Intelligent Protection Management Corp.: Form 10-Q for the period ended Sep 30, 2013

This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results. The following discussion and analysis should be read in conjunction with: (i) the accompanying unaudited condensed consolidated financial statements and notes thereto for the three and nine months ended September 30, 2013, (ii) the consolidated financial statements and notes thereto for the year ended December 31, 2012 included in our Annual Report on Form 10-K (“Form 10-K”) filed with the Securities and Exchange Commission (the “SEC”) on March 14, 2013 and (iii) the discussion under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Form 10-K. Aside from certain information as of December 31, 2012, all amounts herein are unaudited. Unless the context otherwise indicates, references to “Snap,” “we,” “our,” “us” and the “Company” refer to Snap Interactive, Inc. and its subsidiaries on a consolidated basis.

Forward-Looking Statements

In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. See “Forward-Looking Statements.” Our results and the timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Item 1A. Risk Factors” of our most recent Form 10-K.

Overview

We are an Internet company providing services in the expanding social dating market. We own and operate a social dating software application under our AYI brand (formerly known as AreYouInterested.com) that can be accessed on Facebook, mobile devices such as iPhone and Android, and a stand-alone website. Our application is fully integrated across these gateways and incorporates the Facebook Connect integration tool, which enables users to easily “connect” their Facebook profile to our website. Since August 2007, AYI has been one of the leading dating applications on Facebook based on the publicly reported number of DAUs and MAUs.

As of November 11, 2013, we had more than 2.5 million MAUs of AYI across all of our platforms. We primarily generate revenue from subscription fees and, as of November 11, 2013, we had approximately 77,000 active subscribers. The number of our DAUs and MAUs, which includes non-paying users and paying subscribers, varies greatly on a daily and monthly basis, and is greater than the number of our active subscribers for any same measurement period.

While we transitioned users to the redesigned AYI during 2012, we significantly reduced spending on user acquisition campaigns, and this in part led to a significant decrease in the number of active subscribers on AYI. In March 2012, we had approximately 145,000 active subscribers. This number decreased to 75,000 active subscribers in August 2013, and has risen to approximately 77,000 active subscribers as of November 11, 2013.

In addition, the number of new subscription transactions for September 2013 was the highest number of subscription transactions since October 2012. A new subscription transaction includes the purchase of a subscription for new subscribers as well as the purchase of a new subscription by a user that has previously cancelled a subscription.

We believe that the number of active subscribers and new subscription transactions are important operating metrics, and we plan to increase these metrics by increasing user acquisition campaigns, building a recognizable brand and increasing user engagement on AYI through the development of a superior feature set.

We believe that our extensive user base, which includes more than 25 million Facebook connected users and more than 2.5 billion pieces of structured interest data, allows us to create a favorable experience for users looking to meet people with mutual friends or similar interests.

Operational and Financial Highlights

During the nine months ended September 30, 2013, we executed key components of our objectives for 2013:

• We acquired and transitioned to the AYI.com domain name from the AreYouInterested.com domain name;
• We rebranded to “AYI”, a shorter name that is easier for our users to remember; and
• We launched new “social” features for AYI that are designed to integrate a user’s interest and social graphs into the online dating experience.

For the remainder of 2013, our business objectives include:

• Growing our base of paid subscribers;
• Continuing to build out our “social” features to improve the online dating experience for all of our users;
• Building a recognizable brand for AYI by expanding our advertising and marketing efforts beyond pure user acquisition;
• Increasing the amount of resources devoted to mobile initiatives and increasing user engagement on our mobile applications, particularly with regard to our Android application; and
• Increasing our rate of advertising and marketing expenditures to increase traffic for the AYI brand.

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Sources of Revenue

We operate AYI so that users can utilize the application and search for matches for free. We generate revenue primarily when users purchase a subscription to obtain unlimited messaging and certain other premium features on our application. We also generate a small portion of our revenue through micro-transactions that allow users to access certain other premium features and advertisements on our application.

Subscription. We provide our users with the opportunity to purchase a subscription that provides for unlimited messaging and other premium features for the length of the subscription term. We believe that users choose to become paid subscribers to better communicate with potential matches and to enhance the online dating experience. We believe that users are more likely to purchase subscriptions when they have mutual friends or similar interests with other users.

Facebook is currently the primary platform for our application. The majority of our revenue is generated from subscriptions originating through the Facebook platform, and a significant amount of our revenue is being generated through subscriptions through mobile platforms.

Users can purchase subscriptions through various payment methods including credit card, electronic check, PayPal, Fortumo, or as an In-App purchase through Apple Inc.’s iPhone App Store. Pursuant to Apple Inc.’s terms of service, Apple Inc. retains 30% of the revenue that is generated from sales on our iPhone application through In-App purchases in the United States.

We recognize revenue from monthly premium subscription fees in the month in which the services are provided during the subscription term.

Micro-transactions. We introduced micro-transactions in August 2012 in conjunction with the launch of the redesigned AYI application to allow users to access certain premium features by paying for such features without purchasing a recurring subscription. While micro-transactions are not currently a significant driver of revenue, we believe that such micro-transactions may increase user engagement with the application and the likelihood that users will become a paid subscriber. Revenue from micro-transactions is recognized over a two-month period.

Advertising. Advertising revenue is a small portion of our revenue and primarily consists of revenue from our display ads. We generally report our advertising revenue net of amounts due to agencies, brokers and counterparties. We recognize advertising revenue as earned on a cost per impression (CPM) basis.

Costs and Expenses

Programming, hosting and technology. Our programming, hosting and technology expense includes salary and stock-based compensation for our engineers and developers, data center, domain name and other hosting expenses and software licensing fees and various other technology related expenses.

Compensation. Our compensation expense includes salary and stock-based compensation for management and employees (other than expense for engineers and developers recorded in programming, hosting and technology expenses above).

Professional fees. Our professional fees include fees paid to our independent accounting firm, legal expenses and various other professional fees and expenses incurred in our business.

Advertising and marketing. Our advertising and marketing expense consists of online advertising, primarily consisting of user acquisition campaigns. We execute these campaigns through affiliate or affiliate networks that advertise or promote our application and earn a fee whenever visitors click through their advertisement to our application or website and create a profile on our application. For our user acquisition campaigns, we pay to market and advertise our application across the Internet, including on Facebook and other third party platforms.

General and administrative. Our general and administrative expense includes investor relations, public relations, credit card processing fees, overhead and various other employee related expenses.

Non-Operating Expenses

Mark-to-market adjustment on warrant liability. Our outstanding warrants are considered derivative instruments that require liability classification and mark-to-market accounting. Our warrant liability is marked-to-market at the end of each reporting period on our Condensed Consolidated Balance Sheet, with the changes in fair value reported in earnings on our Condensed Consolidated Statements of Operations. We have included the mark-to-market adjustment on warranty liability as a non-operating expense as we do not believe that it is indicative of our core operating results.

We use a custom model that, at each measurement date, calculates the fair value of the warrant liability using a Monte-Carlo style simulation that uses the following assumptions at each valuation date: (i) closing stock price, (ii) contractual exercise price, (iii) remaining contractual term, (iv) historical volatility of the stock prices, (v) an adjusted volatility that incorporates a 10% incremental discount rate premium through a reduction of the volatility estimate to reflect the lack of marketability of the warrants and (vi) risk-free interest rates that are commensurate with the term of the warrant.

An increase or decrease in the fair value of the warrant liability will increase or decrease the amount of our earnings, respectively, separate from income or loss from operations. The primary cause of the change in the fair value of the warrant liability is the value of our common stock. If our common stock price goes up, the value of these derivatives will generally increase and if our common stock price goes down, the value of these derivatives will generally decrease.

Key Metrics

Our management relies on certain performance indicators to manage and evaluate our business. The key performance indicators set forth below help us evaluate growth trends, establish budgets, measure the effectiveness of our advertising and marketing efforts and assess operational efficiencies. We discuss revenues and net cash used in operating activities under ‟Results of Operations” and ‟Liquidity and Capital Resources” below. Deferred revenue and bookings, additional measures of our performance, are also discussed below.

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Deferred Revenue

Revenues from multi-month subscriptions are recognized over the length of the subscription term rather than when the subscription is purchased. Because a significant amount of our subscription revenue comes from subscriptions with a term of three or more months, we apportion that revenue over the duration of the subscription term even though it is collected in full at the time of purchase. The difference between the gross cash receipts collected and the revenue recognized to date from those sales is reported as deferred revenue.

Bookings

Bookings is a financial measure representing the aggregate dollar value of subscription fees and micro-transactions received during the period but is not a financial measure that is calculated and presented in accordance with generally accepted accounting principles in the United States of America (“GAAP”). We calculate bookings as subscription revenue recognized during the period plus the change in deferred revenue recognized during the period. We record subscription revenue from subscription fees and micro-transactions as deferred revenue and then recognize that revenue ratably over the length of the subscription term. We use bookings internally in analyzing our financial results to assess operational performance and to assess the effectiveness of, and plan future, user acquisition campaigns. We believe that this non-GAAP financial measure is useful in evaluating our business because we believe, as compared to subscription revenue, it is a better indicator of the subscription activity in a given period. We believe that both management and investors benefit from referring to bookings in assessing our performance and when planning, forecasting and analyzing future periods.

While the factors that affect bookings and subscription revenue are generally the same, certain factors may affect subscription revenue more or less than such factors affect bookings in any period. While we believe that bookings is useful in evaluating our business, it should be considered as supplemental in nature and it is not meant to be a substitute for subscription revenue recognized in accordance with GAAP.

The following table presents a reconciliation of subscription revenue to bookings for each of the periods presented:

Limitations of Bookings

Some limitations of bookings as a financial measure include that:

• Bookings does not reflect that we recognize subscription revenue from subscription fees and micro-transactions over the length of the subscription term; and
• Other companies, including companies in our industry, may calculate bookings differently or choose not to calculate bookings at all, which reduces its usefulness as a comparative measure.

Because of these limitations, you should consider bookings along with other financial performance measures, including total revenues, subscription revenue, deferred revenue, net income (loss) and our financial results presented in accordance with GAAP.

Results of Operations

The following table sets forth Condensed Consolidated Statements of Operations data for each of the periods indicated as a percentage of total revenues:

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Three Months Ended September 30, 2013 Compared to Three Months Ended September 30, 2012

Revenues

Revenues decreased to $2,989,978 for the three months ended September 30, 2013, from $4,331,701 for the three months ended September 30, 2012. The decrease is primarily related to lower revenues from subscription sales on the AYI brand in the three months ended September 30, 2013 as compared to the three months ended September 30, 2012. We believe the decrease in revenues from subscription sales for the three months ended September 30, 2013 primarily resulted from our reduced advertising and marketing expense for the period as compared to the three months ended September 30, 2012. We intentionally reduced our user acquisition campaigns from the second half of 2012 through January 2013, which primarily affected new subscriptions, while we focused on rebuilding, testing and optimizing the redesigned AYI application. We began to increase user acquisition campaigns in January 2013 and intend to increase our user acquisition campaigns during the remainder of 2013 and into 2014. The following table sets forth our subscription revenue, advertising revenue and total revenues for the three months ended September 30, 2013 and the three months ended September 30, 2012, the decrease between those periods, the percentage decrease between those periods, and the percentage of total revenue that each represented for those periods:

Subscription – The results for the three months ended September 30, 2013 reflect a decrease in subscription revenue of $1,316,612, or 30.6%, as compared to the three months ended September 30, 2012. The decrease in subscription revenue for the three months ended September 30, 2013, was primarily driven by a decrease in our marketing and advertising expense versus the prior year period, which primarily affects new subscriptions. Subscription revenue as a percentage of total revenue was 99.9% for the three months ended September 30, 2013, as compared to 99.4% for the three months ended September 30, 2012.

Advertising – The results for the three months ended September 30, 2013 reflect a decrease in advertising revenue of $25,111, or 93.2%, as compared to the three months ended September 30, 2012. We believe the decrease in advertising revenue resulted from our discontinuation of online advertising campaigns in February 2013 in order to focus on improving a user’s experience on AYI, which we believe will be more valuable in the long-term. Advertising revenue as a percentage of total revenue was 0.1% for the three months ended September 30, 2013, as compared to 0.6% for the three months ended September 30, 2012.

Costs and Expenses

Total costs and expenses for the three months ended September 30, 2013 reflect a decrease in costs and expenses of $48,068, or 1.0%, as compared to the three months ended September 30, 2012. The following table presents our costs and expenses for the three months ended September 30, 2013 and the three months ended September 30, 2012, the increase or decrease between those periods, and the percentage increase or decrease between those periods:

Programming, Hosting and Technology – The results for the three months ended September 30, 2013 reflect a decrease in programming, hosting and technology expense of $11,603 or 0.9%, as compared to the three months ended September 30, 2012. The decrease in this expense for the three months ended September 30, 2013, was primarily driven by lower stock-based compensation, consulting expense and hosting expense. Programming, hosting and technology expense as a percentage of total revenues was 41.0% for the three months ended September 30, 2013, as compared to 28.6% for the three months ended September 30, 2012.

Compensation – The results for the three months ended September 30, 2013 reflect an increase in compensation expense, which excludes the cost of developers and programmers included in programming, hosting and technology expense above, of $467,006, or 61.7%, as compared to the three months ended September 30, 2012. The increase in compensation expense for the three months ended September 30, 2013 was primarily driven by increased stock-based compensation expense and consulting expense, which was offset by a reduced headcount in management and support areas as compared to the comparable period in 2012. Compensation expense as a percentage of total revenues was 40.9% for the three months ended September 30, 2013, as compared to 17.5% for the three months ended September 30, 2012.

Professional fees – The results for the three months ended September 30, 2013 reflect an increase in professional fees of $44,265, or 28.3%, as compared to the three months ended September 30, 2012. The increase in professional fees for the three months ended September 30, 2013, was primarily driven by an increase in legal fees. Professional fees as a percentage of total revenues were 6.7% for the three months ended September 30, 2013, as compared to 3.6% for the three months ended September 30, 2012.

Advertising and Marketing – The results for the three months ended September 30, 2013 reflect a decrease in advertising and marketing expense of $366,111, or 25.5%, as compared to the three months ended September 30, 2012. The decrease in advertising and marketing expense for the three months ended September 30, 2013, as compared to the prior year period, was primarily driven by reducing the number of user acquisition campaigns. We also significantly reduced our rate of advertising and marketing expense as we continued to optimize the redesigned AYI application. We anticipate that advertising and marketing expense will increase during the remainder of 2013 (as compared to our advertising and marketing expense for the three months ended September 30, 2013) as we promote the redesigned AYI application. Advertising and marketing expense as a percentage of total revenues was 37.6% for the three months ended September 30, 2013, as compared to 34.9% for the three months ended September 30, 2012.

General and Administrative – The results for the three months ended September 30, 2013 reflect a decrease in general and administrative expense of $161,625, or 17.3%, as compared to the three months ended September 30, 2012. The decrease in general and administrative expense for the three months ended September 30, 2013, as compared to the comparable period in the prior year, was primarily driven by lower recruiting and public relations expenses. General and administrative expense as a percentage of total revenues was 25.9% for the three months ended September 30, 2013, as compared to 21.6% for the three months ended September 30, 2012.

Non-Operating Income

The following table presents the components of non-operating income for the three months ended September 30, 2013 and the three months ended September 30, 2012, the increase or decrease between those periods and the percentage increase or decrease between those periods:

Interest Income, net

Interest income, net for the three months ended September 30, 2013 was $1,405, a decrease of $4,184, or 74.9%, as compared to $5,589 for the three months ended September 30, 2012. Interest income, net represented 0.0% and 0.1% of total revenues for the three months ended September 30, 2013 and 2012, respectively.

Mark-to-Market Adjustment

Our warrant liability is marked-to-market at each reporting period, with changes in fair value reported in earnings. The mark-to-market income adjustment of $163,975 for the three months ended September 30, 2013 and income of $562,200 for the three months ended September 30, 2012 represented the changes in fair value of the warrant liability during those periods. Mark-to-market adjustment on warrant liability represented 5.5% and 13.0% of total revenues for the three months ended September 30, 2013 and 2012, respectively.

Other Expense

We had other expense from fixed asset disposals totaling $2,961 for the three months ended September 30, 2012, as compared to no other expense for the three months ended September 30, 2013. Other expense represented 0.1% and 0.0% of total revenues for the three months ended September 30, 2013 and 2012, respectively.

Nine Months Ended September 30, 2013 Compared to Nine Months Ended September 30, 2012

Revenues

Revenues decreased to $9,611,528 for the nine months ended September 30, 2013, from $15,289,791 for the nine months ended September 30, 2012. The decrease is primarily related to lower revenues from subscription sales on the AYI brand in the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012. We believe the decrease in revenues from subscription sales for the nine months ended September 30, 2013 primarily resulted from our reduced advertising and marketing expense for the period as compared to the nine months ended September 30, 2012. We intentionally reduced our user acquisition campaigns from the second half of 2012 through January 2013, which primarily affected new subscriptions, while we focused on rebuilding, testing and optimizing the redesigned AYI application. We began to increase user acquisition campaigns in January 2013 and intend to increase our user acquisition campaigns during the remainder of 2013 and into 2014. The following table sets forth our subscription revenue, advertising revenue and total revenues for the nine months ended September 30, 2013 and 2012, the decrease between those periods, the percentage decrease between those periods, and the percentage of total revenue that each represented for those periods:

Subscription – The results for the nine months ended September 30, 2013 reflect a decrease in subscription revenue of $5,435,348, or 36.2%, as compared to the nine months ended September 30, 2012. The decrease in subscription revenue for the nine months ended September 30, 2013, was primarily driven by a decrease in our marketing and advertising expense versus the prior year period, which primarily affects new subscriptions. Subscription revenue as a percentage of total revenue was 99.5% for the nine months ended September 30, 2013, as compared to 98.1% for the nine months ended September 30, 2012.

Advertising – The results for the nine months ended September 30, 2013 reflect a decrease in advertising revenue of $242,915 or 84.3%, as compared to the nine months ended September 30, 2012. We believe the decrease in advertising revenue resulted from our discontinuation of online advertising campaigns in February 2013 in order to focus on improving a user’s experience on AYI, which we believe will be more valuable in the long-term. Advertising revenue as a percentage of total revenue was 0.5% for the nine months ended September 30, 2013, as compared to 1.9% for the nine months ended September 30, 2012.

Costs and Expenses

Total costs and expenses for the nine months ended September 30, 2013 reflect a decrease in costs and expenses of $4,443,094, or 24.1%, as compared to the nine months ended September 30, 2012. The following table presents our costs and expenses for the nine months ended September 30, 2013 and the nine months ended September 30, 2012, the increase or decrease between those periods, and the percentage increase or decrease between those periods:

Programming, Hosting and Technology – The results for the nine months ended September 30, 2013 reflect an increase in programming, hosting and technology expense of $848,762, or 27.0%, as compared to the nine months ended September 30, 2012. The increase in this expense for the nine months ended September 30, 2013, was primarily driven by increased salary expenses due to expansion of our engineering and development staff and increased expenses related to hosting and bandwidth, primarily to support the redesigned AYI application. Programming, hosting and technology expense as a percentage of total revenues was 41.6% for the nine months ended September 30, 2013, as compared to 20.6% for the nine months ended September 30, 2012.

Compensation – The results for the nine months ended September 30, 2013 reflect an increase in compensation expense, which excludes the cost of developers and programmers included in programming, hosting and technology expense above, of $396,760, or 14.6%, as compared to the nine months ended September 30, 2012. The increase in compensation expense for the nine months ended September 30, 2013 was primarily driven by consulting fees and an increase in stock-based compensation. Compensation expense as a percentage of total revenues was 32.5% for the nine months ended September 30, 2013, as compared to 17.8% for the nine months ended September 30, 2012.

Professional fees – The results for the nine months ended September 30, 2013 reflect an increase in professional fees of $185,846 or 38.0%, as compared to the nine months ended September 30, 2012. The increase in professional fees for the nine months ended September 30, 2013, was primarily driven by an increase in accounting fees as a result of the change in accounting firms and an increase in legal expenses. Professional fees as a percentage of total revenues were 7.0% for the nine months ended September 30, 2013, as compared to 3.2% for the nine months ended September 30, 2012.

Advertising and Marketing – The results for the nine months ended September 30, 2013 reflect a decrease in advertising and marketing expense of $5,849,080, or 64.6%, as compared to the nine months ended September 30, 2012. The decrease in advertising and marketing expense for the nine months ended September 30, 2013 as compared to the prior year period, was primarily driven by reducing the number of user acquisition campaigns. We also significantly reduced our rate of advertising and marketing expense as we continued to optimize the redesigned AYI application. We anticipate that advertising and marketing expense will increase during the remainder of 2013 (as compared to our advertising and marketing expense for the three months ended September 30, 2013) as we promote the redesigned AYI application. Advertising and marketing expense as a percentage of total revenues was 33.4% for the nine months ended September 30, 2013, as compared to 59.2% for the nine months ended September 30, 2012.

General and Administrative – The results for the nine months ended September 30, 2013 reflect an decrease in general and administrative expense of $25,382, or 0.8%, as compared to the nine months ended September 30, 2012. The decrease in general and administrative expense for the nine months ended September 30, 2013 as compared to the comparable period in the prior year, was primarily driven by decreases in investor relations expense and branding expenses, other employee related expenses and other decreased costs. General and administrative expense as a percentage of total revenues was 30.9% for the nine months ended September 30, 2013, as compared to 19.6% for the nine months ended September 30, 2012.

Non-Operating Income

The following table presents the components of non-operating income for the nine months ended September 30, 2013 and the nine months ended September 30, 2012, the increase or decrease between those periods and the percentage increase or decrease between those periods:

Interest Income, net

Interest income, net for the nine months ended September 30, 2013 was $4,510, a decrease of $19,680, or 81.4%, as compared to $24,190 for the nine months ended September 30, 2012. Interest income, net represented 0.0% and 0.2% of total revenues for the nine months ended September 30, 2013 and 2012, respectively.

Mark-to-Market Adjustment

Our warrant liability is marked-to-market at each reporting period, with changes in fair value reported in earnings. The mark-to-market income adjustment of $1,007,275 for the nine months ended September 30, 2013 and expense adjustment of $609,050 for the nine months ended September 30, 2012 represented the changes in fair value of the warrant liability during those periods. Mark-to-market adjustment on warrant liability represented 10.5% and 4.0% for the nine months ended September 30, 2013 and 2012, respectively.

Other Income (Expense)

We had losses from fixed asset disposals totaling $16,885 for the nine months ended September 30, 2012, as compared to other income of $2,961 for the nine months ended September 30, 2013. Other expense represented 0.0% and 0.1% of total revenues for the nine months ended September 30, 2013 and 2012, respectively.

Liquidity and Capital Resources

We have historically financed our operations through cash generated from our equity offering in January 2011, subscription fees received from our application, fees for premium features on our application and revenues derived from advertisements purchased on our application.

As of September 30, 2013, we had $1,480,183 in cash and cash equivalents, as compared to cash and cash equivalents of $5,357,596 as of December 31, 2012. Historically, our working capital has been generated through operations and equity offerings. If we continue to grow and expand our operations, our need for working capital will increase. We do not anticipate being profitable during the remainder of 2013 because we expect to increase our marketing and advertising expense during the remainder of 2013 (as compared to our advertising and marketing expense for the three months ended September 30, 2013) to acquire new users and create brand awareness. We intend to finance our business and growth with cash on hand, cash provided from operations, borrowings, debt or equity offerings, or some combination thereof. To the extent that these are not successful, we expect that our cash and cash equivalents will further decrease during 2013.

A significant portion of our expenses are related to user acquisition costs. Our marketing and advertising expenses are primarily spent on channels where we can estimate the return on investment without long-term commitments. Accordingly, we can adjust our marketing and advertising expenditures quickly based on the expected return on investment, which provides flexibility and enables us to manage our marketing and advertising expense.

Operating Activities

Net cash used in operating activities was ($3,750,249) for the nine months ended September 30, 2013, as compared to net cash used in operating activities of ($2,253,418) for the nine months ended September 30, 2012. This increase in net cash used in operating activities of $1,496,831 was primarily a result of the decrease in deferred revenue, as well as the increase in the amount of restricted cash. These uses of cash were offset in part by decrease in credit card holdback receivable and prepaid expenses, and an increase in accounts payable and accrued expenses and other current liabilities.

Significant items impacting cash flow in the nine months ended September 30, 2013 included significant cash outlays relating to advertising and marketing expense, the mark-to-market adjustment on warranty liability, and increases in programming, hosting and technology expense, professional fees and related benefits associated with the growth of our business. These uses of cash were offset in part by collections in subscription revenues received during the period.

Significant items impacting cash flow in the nine months ended September 30, 2012 included increased cash outlays relating to advertising and marketing expense, and an increase in salaries and related benefits associated with the growth of our business. These uses of cash were offset in part by increased collections on subscription revenues, credit card collections, and payments received from the growth of advertising revenue during the quarter.

Investing Activities

Cash (used in) provided by investing activities for the nine months ended September 30, 2013 and 2012 was ($127,164) and $6,358,861, respectively. Cash used in investing activities included purchases of property and equipment totaling $48,553 and $124,479 during the nine months ended September 30, 2013 and 2012, respectively. These purchases consisted primarily of computers and servers during the periods. We continue to invest in technology hardware and software to support our growth. Purchases of property and equipment may vary from period to period due to the timing of the expansion of our operations and software development. In addition, we also acquired 75,000 shares of DCL’s common stock for an aggregate purchase price of $75,000 under our subscription agreement with DCL and Darrell Lerner during the nine months ended September 30, 2013. Redemption of investments during the nine months ended September 30, 2012 totaled $6,475,000 and consisted of redemptions of our certificates of deposit and U.S. Treasury notes purchased in the prior year. We also received cash during the nine months ended September 30, 2012 from the partial repayment of a note receivable issued to an employee.

Financing Activities

There was no cash provided by financing activities for the nine months ended September 30, 2013. We received $25,000 in cash pursuant to the exercise of a stock option during the nine months ended September 30, 2012.

Off-Balance Sheet Arrangements

As of September 30, 2013, we did not have any off-balance sheet arrangements.

Contractual Obligations and Commitments

During the nine months ended September 30, 2013, there were no material changes to the Company’s contractual obligations and commitments from those disclosed in “Note 13. Commitments” in the Notes to the Condensed Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 14, 2013, which is hereby incorporated by reference herein.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements that have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates relied upon in preparing these financial statements include the provision for future credit card chargebacks and refunds on subscription revenue, estimates used to determine the fair value of our common stock, stock options, non-cash capital stock issuances, stock-based compensation and common stock warrants, collectability of our accounts receivable and the valuation allowance on deferred tax assets. Management evaluates these estimates on an ongoing basis. Changes in estimates are recorded in the period in which they become known. We base estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates.

During the nine months ended September 30, 2013, there were no material changes to our significant accounting policies from those contained in our Annual Report on Form 10-K for the year ended December 31, 2012, filed with the SEC on March 14, 2013, which are hereby incorporated by reference herein.

Evaluation of Disclosure Controls and Procedures

Our management, including our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Based on the evaluation as of September 30, 2013, for the reasons set forth below, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were not effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure.

A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control our financial reporting as of September 30, 2013, the Company determined that the following item constituted a material weakness:

• The Company does not have an independent audit committee in place, which would provide oversight of the Company’s officers, operations and financial reporting function.

Changes in Internal Control over Financial Reporting

There have been no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) under the Exchange Act) during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

There were no material changes to the Risk Factors disclosed in “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2012. For more information concerning our risk factors, please see “Item 1A. Risk Factors” of our Annual Report on Form 10-K.