Note 5 – Convertible Notes and Warrants

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

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

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

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

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

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

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

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

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

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

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

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

The Company recorded the issuance of the convertible note payable, original issue discount, net of additional debt discount, in its balance sheet and is amortizing the debt discount using the effective interest method over the 12-month term of the Notes. The table below summarizes the transactions and components related to this convertible notes financing:

	Convertible		Original			Debt			Net Value of
(in thousands)	Notes Payable		Issue Discount			Discount			Convertible Notes Payable
Issuance of notes on May 31, 2011	$	5,814	$	(529	)	$	(2,308	)	$	2,977
Accretion: June - September 2011		-		194			849			1,043
Value as of September 30, 2011	$	5,814	$	(335	)	$	(1,459	)	$	4,020

The Company also recorded a derivative liability, representing the fair market value of the Notes’ embedded convertible derivative and the fair market value of the Warrants. This derivative liability will be marked-to-market each period and any resulting increase or (decrease) in the derivative liability will be recorded as interest expense (income). As a result of the marked-to-market adjustment, the Company recorded interest expense of $0.6 million during 2011. See Note 11 for further information on the accounting for the derivative liability.