in ASC 855-10.  ASC 855-10
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are
issued.  The effective date of ASC 855-10 is interim or annual
financial periods ending after June 15, 2009.  The adoption of ASC
855-10 did not have a material effect on the Company’s consolidated financial
statements.In
June 2008, the FASB issued Staff Position No. EITF 03-6-1,
“Determining Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities” which has been superseded by the FASB codification ASC
260-10 gives guidance as to the circumstances when unvested share-based payment
awards should be included in the computation of EPS. ASC 260-10 is effective for
fiscal years beginning after December 15, 2008. The adoption of ASC 260-10
did not have an impact on the Company’s financial statements. In
December 2007, the FASB issued SFAS No. 141R, “Business Combinations” which has
been superseded the FASB codification and included in ASC 805. ASC 805
establishes the principles and requirements for how an acquirer: (i) recognizes
and measures in its financial statements the identifiable assets acquired, the
liabilities assumed and any non-controlling interest in the acquiree; (ii)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase; and (iii) determines what information to disclose
to enable users of the financial statements to evaluate the nature and financial
effects of the business combination. ASC 805 is to be applied prospectively to
business combinations consummated on or after the beginning of the first annual
reporting period on or after December 15, 2008, with early adoption prohibited.
Previously, any release of valuation allowances for certain deferred tax assets
would serve to reduce goodwill, whereas under the new standard any release of
the valuation allowance related to acquisitions currently or in prior periods
will serve to reduce our income tax provision in the period in which the reserve
is released. Additionally, under ASC 805 transaction-related expenses, which
were previously capitalized, will be expensed as incurred. The adoption of ASC
805 did not have a material effect on our results of operations or financial
position.In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements,” which has been superseded by the FASB
codification and included in ASC 810-10-65-1 and establishes requirements for
ownership interests in subsidiaries held by parties other than us (minority
interests) be clearly identified and disclosed in the consolidated statement of
financial position within equity, but separate from the parent's equity. Any
changes in the parent's ownership interests are required to be accounted for in
a consistent manner as equity transactions and any noncontrolling equity
investments in deconsolidated subsidiaries must be measured initially at fair
value. ASC 810-10-65-1 is effective, on a prospective basis, for fiscal years
beginning after December 15, 2008; however, presentation and disclosure
requirements must be retrospectively applied to comparative financial
statements. Except for presentation and disclosure requirements, the adoption of
ASC 810-10-65-1 had no material impact on the Company’s financial
statements.Not
Yet AdoptedIn
June 2009, the FASB issued SFAS No. 167, “Amendments to FASB
Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded
by the FASB Codification and included in ASC 810 to require an enterprise to
perform an analysis to determine whether the enterprise’s variable interest or
interests give it a controlling financial interest in a variable interest
entity. This analysis identifies the primary beneficiary of a variable interest
entity as one with the power to direct the activities of a variable interest
entity that most significantly impact the entity’s economic performance and the
obligation to absorb losses of the entity that could potentially be significant
to the variable interest. These revisions to ASC 810 will be effective as of the
beginning of the annual reporting period commencing after November 15, 2009
and will be adopted by the Company in the first quarter of 2010. We do not
believe that the adoption of these revisions to ASC 810 will have a material
impact to our results of operations or financial position.In
October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue
08-01, Revenue Arrangements with Multiple Deliverables which has been superseded
by FASB codification and included in ASC 605-25. This statement provides
principles for allocation of consideration among its multiple-elements, allowing
more flexibility in identifying and accounting for separate deliverables under
an arrangement. The EITF introduces an estimated selling price method for
valuing the elements of a bundled arrangement if vendor-specific objective
evidence or third-party evidence of selling price is not available, and
significantly expands related disclosure requirements. This standard is
effective on a prospective basis for revenue arrangements entered into or
materially modified in fiscal years beginning on or after June 15, 2010.
Alternatively, adoption may be on a retrospective basis, and early application
is permitted. The Company is currently evaluating the impact of adopting this
pronouncement.


37

*This
expenditure may depend on a successful capital raising event.

|  |  | Estimated  Cost | |  |
| --- | --- | --- | --- | --- |
| 1Q  2018 |  |  |  |  |
| Completion  of ELISA tests |  | $ | 45,000 |  |
| Complete  Custom antibodies as an alternative to ELISA |  | $ | 21,000 |  |
|  |  |  |  |  |
| 2Q  2018 |  |  |  |  |
| Complete  Stability and Formulation |  | $ | 85,000 |  |
| Write  our first IND application |  | $ | 80,000 |  |
|  |  |  |  |  |
| 3Q  2018 |  |  |  |  |
| Possibly  Complete toxicology studies in two species |  | $ | 850,000 | \* |
|  |  |  |  |  |
| 4Q  2018 |  |  |  |  |
| Submit  our first IND application |  | $ | 60,000 |  |
|  |  |  |  |  |
| 1Q  2019 |  |  |  |  |
| Begin  dosing healthy volunteers in Phase I trial |  | $ | 175,000 |  |


ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Revenues decreased approximately $29.1 million, or 42%, to $40.0 million for the year ended December 31, 2010, compared to $69.1 million for the year ended December 31, 2009.Subscription revenue consists of content applications billed direct to consumers via mobile or land based telephone lines or credit card. These services are delivered through the Internet to PCs, or mobile phones, or through other Internet-connected devices. Subscription revenue decreased by approximately $3.2 million, or 15%, to $19.0 million for the year ended December 31, 2010, compared to $22.2 million for the year ended December 31, 2009. Subscription revenue for the year ended December 31, 2010 includes an increase in Kazaa revenue of $8.0 million compared to the year ended December 31, 2009, without which, our subscription revenue would have decreased by 50%, or $11.0 million year-over-year.  As of December 31, 2010, the Company had approximately 205,000 subscribers, compared to 338,000 as of December 31, 2009.  This decrease in subscribers was partly offset by a 22% increase in average revenue per user (“ARPU”) to approximately $6.11 for the year ended December 31, 2010, compared to the year ended December 31, 2009. The increase in ARPU was the result of the higher retail price point of the Kazaa digital music subscription service and improvements in billing efficiency. As of December 31, 2010, the Company has approximately 77,000 Kazaa subscribers.  Relative to the approximately 80,000 Kazaa subscribers we had at the end of 2009, for all of 2010, we experienced a net decrease of 3,000 Kazaa subscribers (new subscriber additions, net of attrition).Transactional revenue is principally derived from our search marketing agency business, which consists of targeted and measurable online campaigns and programs for advertisers, to generate qualified customer leads, sales transactions, or increased brand recognition. Transactional revenue decreased by approximately $25.8 million or 55% to $21.0 million for the year ended December 31, 2010 compared to $46.8 million for year ended December 31, 2009. The decrease in revenue was attributable to the loss of accounts and a reduction in discretionary advertising expenditures by our clients, as well as a result of a restructuring of our agency activities. Beginning in the second quarter, and substantially completed by the end of the third quarter, the Company took proactive steps to eliminate any unprofitable or marginally profitable lead generation campaigns and marketing programs from its Transactional offerings. These steps had the effect of curtailing lead generation sales volume, contributing to the decrease in revenue compared to the year ago period. As a result of this restructuring, the bulk of our Transactional revenue now consists of revenue generated from our search agency business, together with higher yielding marketing campaigns.Operating Expenses


Cost of MediaCost of Media – 3rd party decreased by $20.8 million to $22.5 million for the year ended December 31, 2010 from $43.3 million for the year ended December 31, 2009. Cost of Media – 3rd party includes media purchased for monetization of both Transactional and Subscription revenues. The decrease in Cost of Media – 3rd party was due to two primary factors. First, approximately 85% of the decrease in Cost of Media – 3rd party was due to the decline in Transactional related revenue which resulted in a corresponding reduction in purchased media. Second, the remaining 15% of the decrease in Cost of Media – 3rd party was due to significantly lower subscriber acquisition rates, and in turn, a lower number of subscribers acquired.The rate of subscriber acquisitions is based on a number of factors, not least of which is subscriber acquisition cost, or “SAC.” During the year ended December 31, 2010, management moderated and limited the rate of subscriber acquisitions in response to (i) the need to preserve cash, (ii) changes in its alternative billing processes, and (iii) anticipated improvements and enhancements to the Kazaa digital music service.During the year ended December 31, 2010, the Company added approximately 396,000 new subscribers, over half of which were Kazaa subscribers. This level of customer acquisition was not sufficient to replace the Company’s existing subscriber base during the year: “Net Adds,” which represents the number of subscribers acquired, net of subscriber attrition, which was a negative 133,000 for the year ended December 31, 2010. Cost of media for the year ended December 31, 2010 includes an increase in Kazaa-related Cost of Media – 3rd party of $2.3 million compared to the year ended December 31, 2009. We anticipate that  our share of the future cash flows of the Kazaa music service to exceed these Kazaa cost of media expenses, although there can be no assurance of this.During 2010, the Company estimates that its SAC per subscriber was approximately $15.34, which reflects a 10% increase in SAC from 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. Management will continue to monitor SAC closely to ensure that the Company acquires customers in a cost effective manner for both its transactional and subscription services. Because of its strictly variable nature, this decrease was proportionately correlated to the decline in the related revenue.Product and DistributionProduct and distribution expense increased by $9.7 million to $20.2 million in the year ended December 31, 2010 as compared to $10.5 million for the year ended December 31, 2009. Product and distribution expenses are costs necessary to provide licensed content and development and support for our products, websites and technology platforms – which drive both our Transactional and Subscription-based revenues. Compared to the year ended December 2009, in the year ended December 31, 2010 we experienced higher product and distribution expenses of $10.2 million as a result of costs incurred to further develop the Kazaa music service and greater royalty and license expense payable to content owners, also associated with Kazaa. We anticipate that our share of the future cash flows of the Kazaa music service to exceed these Kazaa product and distribution expenses, although there can be no assurance of this. This increase in costs related to Kazaa was partly offset by decreases in staffing costs as we have reduced the number of employees companywide during 2010.   Included in product and distribution cost is stock compensation expense of $54,000 and $111,000 for the years ended December 31, 2010 and 2009, respectively.Selling and marketingSelling and marketing expense decreased by $4.4 million to $4.0 million in the year ended December 31, 2010 as compared to $8.4 million for the year ended December 31, 2009. The decrease is primarily due to a reduction in salaries and other marketing costs, in accordance with the decrease in our revenue over the same period. Included in selling and marketing cost is stock compensation expense of $43,000 for the year ended December 31, 2010.General, Administrative and Other OperatingGeneral and administrative expenses decreased by approximately $5.6 million to $9.1 million for the year ended December 31, 2010 compared to $14.7 million for the year ended December 31, 2009. The decrease is primarily due to a reduction in workforce, and associated savings, a decrease in professional fees and other efforts to reduce the Company’s overall levels of overhead. The rate of decrease in general, administrative and other operating expense, on a year-over-year basis, is slower than for some other components of operating expenses because of the fixed nature of general and administrative costs, relative to the more variable based costs inherent in other categories of operating expense. Included in general and administrative expense is stock compensation expense of $1.0 million and $0.7 million for the year ended December 31, 2010 and 2009.Depreciation and amortizationDepreciation and amortization expense decreased $2.1 million to $1.6 million for the year ended December 31, 2010 compared to $3.7 million for the year ended December 31, 2009 as a result of a reduction in amortization for intangibles, due to the fact that we recorded an impairment charge of $4.1 million at December 31, 2009.   This was partly offset by an increase in depreciation due to a write-off of $0.4 million in property, plant and equipment related to the decision to shut down the Canada facility.Impairment of Goodwill and Intangible AssetsThe Company conducts its annual impairment test in the fourth quarter of the year, unless an event occurs prior to the fourth quarter that would more likely than not reduce the fair value of the Company below its carrying amount. In connection with our annual indefinite lived intangible asset impairment testing conducted in the fourth quarter, and for the year ended December 31, 2010, we determined there was impairment of the carrying value of indefinite lived intangible assets and recorded a non-cash charge of $1.5 million compared to an impairment charge of $2.0 million in 2009. In 2009, goodwill of $13.1 million was also impaired. The goodwill and indefinite lived intangibles impairment, the majority of which is not deductible for income tax purposes, is primarily due to our declining market price, reduced expectations for future operating results and reduced valuation multiples. Such negative factors are reflected in our stock price and market capitalization.As a result of significant adverse changes in the business climate, the Company concluded that triggering events had occurred and the Company tested long-lived assets for impairment as of December 31, 2010 and 2009. The Company determined the fair value of such long lived assets and recognized an impairment charge of $3.4 million and $2.2 million for the years ended December 31, 2010 and 2009 respectively.Loss from OperationsOperating loss decreased to approximately $22.3 million for the year ended December 31, 2010 compared to $28.9 million for the year ended December 31, 2009. Excluding the effect of intangible asset impairment in 2010 and 2009, operating loss increased to approximately $17.4 million for the year ended December 31, 2010, compared to $11.6 million for the year ended December 31, 2009. The higher operating loss is the result of the revenue decrease, together with proportionately higher product and distribution expense offset by an improvement in the Cost of Media – 3rd party margin, selling and marketing expenses and general and administrative expenses.Interest income and dividendsInterest and dividend income decreased approximately $62,000 to $10,000 for the year ended December 31, 2010, compared to $72,000 for the year ended December 31, 2009. The reduction is mainly due to a decrease in the balances of cash and marketable securities at December 31, 2010 compared to December 31, 2009, as well as a reduction in the rate of return on invested capital.Interest expenseInterest expense was $16,000 for the year ended December 31, 2010 compared to $76,000 for the year ended December 31, 2009.Other IncomeOther income was $1.7 million for the year ended December 31, 2010 compared to other income of $5,000 for the year ended December 31, 2009. Other income for 2010 was principally comprised of legal settlements and awards (see “Item 3 – Legal Proceedings”)Income TaxesIncome tax (benefit) expense, before noncontrolling interest and equity in loss (income) of investee, for the year ended December 31, 2010 and 2009 was $(1.1) million and $0.6 million, respectively and reflects an effective tax rate of (5.2)% and 2.2% respectively. The effective tax rates were computed taking into consideration non-deductible impairment charges of $12.1 million for 2009, and the change in the income tax valuation allowance of $8.2 million and $11.1 million for 2010 and 2009, respectively.Equity in (Loss) Income of InvesteeEquity in loss of investee was $183,000 net of taxes at December 31, 2010 compared to equity in income of $59,000 for the year ended December 31, 2009, and represents our 36% interest in The Billing Resource, LLC (TBR).Net Loss Attributable to Noncontrolling InterestNet loss attributable to noncontrolling interest was $28,000 for the year ended December 31, 2009. This related to our investment in MECC which was dissolved in June 2009.Net Loss Attributable to Atrinsic, Inc.Net loss attributable to Atrinsic Inc., decreased by $9.8 million to $19.7 million for the year ended December 31, 2010 as compared $29.5 million for the year ended December 31, 2009. This decrease resulted from the factors described above.Liquidity and Capital ResourcesWe continually project anticipated cash requirements, which may include business combinations, capital expenditures, and working capital requirements. As of December 31, 2010, we had cash and cash equivalents of approximately $6.3 million and working capital of approximately $2.1 million. We used approximately $11.2 million in cash for operations during the year ended December 31, 2010 and, contingent on prospective operating performance may require reductions in discretionary variable costs and other realignments to permanently reduce fixed operating costs. We generated $0.7 million in cash from investing activities, principally from a return of capital from The Billing Resource. Cash used in financing activities was minimal during the fiscal year ended December 31, 2010.In order to fund operations, we need to raise additional capital.  We are currently working with an independent financial advisory firm to assist us in structuring a financing and to engage an investment bank to raise debt or equity capital to fund our immediate cash needs and to finance our longer term growth to further develop the Kazaa business and grow our subscriber base.  We currently have no formal arrangements with respect to additional financing in place and there is no guaranty funding will be available on favorable terms or at all. If we cannot obtain such funds, we will need to significantly curtail or cease our operations.  In addition, the sale of additional equity securities or convertible debt could result in dilution to our stockholders.We continue to evaluate the sale of certain of our assets and businesses.  We cannot provide any assurance that we will be successful in finding suitable purchasers for the sale of such assets.  Even if we are able to find purchasers, we may not be able to obtain attractive terms and conditions for such sales, including attractive pricing. In addition, divestitures of businesses involve a number of risks, including the diversion of management and employee attention, significant costs and expenses, the loss of customer relationships, a decrease in revenues associated with the divested business, and the disruption of operations in the affected business.  Furthermore, divestitures potentially involve significant post-closing separation activities, which could involve the expenditure of significant financial and employee resources. An inability to consummate identified asset sales or manage the post-separation transition arrangements could adversely affect our business, financial condition, results of operations and cash flows.There is substantial doubt about our ability to continue as a going concern. Our consolidated financial statements included in this Annual Report on Form 10-K are prepared using accounting principles generally accepted in the United States of America applicable to a going concern, which contemplates the realization of assets and liquidation of liabilities in the normal course of business. The historical consolidated financial statements included in this Annual Report on Form 10-K do not include any adjustments that might be necessary if we are unable to continue as a going concern. The report of our independent registered public accountants, KPMG LLP, includes an explanatory paragraph related to our ability to continue as a going concern.The assessment of our ability to continue as a going concern was made by management considering, among other factors: (i) our current levels of expenditures, including subscriber acquisition costs, operating expense, including product development, and overhead, (ii) our ongoing working capital needs, (iii) the uncertainty concerning the outcome of any financing, (iv) our fiscal year net loss of $19.7 million and $29.5 million for the years ending December 31, 2010 and 2009, respectively, (v) our $11.2 million and $3.0 million of cash used for operating activities during the years ending December 31, 2010 and 2009, respectively, (vi) the outstanding balance of cash and cash equivalents of $6.3 million as of December 31, 2010, and (vii) our budgets and financial projections of future operations, including the likelihood of achieving operating profitability without the need for additional financing.For periods subsequent to December 31, 2010, we expect losses to continue if we continue expenditures to develop the Kazaa service, acquire subscribers for the Kazaa digital music service, and are not able to reduce other operating expenses and overhead sufficiently to a level in line with our level of revenues.  If we are unable to increase revenues sufficiently or decrease our expenditures to a sustainable level, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. These conditions raise substantial doubt about our ability to continue as a going concern.Based on current financial projections, we believe the continuation of our Company as a going concern is primarily dependent on our ability to, among other factors: (i) consummate a suitable financing, or obtain financing from the sale of our assets or lines of business, (ii) scale our Kazaa subscriber base to a level where the monthly revenue generated from our subscriber base exceeds subscriber acquisition costs, net of expenses required to operate Kazaa, (iii) continue to generate revenue from our legacy subscription products without billing or service disruption, (iv) eliminate or reduce operating and overhead expenditures to a level more in line with our revenue, (v) improve utilization of the Kazaa digital music service and improve LTVs of subscribers to that service, and (vi) acquire profitable subscribers to the Kazaa digital music service at cost effective rates, (vii) grow our search marketing agency revenue base through the addition of new customers or expansion of business with existing customers and, (viii) expand margins in our search marketing agency and on our affiliate platform.  While we address these operating matters, we must continue to meet expected near-term obligations, including normal course operating cash requirements and costs associated with developing and operating the Kazaa digital music service, as well as funding overhead and the working capital needs of our other businesses.  If we are not able to obtain sufficient funds through a financing, or if we experience adverse outcomes with respect to our operational forecasts, our financial position, results of operations, cash flows and liquidity will continue to be materially adversely affected. See Item 1A—“Risk Factors” included in this Annual Report on Form 10-K regarding additional risks we face with respect to these matters.In the near term, we are focused on: (i) raising debt or equity capital to fund our immediate cash needs and to finance our longer term growth to further develop the Kazaa business and grow our subscriber base, and (ii) pursuing various means to minimize operating costs and increase cash. We cannot provide assurance that we will be able to realize the cost reductions in our operations, or that we can obtain additional cash through asset sales or the issuance of equity. If we are unsuccessful in our efforts we will be required to further reduce our operations, including further reductions of our employee base, or we may be required to cease certain or all of our operations in order to offset the lack of available funding.Critical Accounting Policies and EstimatesPrinciples of ConsolidationThe consolidated financial statements include the accounts of all majority and wholly-owned subsidiaries and significant intercompany balances and transactions have been eliminated.The equity method is used to account for investments in entities in which we have an ownership of less than 50% and have significant influence over the operating and financial policies of the affiliate.Use of EstimatesThe preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions. Management has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors. Accounts Receivable and Related AllowancesThe Company maintains allowances for doubtful accounts for estimated losses which may result from the inability of its customers to make required payments. The Company bases its allowances on the likelihood of recoverability of accounts receivable by customer, based on past experience, the age of the accounts receivable balance, the credit quality of the Company’s customers, and, taking into account current collection and economic trends. If specific customer circumstances change or industry trends worsen beyond the Company’s estimates, the Company would be required to increase its allowances for doubtful accounts. Alternatively, if trends improve beyond the Company’s estimates, the Company would be required to decrease its allowance for doubtful accounts. The Company’s estimates are reviewed periodically, and adjustments are reflected through bad debt expense in the period they become known. Changes in the Company’s bad debt experience can materially affect its results of operations.The Company also makes estimates for refunds and provides for these probable uncollectible amounts through a reduction of recorded revenues in the period for which the sale occurs, based on analyses of historical trends as well as an evaluation of the impact of current and projected economic conditions.The Company effectuates its subscription revenues through a carrier or distributors who are paid a transaction fee for their services.  Due to the payment terms of the carriers requiring in excess of 60 days from the date of billing or sale, at its sole discretion, the Company can elect to use trade discounts in order to facilitate quicker payment. This discount or fee allows for payments of approximately 80% of the prior month’s billings 15 to 20 days after the end of the month. The Company records revenue net of that fee, if incurred, which is 3.5% to 5% of the associated revenue.Goodwill and Intangible AssetsGoodwill represents the excess of cost over fair value of net assets of businesses acquired. In accordance with ASC 350 formerly Statement of Financial Accounting Standards No. 142 (“SFAS 142”) “Goodwill and Other Intangible Assets”, the value assigned to goodwill and indefinite lived intangible assets is not amortized to expense, but rather it is evaluated at least on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value. If the fair value of an indefinite lived intangible is less than its carrying amount, an impairment loss is recorded. Fair value is determined based on discounted cash flows, market multiples or appraised values as appropriate. Discounted cash flow analysis requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management’s judgment. Any changes in key assumptions about the Company’s businesses and their prospects, or changes in market conditions, could result in an impairment charge. Some of the more significant estimates and assumptions inherent in the intangible asset valuation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset’s life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory trends.The Company has determined that there was an impairment of the carrying value of goodwill for the fiscal year ended December 31, 2009, and non-amortizable intangible assets in each of the fiscal years ended December 31, 2010 and 2009 as a result of completing annual impairment analysis for such periods. In performing the related valuation analysis the company used various valuation methodologies including probability weighted discounted cash flows, comparable transaction analysis, and market capitalization and comparable company multiple comparison. The results of this review and impact of the impairment are more fully described in Note 6 to the Consolidated Financial Statements – “Goodwill and Intangible Assets”.Intangible assets subject to amortization primarily consist of customer lists, trade names and trademarks, and restrictive covenants that were acquired.  The intangible asset values assigned to the identified assets for each acquisition were generally determined based upon the expected discounted aggregate cash flows to be derived over the estimated useful life. The intangible assets are amortized in a manner that reflects the pattern of the projected net cash inflows to the Company that are expected to occur, or when such pattern does not exist, using the straight-line basis over their respected estimated useful lives. The Company reviews the recoverability of its finite-lived intangible assets for recoverability whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable.The Company has determined that there was an impairment of intangible assets during the fourth quarters of 2010 and 2009.  The results of this assessment are more fully described in Note 6 of the Company’s Financial Statement – “Goodwill and Intangible Assets.”Stock-Based CompensationThe Company records stock based compensation in accordance with ASC 718 formerly Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123 (revised 2004). In estimating the grant date fair value of stock option awards and performance based restricted stock, we use the Black Scholes option pricing model where appropriate. The key assumptions for this models to derive fair value include expected term, rate of risk free returns and volatility. If different assumptions and estimates were used, the amounts charged to compensation expense would be different.Revenue RecognitionIn accordance with ASC 605 and SEC Accounting Bulletin 104, the Company monetizes a portion of its user activities through subscription based sources by providing on-going monthly access to and usage of premium products and services. In general, customers are billed at standard rates, during the month, and revenues are recognized upon receipt of information confirming an arrangement in that same month. The Company estimates a provision for refunds and credits which is recorded as a reduction to revenues. In determining the estimate for refunds and credits, the Company relies upon historical data, contract information and other factors. The estimated provision for refunds can vary from actual results.The Company effectuates its subscription revenues through a carrier or distributors who are paid a transaction fee for their services. In accordance with ASC 605 formerly Emerging Issues Task Force (“EITF” No 99-19) “Reporting Revenues Gross as Principal Versus Net as an Agent”, the Company recognizes as revenues the net amount received from the carrier or distributor, net of their fee.The Company monetizes a portion of its user activities through transactional based services generated primarily from (a) fees earned, primarily on a Cost Per Click basis, from search syndication services; (b) fees earned for the Company's search engine marketing ("SEM") services; and (c) other fees for marketing services including data and list management services, which can be either periodic or transactional. Commission fee revenue is recognized in the period that the Company's advertiser customer generates a sale or other agreed-upon action on the Company's affiliate marketing networks or as a result of the Company's SEM services, provided that no significant Company obligations remain, collection of the resulting receivable is reasonably assured, and the fees are fixed or determinable. All transaction services revenues are recognized on a gross basis in accordance with the provisions of ASC 605-45, due to the fact that the Company is the primary obligor and bears all credit risk to its customer, and publisher expenses that are directly related to a revenue-generating event are recorded as a component of 3rd part Media Cost.Income TaxesThe Company uses the asset and liability method of financial accounting and reporting for income taxes required by ASC 740 formerly Statement of Financial Accounting Standards No. 109 (“SFAS 109”), “Accounting for Income Taxes”. Under ASC 740, deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized.Under ASC 740-10-25 the Company classifies interest expense and penalties related to unrecognized tax benefits as income tax expense. ASC 740 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with ASC 740 and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The evaluation of a tax position in accordance with this Interpretation is a two-step process. The first step is recognition, in which the enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The second step is measurement. A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.The Company and its subsidiaries file income tax returns in the U.S and Canada. The Company is subject to federal, state and Canadian examinations. The statute of limitations for 2007 through 2009 in all jurisdictions (except California includes 2006 through 2009) remain open and income tax returns filed for such periods are subject to potential examination by tax authorities.Contractual Obligations and Off-Balance Sheet ArrangementsAt December 31, 2010, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if it had engaged in such relationships.The following table shows the Company’s future commitments for future minimum lease payments required under operating leases that have remaining non cancellable lease terms in excess of one year, future commitments under investment and marketing agreements and future commitments under employment agreements as of December 31, 2010:


Subsequent to December 31, 2010, the Company entered into a surrender of lease agreement with its landlord for the former Traffix office located in Pearl River, New York.  In consideration for the lease termination, the Company agreed to pay the landlord a cancellation fee of $0.2 million in the form of an unsecured note payable. The termination of this resulted in a reduction of 2011 operating lease payments of $0.3 million.  The table above does not reflect any obligation relating to this lease.Recent Accounting PronouncementsAdopted in 2010In September 2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”) which has been superseded by the FASB Codification and included in ASC 810 to require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity. This analysis identifies the primary beneficiary of a variable interest entity as one with the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and the obligation to absorb losses of the entity that could potentially be significant to the variable interest. These revisions to ASC 810 are effective as of January 1, 2010 and the adoption of these revisions to ASC 810 had no impact on our results of operations or financial position.Not Yet AdoptedIn October 2009, FASB approved for issuance Emerging Issues Task Force (EITF) issue 08-01, Revenue Arrangements with Multiple Deliverables which has been superseded by the FASB codification and included in ASC 605-25. This statement provides principles for allocation of consideration among its multiple-elements, allowing more flexibility in identifying and accounting for separate deliverables under an arrangement. The EITF introduces an estimated selling price method for valuing the elements of a bundled arrangement if vendor-specific objective evidence or third-party evidence of selling price is not available, and significantly expands related disclosure requirements. This standard is effective on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after September 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 December 2010, the FASB issued ASU 2010-28, Intangibles - Goodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (“ASU 2010-28”). Upon adoption of ASU 2010-28, an entity with reporting units that have carrying amounts that are zero or negative is required to assess the likelihood of the reporting units’ goodwill impairment. ASU 2010-28 is effective January 1, 2011 and we do not believe that the adoption of ASU 2010-28 will have a significant impact on our results of operations and financial position.


STRATEGIC
INITIATIVES

(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 experiences. Accordingly, this factor should
      be considered in evaluating the relative revenues generated from our
      Subscription and Transactional
Services.

Revenues
increased approximately by $76.9 million, or 208%, to $113.9 million for the
year ended December 31, 2008, compared to $37.0 million for the year ended
December 31, 2007. Subscription based revenue increased by approximately $7.2
million, or 20%, to $44.2 million for the year ended December 31, 2008, compared
to $37.0 million for the year ended December 31, 2007. The increase in
subscription service revenue was principally attributable to an increase in the
average number of billable subscribers added during the period and our purchase
of Ringtone.com, coupled with our efforts to improve subscriber retention.
Although we ended 2008 with approximately 501,000 subscribers as compared to
approximately 840,000 subscribers at the end of 2007, during 2008 the average
number of monthly billable subscribers was higher than in 2007 and the number of
subscribers increased disproportionally at the end of 2007. The number of
subscribers is largely, but not precisely, correlated to the periodic reported
revenues as a result of inter-period volatility and the circumstance that
subscribers are billed on a monthly basis.Transactional
revenues increased by $69.7 million or 100% in 2008. The increase is
attributable to the service offerings acquired in connection with our
acquisition of Traffix, Inc which took place in February 4, 2008.Operating
Expenses