Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. The following is a discussion of the results of operations for 2010 compared with 2009 and changes in financial condition dur

The following is a discussion of the results of operations for 2010 compared with 2009 and changes in financial condition during 2010. This information should be read in conjunction with the consolidated financial information provided in Item 8 of this Form 8-K.

Results of Operations for the years ended December 31, 2010 and 2009.

Our business is focused on two key areas:

Our subscription business is built around a recurring-revenue business model. We are focused on digital music in the rapidly growing mobile space, and our lead offering, Kazaa, is a recognizable brand in this market. We also provide alternative billing capabilities, allowing our subscribers to utilize payment methods other than just credit cards, to purchase our services. Our core strategic focus for Kazaa and our direct-to-consumer subscription business is to build and sustain a large and profitable subscriber base and a growing and engaged audience and to deliver entertainment content to our customers anywhere, anytime and on any device, in a manner our customers choose.

Transactional services is built around Atrinsic Interactive, our affiliate network and search marketing agency. Atrinsic Interactive is a top ten search agency according to Advertising Age (2010) and a top-tier affiliate network. We offer advertisers an integrated service offering across paid search, or search engine marketing ("SEM"), search engine optimization ("SEO"), display advertising, affiliate marketing, as well as offering business intelligence and brand protection services to our clients. We work with all types and sizes of advertisers on a performance basis to assist them in acquiring customers at an attractive return on investment. Our core strategic focus for Atrinsic Interactive is to build a leading independent search marketing agency and a top-five affiliate network.

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

In 2009 and 2010, we did not operate our business in separate operating segments. Other than net revenue, cost of media - 3rd party and content costs, it is not practicable to retroactively segregate 2009 costs between the subscription and transactional segments.

Results of Operations for the year ended December 31, 2010 compared to the year ended December 31, 2009.

Revenues presented by type of activity are as follows for the year ended December 31:

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.

Cost 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. Cost of Media - 3rd party for the Subscription Segment decreased by $0.1 million or 2% to $5.4 million for the year ended December 31, 2010 from $5.5 million for the year ended December 31, 2009. Cost of Media - 3rd party for the Transactional Segment decreased by $20.7 million or 55% to $17.2 million for the year ended December 31, 2010 from $37.9 million for the year ended December 31, 2009. 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 paroty 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 Distribution

Product 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. Content costs for the Subscription Segment increased $6.9 million or 467% to $8.4 million for the year ended December 31, 2010 from $1.5 million for 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 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 marketing

Selling 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 Operating

General 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 amortization

Depreciation 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 Assets

The Company conducts its annual impairment test in the fourth quarter of the year, unless an event occurs prior to the fourth quarter that would more likely than not reduce the fair value of the Company below its carrying amount. In connection with our annual 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 Operations

Operating 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, 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 $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 expense was $16,000 for the year ended December 31, 2010 compared to $76,000 for the year ended December 31, 2009.

Other Income (Expense)

Other 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 tax (benefit) expense, before noncontrolling interest and equity in 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 Investee

Equity 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 Interest

Net 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 Resources

We 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 (vi) 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 an additional 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 Estimates

Principles of Consolidation

The consolidated financial statements include the accounts of all majority and wholly-owned subsidiaries and significant intercompany balances and transactions have been eliminated.

The equity method is used to account for investments in entities in which we have an ownership of less than 50% and have significant influence over the operating and financial policies of the affiliate.

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses as well as the disclosure of contingent assets and liabilities. Management continually evaluates its estimates and judgments including those related to allowances for doubtful accounts, useful lives of property, plant and equipment and intangible assets, fair value of stock options granted, forfeiture rate of equity based compensation grants, probable losses associated with pre-acquisition contingencies, income taxes and other contingencies. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable in the circumstances. Actual results may differ from those estimates. Macroeconomic conditions may directly, or indirectly through our business partners and vendors, impact our financial performance and available resources. Such conditions may, in turn, impact the aforementioned estimates and assumptions. Management has discussed the development, selection and disclosure of these estimates and assumptions with the Audit Committee of the Board of Directors.

For 2009 and 2010 the Company operated as a single segment. Operating segments are components of an enterprise for which separate financial information is available and is evaluated regularly by the Company in deciding how to allocate resources and in assessing performance. In the first quarter of 2011, the company began segmenting operating results into two segments: Consumer Subscription Services and Transactional Services.

Accounts Receivable and Related Allowances

The Company maintains allowances for doubtful accounts for estimated losses which may result from the inability of its customers to make required payments. The Company bases its allowances on the likelihood of recoverability of accounts receivable by customer, based on past experience, the age of the accounts receivable balance, the credit quality of the Company's customers, and, taking into account current collection 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 Assets

Goodwill represents the excess of cost over fair value of net assets of businesses acquired. In accordance with ASC 350 formerly Statement of Financial Accounting Standards No. 142 ("SFAS 142") "Goodwill and Other Intangible Assets", the value assigned to goodwill and indefinite lived intangible assets is not amortized to expense, but rather it is evaluated at least on an annual basis to determine if there is a potential impairment. If the fair value of the reporting unit is less than its carrying value, an impairment loss is recorded to the extent that the implied fair value of the reporting unit goodwill is less than the carrying value. If the fair value of an indefinite lived intangible is less than its carrying amount, an impairment loss is recorded. Fair value is determined based on discounted cash flows, market multiples or appraised values as appropriate. Discounted cash flow analysis requires assumptions about the timing and amount of future cash inflows and outflows, risk, the cost of capital, and terminal values. Each of these factors can significantly affect the value of the intangible asset. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require management's judgment. Any changes in key assumptions about the Company's businesses and their prospects, or changes in market conditions, could result in an impairment charge. Some of the more significant estimates and assumptions inherent in the intangible asset valuation process include: the timing and amount of projected future cash flows; the discount rate selected to measure the risks inherent in the future cash flows; and the assessment of the asset's life cycle and the competitive trends impacting the asset, including consideration of any technical, legal or regulatory trends.

The Company has determined that there was an impairment of the carrying value of goodwill 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 indicated that the carrying amount of an asset may not be recoverable.

Stock-Based Compensation

The Company records stock based compensation in accordance with ASC 718 formerly Financial Accounting Standard Board Statement of Financial Accounting Standards No. 123 (revised 2004). In estimating the grant date fair value of stock option awards and performance based restricted stock, we use the Black Scholes option pricing model 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.

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 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.

The Company uses the asset and liability method of financial accounting and reporting for income taxes required by ASC 740 formerly Statement of Financial Accounting Standards No. 109 ("SFAS 109"), "Accounting for Income Taxes". Under ASC 740, deferred income taxes reflect the tax impact of temporary differences between the amount of assets and liabilities recognized for financial reporting purposes and the amounts recognized for tax purposes.

We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized.

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 Arrangements

At 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 tenant 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 Pronouncements

In 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.

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 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.

Item 8. Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Atrinsic, Inc. and subsidiaries:

We have audited the accompanying consolidated balance sheets of Atrinsic, Inc. and subsidiaries, as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity, comprehensive loss, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with auditing standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Atrinsic, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the years then ended in conformity with U.S. generally accepted accounting principles.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in note 3 to the consolidated financial statements, the Company has suffered recurring losses from operations that raise substantial doubt about its ability to continue as a going concern. Management's plans in regard to these matters are also described in note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

April 7, 2011 , except for Note 17 which is as of June 30, 2011

ATRINSIC, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands except share data)

All outstanding share amounts have been retroactively restated to reflect Atrinsic, Inc.'s December 2010 1-for-4 Reverse Stock Split. See Note 9, "Stockholders' Equity".

The accompanying notes are an integral part of the Consolidated Financial Statements.

ATRINSIC, INC. AND SUBSIDIARIES