XNAS:KITD Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

  Washington, D.C. 20549

 

Form 10-Q

 

(Mark One)

 

x          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

OR

 

o          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from __________ to __________

 

Commission file number 001-34437

 

KIT digital, Inc.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   11-3447894

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

26 West 17th Street, 2nd Floor, New York, New York      10011   
(Address of Principal Executive Offices)   (Zip Code)

 

(646) 553-4845

(Registrant’s Telephone Number, Including Area Code)

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x   No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated Filer  o Accelerated filer  x
Non-accelerated filer  o Smaller reporting company  o
(Do not check if a smaller reporting company)  

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of August 13, 2012, there were 57,097,255 shares of the issuer’s common stock outstanding.

 
 

 

KIT digital, Inc.

TABLE OF CONTENTS

 

    Page  
 PART I - FINANCIAL INFORMATION      
Item 1. Financial Statements   3  
  Consolidated Balance Sheets - As of June 30, 2012 (unaudited) and December 31, 2011 (as adjusted)    3  
  Consolidated Statements of Operations and Comprehensive Loss - For the three and six months ended June 30, 2012 and 2011 (unaudited)    4  
  Consolidated Statements of Stockholders’ Equity - For the six months ended June 30, 2012 (unaudited)   5  
  Consolidated Statements of Cash Flows - For the six months ended June 30, 2012 and 2011 (unaudited)    6  
  Notes to Consolidated Financial Statements (unaudited)   7  
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations      25  
Item 3. Quantitative and Qualitative Disclosures About Market Risk     32  
Item 4. Controls and Procedures   32  
 PART II - OTHER INFORMATION      
Item 1. Legal Proceedings     34  
Item 1A. Risk Factors   35  
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds     44  
Item 3. Defaults Upon Senior Securities     44  
Item 4. Mine Safety Disclosures     44  
Item 5. Other Information     44  
Item 6. Exhibits     44  
       
SIGNATURES    45  

 

All currency amounts are in thousands in this report. Share, per share and other numerical data are listed without abbreviation.

2
 

 

PART I - FINANCIAL INFORMATION

 Item 1.  Financial Statements  

 

KIT DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in Thousands, Except Share Data)

   June 30, 
2012
   December 31, 2011 (A) 
   (unaudited)   (As adjusted) 
Assets:        
Current assets:        
Cash and cash equivalents  $30,562   $44,229 
Restricted cash   5,346    238 
Investments   1,015    1,915 
Accounts receivable, net   42,924    56,672 
Unbilled revenue   18,249    12,533 
Inventory, net   1,488    1,336 
Other receivable, current portion   1,690    2,756 
Deferred tax assets, current portion   399    399 
Other current assets    11,091    10,514 
Current assets held for sale   -    20,938 
Total current assets   112,764    151,530 
Property and equipment, net   9,096    11,071 
Other receivable, net of current   8,668    5,876 
Deferred tax assets, net of current   611    600 
Intangible assets   58,305    63,835 
Goodwill   167,619    206,101 
Long-term assets held for sale   -    34,168 
Total assets  $357,063   $473,181 
           
Liabilities and Stockholders' Equity:          
Current liabilities:          
Capital lease and other obligations, current portion  $127   $169 
Secured notes payable, net of debt discount, current portion   7,298    6,406 
Notes payable   -    2,525 
Accounts payable   20,688    16,599 
Accrued expenses   15,973    6,387 
Deferred revenue   6,066    5,066 
Income tax payable   1,718    1,410 
Deferred tax liability, current portion   344    344 
Acquisition liabilities, current portion   17,032    8,648 
Derivative liability   28,388    557 
Other current liabilities   27,702    25,546 
Current liabilities held for sale   -    11,293 
Total current liabilities   125,336    84,950 
Capital lease and other obligations, net of current   70    91 
Secured notes payable, net of current   8,088    11,868 
Deferred tax liability, net of current   9,919    11,659 
Acquisition liabilities, net of current   3,438    8,004 
Long-term liabilities held for sale   -    2,939 
Total liabilities   146,851    119,511 
           
Equity:          
Stockholders' equity:          
Common stock, $0.0001 par value: authorized 150,000,000 shares; issued and outstanding 56,622,201 and 46,342,851, respectively   6    5 
Additional paid-in capital   547,605    513,882 
Accumulated deficit   (332,287)   (156,326)
Accumulated other comprehensive loss   (5,112)   (3,891)
Total stockholders' equity   210,212    353,670 
Total liabilities and stockholders' equity  $357,063   $473,181 

 

The Company has recasted its December 31, 2011 balance sheet as part of the Sezmi acquisition and certain assets and liabilities have been reclassified as part of Discontinued Operations. See Note 2.

 

The Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

3
 

 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

          As Adjusted 
  Three months ended   Six months ended 
  June 30,   June 30, 
   2012   2011   2012   2011 
Revenue  $51,149   $44,952   $107,267   $75,739 
                     
Variable and direct third party costs:                    
Cost of goods and services (exclusive of depreciation shown separately below)   16,412    9,799    33,272    17,841 
Hosting, delivery, reporting and content costs   3,114    2,650    6,203    3,883 
Direct third party creative production costs   396    317    1,013    682 
Total variable and direct third party costs   19,922    12,766    40,488    22,406 
                     
Gross profit   31,227    32,186    66,779    53,333 
                     
General and administrative expenses:                    
Compensation, travel and associated costs (including non-cash stock-based compensation of $8,254, $4,384, $15,557 and $6,410, respectively)   44,823    21,108    84,400    32,443 
Legal, accounting, audit and other professional service fees   3,752    767    4,535    1,344 
Office, marketing and other corporate costs   11,715    4,405    18,929    8,145 
Merger and acquisition and investor relations (income) expenses   (2,241)   10,916    2,249    16,166 
Depreciation and amortization   4,194    3,096    8,354    5,469 
Restructuring charges   3,349    34    3,349    3,352 
Integration expenses   -    9,710    -    18,398 
Impairment of goodwill   55,718    -    55,718    - 
Total general and administrative expenses   121,310    50,036    177,534    85,317 
                     
Loss from operations   (90,083)   (17,850)   (110,755)   (31,984)
                     
Interest income   1    69    52    141 
Interest expense   (1,203)   (383)   (1,892)   (636)
Amortization of deferred financing costs and debt discount   (104)   (76)   (208)   (94)
Derivative income (expense)   (3,173)   433    (2,986)   3,042 
Other expense   (9,333)   (378)   (9,537)   (448)
                     
Net loss before income taxes   (103,895)   (18,185)   (125,326)   (29,979)
                     
Income tax benefit (expense)   1,319    (796)   1,259    (910)
Net loss from continuing operations  $(102,576)  $(18,981)  $(124,067)  $(30,889)
                     
 Loss from discontinued operations   (48,506)   (822)   (51,894)   (1,415)
                     
Net loss  $(151,082)  $(19,803)  $(175,961)  $(32,304)
                     
Basic and diluted net loss from continuing operations per common share  $(1.99)  $(0.47)  $(2.56)  $(0.81)
Basic and diluted net loss from discontinued operations per common share   (0.95)   (0.02)   (1.07)   (0.03)
Basic and diluted net loss per common share  $(2.94)  $(0.49)  $(3.63)  $(0.84)
Basic and diluted weighted average common shares outstanding   51,418,613    40,063,874    48,513,809    38,316,369 
                     
Comprehensive loss:                    
Net loss  $(151,082)  $(19,803)  $(175,961)  $(32,304)
Foreign currency translation   (2,571)   (934)   (1,022)   (76)
Change in unrealized gain on investments, net   (245)   7    (199)   56 
Comprehensive loss:  $(153,898)  $(20,730)  $(177,182)  $(32,324)

 

The Company has adjusted prior year financials as part of Discontinued Operations. See Note 2.

The Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

4
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Amounts in Thousands, Except Share Data)

(Unaudited)

 

   Common
Stock
  

Common

Stock 

Par Value

   Additional
Paid-in
Capital
   Accumulated
Deficit
   Accumulated Other Comprehensive
Loss
   Total
Stockholders’ Equity
 
Balance – December 31, 2011   46,342,851   $5   $513,882   $(156,326)  $(3,891)  $353,670 
Issue of stock for exercise of stock options   63,283        483            483 
Issue of stock to 3rd party investors in private placement   7,000,000    1    27,173            27,174 
Issue of stock for acquisitions   2,717,530        15,273            15,273 
Stock price reset provision related to the issuance of stock in private placement           (10,512)           (10,512)
Initial value of derivative liability           (14,333)           (14,333)
Issue of stock for compensation   416,848        3,495            3,495 
Issue of stock for services   81,689        735            735 
Issue of warrants for services           530            530 
Stock-based compensation           10,879            10,879 
Foreign currency translation adjustment                   (1,022)   (1,022)
Fair market value adjustment for available for sale securities                   (199)   (199)
Net loss               (175,961)       (175,961)
Balance – June 30, 2012   56,622,201   $6   $547,605   $(332,287)  $(5,112)  $210,212 

  

The Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

5
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Amounts in Thousands)

       As Adjusted 
(Unaudited)  Six months ended June 30,
2012
   Six months ended June 30,
2011
 
         
Operating Activities:        
Net loss  $(175,961)  $(32,304)
Adjustments to reconcile net loss to net cash used by operating activities:          
Net loss from discontinued operations   51,894    1,415 
Provision for doubtful accounts   7,029    131 
Depreciation   2,875    2,780 
Amortization of intangible assets   5,479    2,689 
Amortization of deferred financing costs and debt discount   208    94 
Loss on impairment of goodwill   55,718    - 
Loss on impairment of notes receivable   6,474    - 
Realized loss on investment   1,050    - 
Loss on disposal of property plant and equipment   948    - 
Derivative expense (income)   2,986    (3,042)
Less: merger and acquisition expenses   -    6,517 
Non-cash stock based compensation   15,557    6,410 
Non-cash warrants for services   530    1,559 
Non-cash stock for services   50    - 
Changes in assets and liabilities:          
Accounts receivable   (800)   (2,904)
Unbilled revenue   (1,692)   523 
Inventory   (149)   (268)
Other assets   (1,088)   (2,350)
Accounts payable   3,763    (37)
Accrued expenses   9,943    4,082 
Income tax payable   300    (459)
Other liabilities   (2,133)   4,980 
Total adjustments   158,942    22,120 
Net cash used by operating activities- continuing operations  $(17,020)  $(10,184)
Net cash used by operating activities- discontinued operations   (8,116)   (1,075)
Net cash used by operating activities  $(25,136)  $(11,259)
           
Investing Activities:          
Cash paid into investment   (149)   (307)
Cash paid in acquisitions   (5,810)   (120,591)
Cash received in acquisitions   -    16,860 
Receipt of payment on notes receivable   -    877 
Merger and acquisition expenses   -    (6,517)
Purchase of equipment   (1,824)   (2,266)
Net cash used by investing activities- Continuing operations  $(7,783)  $(111,944)
 Net cash used by investing activities- Discontinued operations   (144)   (24)
Net cash used by investing activities  $(7,927)  $(111,968)
           
Financing Activities:          
Proceeds from private placement, net   27,174    - 
Proceeds from exercise of stock options   483    837 
Payments made to restricted cash accounts and letters of credit   (3,495)   (143)
Proceeds from exercise of warrants   -    2,982 
Proceeds from issuance of secured notes   -    15,000 
Payments of secured notes   (2,889)   (751)
Repayments of notes payable   (2,225)   - 
Payment on capital leases   (65)   (248)
Net cash from financing activities- Continuing operations  $18,983   $17,677 
Net cash used by financing activities- Discontinued operations   -    84 
Net cash from financing activities  $18,983   $17,761 
           
Effect of exchange rate changes on cash   413    2,043 
           
Net increase (decrease) in cash and cash equivalents  $(13,667)  $(103,423)
Cash and cash equivalents - beginning of period   44,229    140,585 
Cash and cash equivalents - end of period  $30,562   $37,162 
           
Supplemental disclosures of cash flow information:          
Cash paid during the period for:          
Income taxes  $222   $439 
Interest  $1,273   $660 
Non-cash investing and financing activities:          
Non-cash issuances of stock for acquisitions (2,717,530 and 7,582,056 shares issued, respectively)  $(15,273)  $(76,218)

  

The Company has adjusted prior year financials as part of Discontinued Operations. See Note 2.

The Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

6
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

(1) Nature of Business and Nature of Presentation   

 

KIT digital, Inc. (“we,” “us,” “our,” the “Company” or “KIT digital”), through our operating subsidiaries, provides software solutions that enable our customers to manage and distribute video content through Internet websites, mobile and tablet devices and both closed network Internet Protocol television (“IPTV”) and over-the-top (“OTT”) connected television environments. Our core video asset management software suite, marketed under the “KIT Platform” brand (and “KIT Cosmos” and “KIT Cloud” sub-brands), includes online and mobile video players, ingestion and trans-coding for Internet and mobile connected devices, live and video-on-demand OTT and IPTV video serving, editing and content transformation, content meta-tagging, content localization and syndication, digital rights management, hosting, storage, content delivery and content syndication. We currently provide IP video solutions internationally through over 20 offices globally, including principal locations in Atlanta, Beijing, Boston, Chennai, Cologne, Delhi, Dubai, Ely (UK), Grenoble (France), London, Madrid, Melbourne (Australia), Mumbai, New York, Paris, Prague, San Francisco, Singapore, and Sydney. In support of our KIT Platform deployments, we provide systems integration, broadcast engineering services, content transformation services and integrated marketing services.

  

The accompanying interim consolidated financial statements are unaudited and have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, for interim financial information. These financial statements include the accounts of KIT digital and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in the accompanying financial statements.

 

Certain information and footnote disclosures normally included in the Company’s annual audited consolidated financial statements and accompanying notes have been condensed or omitted in these interim financial statements. Accordingly, the unaudited consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and accompanying notes included in KIT digital’s annual report on Form 10-K for the year ended December 31, 2011, filed with the U.S. Securities and Exchange Commission.

 

The results of operations presented in this quarterly report on Form 10-Q are not necessarily indicative of the results of operations that may be expected for any future periods. In the opinion of management, these unaudited consolidated financial statements include all adjustments and accruals, consisting only of normal recurring adjustments, that are necessary for a fair statement of the results of all interim periods reported herein.

 

(2) Adjustments to prior period financials and discontinued operations.

 

Certain amounts have been reclassified to present the Company’s divesture of its Content Solutions Businesses and Sezmi business as discontinued operations. Unless otherwise indicated, information presented in the notes to the financial statements relates only to KIT digital’s continuing operations. Information related to discontinued operations is included in Note 25 and in some instances, where appropriate, is included as a separate disclosure within the individual footnotes.

 

The Company has recasted its December 31, 2011 balance sheet as it relates to the purchase accounting of Sezmi as the Company has determined that projections and certain assumptions used in the establishment of the earn-out liability were inaccurate. Therefore, the Company has reduced the original recorded earn-out liability by reducing goodwill in the amount of $25,003 and has reduced the acquisition liability by the same amount.

 

 

 

(3) Recent Accounting Pronouncements   

 

In May 2011, the Financial Accounting Standards Board (FASB) issued a new accounting standard update which amends the fair value measurement guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning after December 15, 2011. We adopted this standard in the first quarter of 2012 and the adoption of the guidance did not have a material impact on our financial statements and disclosures.

 

In June 2011, the FASB issued a new accounting standard which eliminates the current option to report other comprehensive income and its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The standard is effective for fiscal years beginning after December 15, 2011. We adopted this standard in the first quarter of 2012. There is no impact to our consolidated financial results as the amendments relate only to changes in financial statement presentation.

7
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

In September 2011, the FASB issued a revised accounting standard, which is intended to reduce the cost and complexity of the annual goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether further impairment testing is necessary. Specifically, an entity has the option to first assess qualitative factors to determine whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment, that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment test is required. Otherwise, no further testing is required. We adopted this standard during the first quarter of 2012. The adoption of the standard did not have material impact on our consolidated financial

statements.

 

(4) Net income (loss) per share

 

Basic net income per share is computed using the weighted average number of common shares outstanding during the applicable period. Diluted net income per share is computed using the weighted average number of common shares outstanding during the period, plus the dilutive effect of potential common stock. Potential common stock consists of shares issuable pursuant to stock options, warrants and restricted stock awards (“RSAs”).

 

The following table sets forth the components used in the computation of basic and diluted net loss per common share (in thousands, except share and per share data):

 

  For the Three Months Ended
June 30,
   For the Six Months Ended
June 30, 
 
   2012   2011   2012   2011 
Numerator:                
Net loss from continuing operations  $(102,576)  $(18,981)  $(124,067)  $(30,889)
Loss from discontinued operations   (48,506)   (822)   (51,894)   (1,415)
Net loss  $(151,082)  $(19,803)  $(175,961)  $(32,304)
Denominator:                    
Denominator for basic net loss per common share   51,418,613    40,063,874    48,513,809    38,316,369 
Effect of dilutive securities:                    
Stock options   -    -    -    - 
Warrants   -    -    -    - 
RSAs   -    -    -    - 
Denominator for diluted net income (loss) per common share   51,418,613    40,063,874    48,513,809    38,316,369 
Basic net loss from continuing operations per common share  $(1.99)  $(0.47)  $(2.56)  $(0.81)
Basic net loss from discontinued operations per common share   (0.95)   (0.02)   (1.07)   (0.03)
Basic net loss per common share  $(2.94)  $(0.49)  $(3.63)  $(0.84)
Diluted net loss from continuing operations per common share  $(1.99)  $(0.47)  $(2.56)  $(0.81)
Diluted net loss from discontinued operations per common share   (0.95)   (0.02)   (1.07)   (0.03)
Diluted net loss per common share  $(2.94)  $(0.49)  $(3.63)  $(0.84)

 

All equivalent shares underlying stock options, warrants and RSAs were excluded from the calculation of diluted loss per share because we had net losses for all periods presented and therefore equivalent shares would have an anti-dilutive effect.

8
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

Potentially dilutive shares excluded as a result of the effects being anti-dilutive were as follows:

 

  For the Three Months Ended
June 30,
   For the Six Months Ended
June 30,
 
   2012   2011   2012   2011 
Stock options   136,370    225,857    1,891,738    281,761 
Warrants   77,860    1,013,974    141,971    1,359,444 
RSAs   273,432    91,927    273,433    91,927 
Total dilutive shares   487,662    1,331,758    2,307,142    1,733,132 

   

(5) Cash and Cash Equivalents

 

We consider all highly liquid investments with original maturities of ninety days or less when purchased to be cash and cash equivalents.  Cash and cash equivalents in financial institutions outside the United States as of June 30, 2012 was $5,333 and $24,379 for December 31, 2011.

 

(6) Fair Value of Financial Instruments

 

Fair value is the amount that would be received upon sale of an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting Standards Codification (“ASC”) Topic 820 also establishes a fair value hierarchy which prioritizes the types of inputs to valuation techniques that companies may use to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1). The next highest priority is given to inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly (Level 2). The lowest priority is given to unobservable inputs in which there is little or no market data available and which require the reporting entity to develop its own assumptions (Level 3).

 

The assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy are Investments and Derivative Liabilities. Investments are measured using net asset value as a practical expedient (Level 2). See Note 15 for fair value hierarchy on the Derivative Liabilities.

 

(7) Accounts Receivable

 

Trade accounts receivable are stated net of allowances for doubtful accounts. Specific customer provisions are made when a review of significant outstanding amounts, customer creditworthiness and current economic trends, indicates that collection is doubtful. In addition, provisions are made at differing amounts, based upon the balance and age of the receivable and the Company’s historical collection experience. Trade accounts are charged off against the allowance for doubtful accounts or expense when it is probable the accounts will not be recovered. The allowance for doubtful accounts as of June 30, 2012 and December 31, 2011 was $2,821 and $2,943, respectively.

 

(8) Concentration of Credit Risk

 

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We place our cash and cash equivalents with high credit quality institutions to limit credit exposure. We believe no significant concentration of credit risk exists with respect to these balances. The amount held in foreign currencies as of June 30, 2012 and December 31, 2011 was $4,869 and $9,329, respectively. The amount of cash in excess of FDIC insured amounts as of June 30, 2012 and December 31, 2011, was $29,785 and $43,366, respectively.

  

Concentrations of credit risk with respect to trade accounts receivable are limited due to the nature of our customers who are dispersed across many industries and geographic regions. As of June 30, 2012 and December 31, 2011, no customer accounted for 10% or more of our trade accounts receivable. As of the three and six months ended June 30, 2012 and for the three months ended June 30, 2011, no customer accounted for 10% or more of the revenue for the respective period. For the three months ended June 30, 2011, we had one customer who accounted for approximately 11% of our revenue for the quarter. We routinely assess the financial strength of customers and, based upon factors concerning credit risk, establish an allowance for doubtful accounts. We believe that accounts receivable credit risk exposure beyond such allowance is limited.

 

(9) Inventory

 

Inventory is valued at the lower of cost (first-in, first-out method) or market and is comprised of finished goods. On a quarterly basis, we review inventory quantities on hand and analyze the provision for excess and obsolete inventory based primarily on product age in inventory and our estimated sales forecast, which is based on sales history and anticipated future demand. As of June 30, 2012 and December 31, 2011, our reserves for excess and obsolete inventory were $144 and $146, respectively.

9
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

(10) Goodwill and Intangible Assets

 

The change in the carrying amount of goodwill is as follows:

 

   Goodwill 
Balance as of December 31, 2011  206, 101 
Acquisitions- Hyro   15,390 
Impairment charge of goodwill   (55,718)
Other adjustments, net   1,846 
Balance as of June 30, 2012  167,619 

  

We evaluate the carrying value of our goodwill annually at the end of December and whenever events or circumstances make it more likely than not that an impairment may have occurred. Accounting standard on Goodwill and Other Intangible Assets prescribes a two-step method for determining goodwill impairment. In the first step, we compare the estimated fair value of each reporting unit to its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the estimated fair value, step two is completed to determine the amount of the impairment loss. Step two requires the allocation of the estimated fair value of the reporting unit to the assets, including any unrecognized intangible assets, and liabilities in a hypothetical purchase price allocation. Any remaining unallocated fair value represents the implied fair value of goodwill, which is compared to the corresponding carrying value of goodwill to compute the goodwill impairment amount.

 

As part of our impairment analysis for each reporting unit, we estimate the fair value of each unit utilizing the income approach and market approach. The income approach requires management to estimate a number of factors for each reporting unit, including projected future operating results, economic projections, anticipated future cash flows, discount rates, and the allocation of shared service or corporate items. The market approach was used as a test of reasonableness of the conclusions reached in the income approach. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping.

 

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. During the second quarter ended June 30, 2012, our market capitalization declined significantly. As this measure is our significant indicator of the fair value of our business unit, management considered this decline to be a triggering event, requiring us to perform an interim impairment analysis. As of June 30, 2012, we completed this interim analysis and our management has concluded that an impairment charge of $55,718 should be recognized. This is a noncash charge and has been recorded in the second quarter ended June 30, 2012. As of December 31, 2011, approximately $32,169 of goodwill was part of discontinued operations and is included in long-term assets held for sale. (See Note 25).


The determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within those reporting units requires management to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which we compete; the discount rate; terminal growth rates; and forecasts of net sales, operating income, depreciation and amortization and capital expenditures. Although we believe our estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on the fair value of the reporting units.

 

Intangible assets include the following:

 

   June 30, 2012 
   Weighted
Average
Remaining Amortization
Period (Years)
   Gross
Carrying
Amount
   Accumulated Amortization   Net Carrying Amount 
Intangible assets with determinable lives:                
Software   4.0   $15,862   $(7,472)  $8,390 
Customer list   7.0    64,905    (15,687)   49,218 
Trademarks   4.0    621    (561)   60 
Other   2.0    1,363    (726)   637 
Total       $82,751   $(24,446)  $58,305 

 

10
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

  

 

    December 31, 2011 
   Weighted
Average
Remaining Amortization
Period (Years)
   Gross
Carrying
Amount
   Accumulated
Amortization
   Net Carrying
Amount
 
Intangible assets
with determinable lives:
                
Software   4.0   $15,861   $(6,168)  $9,693 
Customer list   7.0    64,905    (11,654)   53,251 
Trademarks   3.5    621    (537)   84 
Other   2.5    1,362    (555)   807 
Total       $82,749   $(18,914)  $63,835 

 

Amortization expense on intangible assets for the three months ended June 30, 2012 and 2011 were $2,735 and $1,403, respectively and for the six months ended June 30, 2012 and 2011 were $5,479 and $2,689 respectively. No impairment charges were recorded for the three and six months ended June 30, 2012 and 2011.

 

Estimated future annual amortization expense as of June 30, 2012 is as follows:

 

    Software     Customer List     Trademarks     Other      Total  
2012   $ 1,304     $ 4,000     $ 8     $ 184     $ 5,496  
2013     2,407       7,947       17       344       10,715  
2014     2,121       7,921       17       110       10,169  
2015     1,851       7,780       17       -       9,648  
2016     706       7,196       1       -       7,903  
Thereafter     -       14,374       -       -       14,374  
Totals   $ 8,389     $ 49,218     $ 60     $ 638     $ 58,305  

   

 

(11) Acquisitions 

 

Hyro Acquisition

 

On June 22, 2012, the Company acquired certain technology assets through the purchase of stock of certain subsidiaries of Hyro Limited, an Australian technology company that delivers enterprise level online and mobile solutions to the telecommunications, broadcast, retail, finance and government sectors. These technology assets will be a part of KIT digital’s continued focus on video software and service offerings in the Asia-Pacific region and to further benefit our existing tier-one customer base. KIT digital has elected to pay consideration of $1,211 in cash and 1,838,134 shares of KIT digital common stock valued at $7,628, subject to adjustment under certain conditions. The number of shares of the Company’s common stock being paid as consideration to Hyro may be increased depending on the price of such common stock in the future, an acquisition liability of $6,461 has been recorded for this provision, See Note 14.  

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

 

Current assets  $3,107 
Property and equipment   818 
Purchased Software   151 
Goodwill   15,390 
Total assets acquired   19,466 
Current liabilities   4,166 
Net assets acquired  $15,300 

  

 

11
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

 

(12) Other Receivables

 

   June 30, 2012   December 31, 2011 
Loan receivable on sale of subsidiary, net of reserves  $2,158   $8,632 
Other receivables   8,200    - 
Total other receivables   10,358    8,632 
Less: current   (1,690)   (2,756)
Other receivables, net of current  $8,668   $5,876 

 

 

In December 2010, we lent $10,847 as part of the sale of subsidiary which matures on January 28, 2015 with payments commencing on February 28, 2011, due in forty-eight equal consecutive monthly payments of $226. The loan is secured by accounts receivable, cash and other assets of the business sold. As of June 30, 2012, the Company has approximately $2,158 remaining on the loan net of $6,474 in reserves. During the second quarter of 2012, the receivable went into default as the purchaser has failed to make certain payments. The Company is currently exploring its legal remedies and has recorded a reserve against this receivable during the three months ended June 30, 2012 of approximately $6,474.

 

During the three months ended June 30, 2012, the Company recorded a receivable of approximately $8,200 related to the sale of the Content Solutions business of which $1,690 is recorded in current assets. See Note 25.

 

(13) Secured Notes Payable

 

   June 30, 2012   December 31, 2011 
April 2010 secured note payable for $5,000, net of discount of $55 and $84, respectively  $2,500   $3,388 
June 2010 secured note payable for $1,000, net of discount of $9 and $13, respectively   565    740 
May 2011 secured note payable for $15,000, net of discount of $683 and $854, respectively   12,321    14,146 
    15,386    18,274 
Less: current portion   (7,298)   (6,406)
Secured notes payable, net of current  $8,088   $11,868 

 

In May 2011, we received $15,000 in gross proceeds from the issuance of a note to a third party investor, as called for in the negotiated structure of our acquisition of ioko, as a means of financing the additional accounts receivable acquired. Interest is payable monthly in advance at 13.6% per year and matures on July 1, 2014.  We paid total interest only of $187 for May and June 2011 and agreed to pay interest only of $122 per month for the next seven months. Commencing on February 1, 2012, payments for principal and interest are due in thirty equal consecutive payments of $561. A final balloon payment of $1,149 will be due and payable upon maturity. The note is secured by our property, including accounts receivable and inventory.  In conjunction with the borrowing, we issued to the lender a warrant entitling it to purchase, for $13.29 per share, 141,083 shares of our common stock with a seven year term through May 15, 2018. A debt discount of $1,081 was recorded related to these warrants and is being amortized over the term of the loan.

 

In June 2010, we received $1,000 in gross proceeds from the issuance of a note to a third party investor. Interest is payable monthly in advance at 12.7% per year and matures on September 1, 2013. We paid interest only of $5 for June 2010 and agreed to pay interest only of $8 per month for the next nine months. Commencing on April 1, 2011 payments for principal and interest are due in thirty equal consecutive payments of $38. A final balloon payment of $108 will be due and payable upon maturity. The note is secured by the Company’s property, including accounts receivable and inventory. In conjunction with the borrowing, we issued to the lender a warrant entitling it to purchase, for $13.76 per share, 8,480 shares of our common stock with a five year term through June 14, 2015. A debt discount of $27 was recorded related to these warrants and is being amortized over the term of the loan.

 

In April 2010, we received $5,000 in gross proceeds from the issuance of a note to a third party investor. Interest is payable monthly in advance at 12.7% per year and matures on July 1, 2013. We paid interest only of $22 for April 2010 and agreed to pay interest only of $42 per month for the next nine months. Commencing on February 1, 2011, payments for principal and interest are due in thirty equal consecutive payments of $188. A final balloon payment of $538 will be due and payable upon maturity. The note is secured by the Company’s property, including accounts receivable and inventory. In conjunction with the borrowing, we issued to the lender a warrant entitling it to purchase, for $14.24 per share, 40,976 shares of our common stock with a five year term through April 15, 2015. A debt discount of $183 was recorded related to these warrants and is being amortized over the term of the loan.

12
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

As of June 30, 2012, we were in compliance with our debt covenants on all of our secured notes payable.

 

(14) Acquisition Liabilities

 

The fair value of the acquisition-related contingent consideration for potential earn-out and other payments was estimated based on the various revenue and gross margin thresholds in each purchase agreement. The varying potential earn-out amounts were then probability weighted and discounted to present value at the average rate of the weighted average cost of capital for each acquired company and the after-tax cost of debt. The potential earn-out payments must be recognized at their fair value, as of the acquisition date, and included as part of the total consideration transferred. The accounting standard requires that the fair value of these liabilities be re-measured at the end of every reporting period with the change in value over the period reported in the statement of operations.

 

Acquisition Liabilities consisted of the following: 

 

   June 30, 2012   December 31, 2011 
Acquisition liabilities, current portion        
Benchmark  $4,047   $3,960 
WWB   2,377    1,427 
ioko   1,374    1,482 
Polymedia   2,573    1,779 
Hyro   6,461    - 
Peerset   200    - 
   $17,032   $8,648 
           
Acquisition liabilities, net of current          
Benchmark  $-   $1,671 
WWB   2,421    3,907 
ioko   -    1,359 
Polymedia   1,017    1,067 
   $3,438   $8,004 

 

 

Pursuant to the Benchmark Stock Purchase Agreement on May 14, 2010, following the 12-month anniversary of the closing, we agreed to pay the seller in the form of shares of our common stock $0.60 for every $1.00 of recognized revenue generated by Benchmark during the 12-month period following the closing, less the purchase price paid at closing. As of June 30, 2011, the fair value of the acquisition-related contingent consideration for the second anniversary on May 15, 2012 for Benchmark increased by $3,208 based on changes in management’s estimates and other factors that occurred during the three months ended June 30, 2011. The increase in the liabilities were recorded as a charge to earnings and is included in the “Merger and acquisition and investor relations expenses” line item in the Consolidated Statements of Operations. Also in the three months ended June 30, 2011, the working capital liability was agreed and paid for $357 with the difference of $762 recorded as an offset to the “Merger and acquisition and investor relations expenses” line item in the Consolidated Statements of Operations.

 

In July 2011, we paid the $1,375 in relation to the Peerset Acquisition liability.

 

As part of the Hyro acquisition, the Company has recorded an acquisition liability in the amount of $6,461 as an estimate of the top-off provision, which is based on the minimum value per the Hyro SPA of $14,346 for the 1,838,134 shares granted as of June 30, 2012. This top-off provision will be due upon and calculated upon the date that the 1,838,134 shares issued are able to be sold under Rule 144 or a change of control. See Note 11.

 

(15) Derivative Liabilities

 

On May 8, 2008, the Company entered into a Securities Purchase Agreement pursuant to which it sold 2,142,858 units to 35 accredited investors, each unit comprising of one share of common stock plus one warrant to purchase one share of common stock. The units were sold at a price of $7.00 per unit for aggregate gross proceeds of $15,000. The warrants have an exercise price of $11.90 per share and a term of five years. The warrants provide the investors with full ratchet anti-dilution protection with relation to the exercise price of each warrant.

13
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

On May 15, 2012, the Company entered into a definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting placement agents’ fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares of the Company’s common stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May 17, 2012) with an effective strike price of $5.00. After deducting the fees of the placement agent and other estimated offering expenses, the net proceeds to the Company from the private placement were approximately $27,174.

 

During the six months ended June 30, 2012 and in conjunction with this share issuance, the Company record a liability of approximately $10,512 representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the stock purchase agreement. This amount consists of approximately 2,588,408 shares and approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 17 and 19.

 

The warrants issued as part of the Securities Purchase Agreement contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair value. On May 17, 2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in capital.

 

The Warrants were valued using a Monte Carlo simulation model. See Note 17 and 19.

 

In relation to the May 2008 warrants the actual number of common shares indexed to the warrants at December 31, 2011 and June 30, 2012 were 251,021 and 421,382, respectively. Upon the issuance of the shares in the May 2012 private placement at $4.17 per share, the anti-dilution provision in the May 2008 warrants was triggered and resulted in the reduction of the exercise price to $4.17 from $7.00 and an increase of 170,361 shares under these warrants.

 

In relation to the May 2012 warrants, the actual number of common shares indexed to the warrants at May 15, 2012 and June 30, 2012 were 5,250,000 and 5,250,000, respectively.

 

We estimate fair values of derivative financial instruments using various techniques (and combinations thereof) that are considered to be consistent with the objective measuring fair values. In selecting the appropriate technique, we consider, among other factors, the nature of the instrument, the market risks that it embodies and the expected means of settlement. For less complex derivative instruments, such as free-standing warrants, we generally use the Black-Scholes model, adjusted for the effect of dilution, because it embodies all of the requisite assumptions (including trading volatility, estimated terms, dilution and risk free rates) necessary to fair value these instruments.

 

Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques (such as Black-Scholes model) are highly volatile and sensitive to changes in the trading market price of our common stock. Since derivative financial instruments are initially and subsequently carried at fair values, our income (expense) going forward will reflect the volatility in these estimate and assumption changes. Under the terms of the new accounting standard, increases in the trading price of our common stock and increases in fair value during a given financial quarter result in the application of non-cash derivative expense. Conversely, decreases in the trading price of our common stock and decreases in trading fair value during a given financial quarter result in the application of non-cash derivative income.

 

The following table summarizes the components of derivative liabilities as of June 30, 2012 and December 31, 2011 for the May 2008 warrants:

 

   June 30, 
2012
   December 31, 
2011
 
Fair value of warrants with anti-dilution provisions  $(604)  $(557)
Significant assumptions (or ranges):          
Trading market values  (1)  $4.29   $8.45 
Term (years) (3)   0.86    1.35 
Volatility   (1)   90.00%   57.00%
Risk-free rate   (2)   0.27%   0.25%
Effective Exercise price  (3)  $4.17   $7.00 

 

14
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

The following table summarizes the components of derivative liabilities as of June 30, 2012 and the measurement date of May 17, 2012 for the May 2012 warrants:

 

   June 30, 
2012
   May 17, 
2012
 
Fair value of warrants with anti-dilution provisions  $(17,273)  $(14,333)
Significant assumptions (or ranges):          
Trading market values  (1)  $4.29   $3.50 
Term (years) (3)   5.38    5.50 
Volatility   (1)   90.00%   90.00%
Risk-free rate   (2)   0.79%   0.78%
Effective Exercise price  (3)  $5.00   $5.00 

  

Fair value hierarchy:

 

(1) Level 1 inputs are quoted prices in active markets for identical assets and liabilities, or derived there from. Our trading market values and the volatilities that are calculated thereupon are level 1 inputs.

 

(2) Level 2 inputs are inputs other than quoted prices that are observable. We use the current published yields for zero-coupon US Treasury Securities, with terms nearest the remaining term of the warrants for our risk free rate.

 

(3) Level 3 inputs are unobservable inputs. Inputs for which any parts are level 3 inputs are classified as level 3 in their entirety. The remaining term used equals the remaining contractual term as our best estimate of the expected term and the effective exercise price which is based on the stated exercise price adjusted for anti-dilution provisions.

 

The effects on our income (expense) associated with changes in the fair values of our derivative financial instruments for the three months ended June 30, 2012 and 2011 were ($3,173) and $433, respectively. For the six months ended June 30, 2012 and 2011, effects on our income (expense) associated with changes in the fair values of our derivative financial instruments were ($2,986) and $3,042, respectively.

 

(16) Other Current Liabilities

 

Other current liabilities consisted of the following:

 

   June 30, 2012   December 31, 2011 
Accrued salaries and benefits  $19,348   $13,827 
Liabilities assumed and to be paid related to acquisitions   5,564    9,756 
Other   2,790    1,963 
   $27,702   $25,546 

 

(17) Fair Value Measurement

 

The following table provides the assets and liabilities carried at fair value measured on a recurring basis:

 

   Fair Value Measurements at June 30, 2012 
   Carrying
Value
   Level 1   Level 2   Level 3 
Liabilities                    
Acquisition liabilities (see note 14)  $20,470    -    -   $20,470 
Derivative liability (see note 15 and 19)  $28,388    -    -   $28,388 

  

   Fair Value Measurements at December 31, 2011 
   Carrying
Value
   Level 1   Level 2   Level 3 
Assets                
Investments  $ 1,352   -   1,352   $ - 
                 
Liabilities                
Acquisition liabilities (see note 14)  $16,652    -    -   $16,652 
Derivative liability (see note 15 and 19)  $557    -    -   $557 

 

A reconciliation of the change in the carrying value of the level 3 acquisition liabilities is as follows:

 

Balance at January 1, 2012  $16,652 
Payment of acquisition liabilities   - 
Increase in earn out estimates and new acquisitions   7,649 
Decrease in earn out estimates and payments   (3,831)
Balance at June 30, 2012  $20,470 

 

15
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

The amount of total gains or losses for the six months ended June 30, 2012 included in losses attributable to the change in unrealized gains or losses relating to liabilities still held at June 30, 2012:

 

Included in statement of operations in Interest expense  $164 
Included in statement of operations in Merger and acquisition and investor relations  $(3,006)

 

A reconciliation of the change in the carrying value of the level 3 derivative liability is as follows: 

Balance at January 1, 2012  $557 
Initial valuation of May 2012 warrants (Note 19)   14,333 
Valuation of May 2012 stock price reset provision   10,512 
Change in valuation   2,986 
Balance at June 30, 2012  $28,388 

 

The amount of total gains or losses for the six months included in losses attributable to the change in unrealized gains or losses relating to liabilities still held at June 30, 2012:

  

Included in statement of operations in Derivative expense   $ 2,986  

 

As of June 30, 2012 and December 31, 2012, the Company has approximately $1,015 and $563, respectively, of cost investments recorded on the balance sheet.

 

(18) Stock-Based Compensation

 

In December 2010, our board of directors voted unanimously to increase the number of shares which may be issued under the 2008 Incentive Plan by 1,500,000 to an aggregate of 5,000,000 shares of common stock, subject to ratification by our stockholders. Subsequently, as a result of acquisition activity, our board of directors authorized at its meetings on March 5, 2011 and August 5, 2011 to amend and increase the number of shares which may be issued under the 2008 Incentive Plan to a new total of 9,500,000 shares of common stock. The holders of a majority of our outstanding shares of common stock approved the amendment to the 2008 Incentive Plan at the stockholders meeting held on October 21, 2011. The 2008 Incentive Plan had 772,417 shares of common stock available for future grants as of June 30, 2012. The 2004 Stock Option Plan has reserved 342,858 shares of common stock for issuance of which 264,108 shares of common stock were available for future grants as of June 30, 2012.

 

The Company’s outstanding unvested stock options have maximum contractual terms of up to five years, principally vest on a quarterly basis ratably over four years and were granted at exercise prices equal to the market price of the Company’s common stock on the date of grant. The Company’s outstanding stock options are exercisable into shares of the Company’s common stock. The Company measures the cost of employee services received in exchange for an award of equity instruments, including grants of employee stock options, warrants and restricted stock awards, based on the fair value of the award at the date of grant in accordance with the modified prospective method. The Company uses the Black-Scholes model for purposes of determining the fair value of stock options and warrants granted and recognizes compensation costs ratably over the requisite service period, net of estimated forfeitures. For restricted stock awards, the grant-date fair value is the quoted market price of the stock.

  

As of June 30, 2012, there was approximately $17,732 of total unrecognized compensation cost related to unvested share-based compensation grants, which is expected to be amortized over a weighted-average period of approximately 2.6 years. As of December 31, 2011, there was approximately $26,513 of total unrecognized compensation cost related to unvested share-based compensation grants, which is expected to be amortized over a weighted-average period of 2.8 years.

16
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

The fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following weighted-average assumptions:

 

   Six months ended
 June 30, 2012
   Six months ended
 June 30, 2011
 
Expected life (in years)   3.96    4.00 
Risk-free interest rate   0.61%   1.52%
Volatility   102.77%   79.40%
Dividend yield   0    0 

 

In 2012 and 2011, we estimated the expected term of stock options using historical exercise experience and used a forfeiture rate of 25% for employees and 0% for officers and directors.

 

A summary of the status of stock option awards and changes during the six months ended June 30, 2012 is presented below:

 

   Shares   Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Life (Years)
   Intrinsic
Value
 
Outstanding at December 31, 2011   6,415,669   $9.90           
Granted   703,857    9.36           
Exercised   (63,283)   7.63           
Cancelled, expired, or forfeited   (1,236,049)   10.82           
Outstanding at June 30, 2012   5,820,194    9.67    3.47   $0 
Exercisable at June 30, 2012   2,882,048   $9.36    3.16   $0 

  

The weighted-average grant-date fair value of option awards granted during the six months ended June 30, 2012 was $6.19.

 

Restricted Stock Awards

 

The following table summarizes the different types of restricted stock awards granted:

 

 

   Six months ended   Six months ended 
   June 30, 2012   June 30, 2011 
         
Restricted stock units ("RSUs") with time-based vesting conditions   204,423    - 
Performance-contingent restricted stock units ("PCRSUs") with market-based vesting conditions   425,000    - 
Restricted stock with vesting conditions   541,170    - 
    1,170,593    - 
           

  

RSUs, PCRSUs and restricted stock awards represent the right to receive one share of our common stock upon vesting. We have issued time-based restricted stock units (“RSUs”), performance and time-based RSUs, market-based PCRSUs, and restricted stock with vesting conditions. The time-based RSUs vest in 36 or 48 equal monthly installments based on continued employment. The performance and time-based RSUs vest in 48 equal monthly installments based on continued employment and our common stock 20-day volume weighted average stock price exceeds the grant date closing price by 115% for 50% of the grant and by 130% for 50% of the grant. Both of these performance targets were met before the end of October 2010. The PCRSUs vesting is generally determined based upon the common stock’s highest 90-Day VWAP attained over a series of vesting periods (each such period is three months in duration) over the term of the agreement or, in the event of a change in control of the company, the fair market value of our common stock on the effective date of the change in control. These performance targets have not been met as of the latest vesting period on June 30, 2012. No grants were made during the six months ended June 30, 2011.

 

 

   Restricted
Stock
   Weighted
Average
Exercise
Price
 
Outstanding at December 31, 2011   1,689,250   $7.05 
Granted   1,170,593    6.54 
Vested   (416,848)   8.05 
Cancelled   (328,223)   10.53 
Outstanding at June 30, 2012   2,114,772   $6.43 

 

17
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

The total pre-tax intrinsic value of restricted stock awards granted during the six months ended June 30, 2012 was $11,915. The total fair value of restricted stock awards vested during the six months ended June 30, 2012 was $7,655. The grant-date fair value of each RSU and restricted stock is calculated based upon the Company’s closing stock price on the date of grant. The grant-date fair value of PCRSUs was calculated using the Monte-Carlo simulation model due to the market-based vesting conditions.

 

The fair value of each PCRSU is estimated on the date of grant using the Monte Carlo simulation model with the following assumptions included (1) 0.66% risk free rate, (2) estimated vesting period (3) expected stock price volatility of 85%, and (4) common stock price of the underlying share on the valuation date.

 

During the three months ended June 30, 2012 the Company recorded approximately $3,400 net, PCRSU expense related to terminations of certain executives.

 

(19) Stock Issuances

 

During the six months ended June 30, 2012, we issued 10,279,350 shares of common stock. Of this amount, we issued 7,000,000 shares in the May 2012 private placement described below, 1,838,134 shares related to the acquisition of Hyro, 879,396 shares related to the acquisition of Sezmi, 81,689 shares for services, 416,848 shares for restricted stock and 63,283 shares for the exercise of options with proceeds of $483. 

 

As of June 30, 2012, the outstanding warrants (excluding the warrants included in the derivative liability of 5,671,382 were 1,017,167 with a weighted average exercise price of $10.84 As of December 31, 2011, the outstanding warrants (excluding the warrants included in the derivative liability of 251,021 and stock-based compensation of 34,286) were 1,361,935 with a weighted average exercise price of $24.21.

 

May 2012 Share Issuance

 

On May 15, 2012, the Company entered into a definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting placement agents’ fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares of the Company’s common stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May 17, 2012) with an effective strike price of $5.00. After deducting the fees of the placement agent and other estimated offering expenses, the net proceeds to the Company from the private placement were approximately $27,174.

 

During the six months ended June 30, 2012 and in conjunction with this share issuance, the Company recorded a liability of approximately $10,512 representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the stock purchase agreement. This amount consists of approximately 2,588,408 shares and approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 15 and 17.

 

The warrants issued as part of the Securities Purchase Agreement contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair value. On May 17, 2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in capital.

 

The Warrants were valued using a Monte Carlo simulation model at $14,333. See Note 15 and 17.

 

(20) Restructuring Charges

 

In the first quarter of 2010, management approved restructuring plans for entities acquired in the fourth quarter of 2009 which included a workforce reduction, reduction in costs related to excess and vacated facilities under non-cancelable leases and settlement of contracts. We expect to make the remaining facility closing costs and contract settlement payments in 2012.

 

In the first quarter of 2011, management approved a companywide restructuring plan related to a workforce reduction. Payments against this plan were completed in 2011.

 

During the second quarter of 2012, management approved a restructuring plan to focus its resources to support its strategic and core assets, streamline its cost structure and move its headquarters to New York and reduce the staff at its former headquarters in Prague. As such, the Company recorded a restructuring charge of $3,349 during the three months ended June 30, 2012. The Company expects to complete this plan within 12 months from the end of the second quarter of 2012.

18
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

The following table summarizes the restructuring accruals for the year ended December 31, 2011 and the six months ended June 30, 2012:

 

   Employee
Termination
Costs
   Contract
Settlements
   Facility
Closing
Costs
   Total 
Balance as of December 31, 2010  $1,212   $13   $518   $1,743 
Additions   3,973    -    34    4,007 
Reversal   (654)   -    -    (654)
Cash payments   (4,531)   (8)   (337)   (4,876)
Balance as of  December 31, 2011  $-   $5   $215   $220 
Additions   3,349    -    -    3,349 
Reversal   -    -    -    - 
Cash payments   (587)   (5)   (134)   (726)
Balance as of  June 30, 2012  $2,762   $-   $81   $2,843 

 

The accrued restructuring of $220 and $2,843 were included in accrued expenses in the consolidated balance sheets as of December 31, 2011 and June 30, 2012, respectively.

 

The following table summarizes the restructuring charges:

  

   Three months ended
June 30, 2012
   Three months ended
June 30, 2011
   Six months ended
June 30, 2012
   Six months ended
June 30, 2011
 
Employee termination costs  $3,349   $-   $3,349   $3,318 
Contract settlements   -    -    -    - 
Facility closing costs   -    34    -    34 
Total restructuring charges  $3,349   $34   $3,349   $3,352 

 

 

(21) Integration Expenses

 

The Company has recorded integration charges related to the cost overlap due to the reorganization and integration of acquisitions of $9,710 and $18,398 for the three and six months ended June 30, 2011, respectively. Integration expenses includes expenses for integrating acquired businesses together and eliminating duplication and inefficiencies. This includes rationalizing hosting and delivery infrastructure (data center consolidation, related hardware purchases, trunk T1 and T3 purchases and combinations, etc.) to merging software platforms and physical plant/office combination. These expenses include directly allocable staff time, travel and associated charges related to executing these integration initiatives. These expenses are almost all without exception cash-based. No such expenses were recorded for the three months and six months ended June 30, 2012.

 

 

(22) Segment Reporting

 

We have presented operating segments in the past for Digital Media Solutions and Professional Services, but since Professional Services represents less than 5% of total assets and total revenues and this segment continues to decrease, we are not presenting financial information for operating segments.

  

The following table provides revenue and assets by major geographical location.

 

 

  For the Three Months Ended
June 30,
   For the Six Months Ended
June 30,
 
   2012   2011   2012   2011 
Revenue:                
EMEA  $29,235   $27,124   $59,999   $40,055 
AsiaPac   8,746    8,579    17,659    17,986 
Americas   13,168    9,249    29,609    17,698 
Total revenue  $51,149   $44,952   $107,267   $75,739 

 

19
 

 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

   June 30,   December 31, 
   2012   2011 
Assets:          
EMEA  $177,215   $176,929 
AsiaPac   28,449    10,344 
Americas   65,027    122,989 
Corporate   86,372    162,919 
Total assets  $357,063   $473,181 

 

In the assets listed above, Corporate includes all intangible assets and goodwill. Assets held for sale related to the divesture of Content Solutions has been included within the EMEA total assets for approximately $23,310 as of December 31, 2011. For the divesture of Sezmi assets held for sale of approximately $31,796 has been included within the Americas segments total assets as of December 31, 2011. See Note 25.

 

(23) Related Party Transactions

 

The managerial services of Kaleil Isaza Tuzman, our former Chairman and Chief Executive Officer, and other non-executive personnel, were provided through KIT Capital, which is beneficially controlled by Mr. Isaza Tuzman. The total amount included in our results of operations in the three months ended June 30, 2012 and 2011 were $0 and $97, respectively, and $53 and $97 for the six months ended June 30, 2012 and 2011, respectively. As of the end of the first quarter of 2012 and as part of the resignation of Mr. Isaza Tuzman on March 31, 2012 as Chief Executive Officer, we no longer use KIT Capital for managerial services.

 

 

(24) Income Taxes

 

Income taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual effective tax rate of 9.9% for the six months ended June 30, 2012 and 2.3% for the six months ended June 30, 2011. The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings, losses and tax planning. During the three and six months ended June 30, 2012, the Company recorded a tax benefit of approximately $1,319 and $1,259, respectively. This tax benefit is primarily driven by the reversal of deferred tax liabilities from acquisition related intangibles. During the three and six months ended June 30, 2011, the Company recorded a tax expense of approximately $796 and $910, respectively. Prior period’s tax expense relates to estimated tax payments for state and local.

 

We are not currently under examination by any taxing authorities. 

 

  

(25) Discontinued Operations

 

During the second quarter of 2012, following the guidance established under “ASC 360, Impairment and Disposal of Long-Lived Assets”, the Company committed to a plan to sell its Content Solutions Businesses which includes Digital Media Productions and its Sezmi business.

 

Digital Media Production Acquisition

 

On October 3, 2011, we acquired Digital Media Production a.s. (“DMP”), a Czech company with its principal office in Prague. A former competitor of Brickbox, DMP is engaged in multimedia video production with a focus on enterprise customers. We acquired DMP in exchange for $2,750 cash and 42,500 shares of our common stock valued at a price of $7.53 for a total of $320. The consideration also includes contingent consideration of $4,284 based upon meeting revenue and profit targets for the periods ending December 31, 2011, December 31, 2012 and December 31, 2013. We have allocated the aggregate cost of the acquisition to DMP’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net estimated fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

 

Current assets  $971 
Property and equipment   1 
Intangible assets - customer list   500 
Goodwill   6,289 
Total assets acquired   7,761 
      
Current liabilities   (265)
Deferred tax liability   (95)
Deferred revenue - long term   (41)
Other long-term liabilities   (6)
Total liabilities   (407)
      
Net assets acquired  $7,354 

 

20
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

During the second quarter of 2012, the Company decided to divest itself of the Content Solutions Businesses which include DMP, and therefore it has been recorded as discontinued operations. The Company has provided below the details of the components of the assets and liabilities held for sale as of December 31, 2011 for the Content Solutions Business. On June 26, 2012, the Company completed a sale of its Content Solutions Businesses to Netherlands-based Content Solutions International NV for $1,000 in cash and up to $18.8 million in earn-outs. Therefore, during the second quarter of 2012, the Company recorded a loss from disposal of approximately $15,462 and has provided a breakout of the loss from discontinued operations for the Content Solutions Businesses for the three and six months ended June 30, 2012 and 2011.

 

Sezmi Acquisition

 

On December 30, 2011, we acquired substantially all the assets and assumed certain liabilities of Sezmi Corporation (“Sezmi”), a Delaware corporation, pursuant to an Asset Purchase Agreement dated as of December 30, 2011. Headquartered in Belmont, CA, Sezmi is a leading global provider of broadband-broadcast hybrid TV solutions. Sezmi employs a cloud-based software-as-a-service model and its target customers are service operators, such as telecommunication companies and Internet service providers, as well as content providers who desire to provide licensed or owned video content to subscribers across mobile and Internet protocol (IP)-connected home entertainment devices. Total consideration was $7,850 in cash, the assumption of $16,525 in liabilities, $2,625 owed to the shareholders of Sezmi which will be issued in shares and held in escrow for a period of up to 12 months following the closing date. The excess of the aggregate cost of the acquisition over the net estimated fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

 

The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of acquisition.

 

Current assets  $138 
Property and equipment   400 
Software   1,000 
Goodwill   27,108 
Total assets acquired   28,646 
      
Current liabilities   1,646 
      
Net assets acquired  $27,000 

 

During the second quarter of 2012, the Company decided to divest itself of Sezmi and therefore it has been recorded as discontinued operations. The Company has provided below the details of the components of the assets and liabilities held for sale as of December 31, 2011 for Sezmi. On June 26, 2012, the Company completed the sale of Sezmi to Total Media for $2,950 to be paid in cash and has recorded a corresponding receivable as of June 30, 2012 which was subsequently received. Due to the divesture of Sezmi during the second quarter of 2012, the Company recorded a loss from disposal of approximately $28,578 and has provided a breakout of the loss from discontinued operations for the Sezmi business for the three and six months ended June 30, 2012 and 2011.

21
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

Assets and Liabilities of Discontinued Operations

 

At June 30, 2012, the assets of Sezmi and Content Solutions are presented separately on our consolidated balance sheet. The components of the assets of discontinued operations are as follows (in thousands):

 

   Discontinued Operations   Discontinued Operations for December 31, 2011 
   June 30, 
2012
   Content
Solutions
   SEZMI   Total 
   (unaudited)             
Assets held for sale:                
Cash and cash equivalents  $-   $1,432   $-   $1,432 
Accounts receivable, net   -    14,010    3,288    17,298 
Unbilled revenue   -    1,366    -    1,366 
Inventory, net   -    2    -    2 
Other current assets    -    840    -    840 
Current assets held for sale   -    17,650    3,288    20,938 
                     
Property and equipment, net   -    599    400    999 
Intangible assets   -    -    1,000    1,000 
Goodwill   -    5,061    27,108    32,169 
Long-term assets held for sale  $-   $5,660   $28,508   $34,168 
                     
Liabilities for sale:                    
Capital lease and other obligations, current portion  $-   $3   $-   $3 
Accounts payable   -    1,645    -    1,645 
Accrued expenses   -    376    -    376 
Deferred revenue   -    18    -    18 
Other current liabilities   -    2,381    6,870    9,251 
Current liabilities held for sale   -    4,423    6,870    11,293 
                     
Other long-term liabilities   -    2,939    -    2,939 
Long-term liabilities held for sale  $-   $2,939   $-   $2,939 

 

 

Results of Discontinued Operations

 

As Sezmi and Content Solutions represented a component of our business and its results of operations and cash flows can be separated from the rest of our operations, the results for the periods presented are disclosed as discontinued operations on the face of the consolidated statements of operations. Net revenues and (loss) from discontinued operations, net of tax, for the three months ended June 30, 2012 and 2011, and for the six months ended June 30, 2012 and 2011, respectively, are as follows (in thousands):

 

Discontinued Operations- Sezmi        
   Three months ended   Six months ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Revenue  $109   $-   $203   $- 
Net loss from operations   (4,310)   -    (7,880)   - 
Loss from Disposal    (28,578)   -    (28,578)   - 
Loss before provision for taxes from discontinued operations    (32,888)   -    (36,458)   - 
Provision for income taxes    -    -    -    - 
Net loss from discontinued operations   $(32,888)  $-   $(36,458)  $- 

 

Discontinued Operations- Content Solutions        
   Three months ended   Six months ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Revenue  $1,333   $3,236   $4,152   $6,899 
                     
Net income (loss) from operations   (156)   (822)   26    (1,415)
Loss from Disposal    (15,462)   -    (15,462)   - 
Loss before provision for taxes from discontinued operations    (15,618)   (822)   (15,436)   (1,415)
Provision for income taxes    -    -         - 
Net loss from discontinued operations   $(15,618)  $(822)  $(15,436)  $(1,415)

 

22
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

Discontinued Operations- Total        
   Three months ended   Six months ended 
   June 30,   June 30, 
   2012   2011   2012   2011 
Revenue  $1,442   $3,236   $4,355   $6,899 
                     
Net loss from operations   (4,466)   (822)   (7,854)   (1,415)
Loss from Disposal    (44,040)   -    (44,040)   - 
Loss before provision for taxes from discontinued operations    (48,506)   (822)   (51,894)   (1,415)
Provision for income taxes    -    -    -    - 
Net loss from discontinued operations   $(48,506)  $(822)  $(51,894)  $(1,415)

 

 

(26) Legal Matters

 

Other than as set forth below, we are not a party to any pending legal proceeding nor is our property the subject of a pending legal proceeding that is not in the ordinary course of business or otherwise material to the financial condition of our business.

  

In December 2007, two former consultants of ROO Media Corporation (ROO Media) (currently KIT Media Corporation) sued that entity together with ROO Group, Inc. (now KIT digital, Inc.) and its founder and former Vice Chairman and ROO Media’s former President and Chief Operating Officer in New York Supreme Court, New York County, New York, alleging breach of an oral employment agreement, fraudulent inducement and other claims relating to the plaintiffs’ employment at ROO Media. In March 2009, the court dismissed all of plaintiffs’ claims except their breach of contract claim on the grounds that it is based on an alleged oral agreement, which, according to the court, plaintiffs may be able to prove. In July 2011, following the completion of discovery, defendants made a motion for summary judgment dismissing the remaining claim in the case. By decision and order dated July 2, 2012, the court denied defendants’ motion. Trial was scheduled for July 23, 2012 but was adjourned to October 9, 2012. On August 9, 2012, defendants filed a motion for leave to reargue the court’s denial of their summary judgment motion, and oral argument on such motion has been scheduled for August 24, 2012. We believe that there is no merit to this suit and we intend to continue to defend vigorously.

 

In November 2007, our wholly-owned subsidiary, ROO HD, Inc., now KIT HD, Inc. (“KIT HD”), was named as the defendant in a purported class action lawsuit entitled Julie Vittengl et al. vs. ROO HD, Inc., in New York Supreme Court, Saratoga County, New York. The suit, brought by four former employees of Wurld Media, Inc. (“Wurld”), purportedly on behalf of themselves and “others similarly situated,” claims that KIT HD’s acquisition of certain assets of Wurld was a fraudulent conveyance and that KIT HD is the alter-ego of Wurld. Plaintiffs seek the appointment of a receiver to take charge of our property in constructive trust for plaintiffs and payment of plaintiffs’ unpaid wages and costs of suit, both in an unspecified dollar amount. KIT HD filed its answer to the complaint in January 2008. In December 2009, plaintiffs served an amended complaint, dropping the class action allegations and joined by 15 additional former employees of Wurld, added us as a defendants and purport to seek to enforce judgments plaintiffs had obtained against Wurld as the result of an arbitration against Wurld in March 2009. In February 2010, we and KIT HD answered the amended complaint, and the case is currently in discovery. We believe that the suit is without merit, and we and KIT HD intend to defend ourselves vigorously.

 

In May 2009, a former employee of Wurld filed suit against ten shareholders of Wurld, Wurld, ROO HD (now KIT HD), and ROO Group, Inc. (now KIT digital, Inc.), in New York Supreme Court, Albany County, New York. Plaintiff seeks to hold the ten largest shareholders of Wurld liable under Business Corporation Law §630, for $100 in wages that Wurld allegedly failed to pay plaintiff. She further asserts a variety of claims based on the allegation that KIT HD’s acquisition of certain assets of Wurld was a fraudulent conveyance, and that KIT HD is the successor to Wurld and liable for Wurld’s debts. Based on these allegations, plaintiff seeks payment of her wages, the (unspecified) fair market value of her shares of stock in Wurld, rescission of the asset purchase agreement between Wurld and KIT HD, plus attorney’s fees. In October 2009, the court dismissed plaintiff's claims against three shareholder/defendants on the grounds that BCL §630 does not apply to Wurld because it is not a New York corporation, a decision that plaintiff unsuccessfully appealed. Consequently, all of plaintiff’s claims against the Wurld shareholder defendants are, or will be, finally dismissed; and this case should move into the discovery phase with respect to plaintiff’s claims against us and KIT HD. We and KIT HD have been served and answered. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

23
 

 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts in Thousands, Except Share and Per Share Data)

(Unaudited)

 

 

On May 29, 2012, McHardy, a shareholder, filed a purported securities class action complaint against the Company and certain former executive officers alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder in connection with purchases of our common stock between November 8, 2011 and May 3, 2012.  The complaint alleges, among other things, that certain prior statements regarding the Company’s past and expected future results of operations were false and misleading. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

On July 13, 2012, Stephen Conrad, through Pershing LLC, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and other misconduct from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

On July 18, 2012, Venkata, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and in connection with prior statements regarding the Company’s past and expected future results of operations from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

The Company and its former chairman and chief executive officer have been responding to SEC subpoenas seeking, in general, documents related to June 2010 transactions in Company common stock and a related Form 4 filing by our former chairman and chief executive officer that reported a purchase of 54,745 shares of Company common stock, as well as certain emails that may have been deleted from his computer but were maintained in the Company’s system.  We are cooperating with the SEC in its investigation, however, we cannot be certain of the scope or outcome of the investigation.  Also, we have disagreements with our former chairman and chief executive officer concerning amounts purportedly owed him under arrangements entered into prior to his departure from those roles earlier this year.  It is uncertain whether those disagreements will be resolved or whether litigation may be filed.

 

The Audit Committee of our Board of Directors has retained independent professional advisors in connection with an investigation it is directing in respect of certain transactions that gave rise to impairments that have been taken by the Company as well as some of the foregoing issues.

24
 

  

ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Amounts in Thousands, Except Share and Per Share Data)

 

Overview

 

Through our operating subsidiaries, we are in the business of providing software solutions that enable our customers to manage and distribute video content through Internet websites, mobile and tablet devices and both closed network Internet Protocol television (“IPTV”) and over-the-top (“OTT”) connected television environments. Our core video asset management software suite, marketed under the “KIT Platform” brand (and “KIT Cosmos” and “KIT Cloud” sub-brands), includes online and mobile video players, ingestion and trans-coding for Internet and mobile connected devices, live and video-on-demand OTT and IPTV video serving, editing and content transformation, content meta-tagging, content localization and syndication, digital rights management, hosting, storage, content delivery and content syndication. We currently provide IP video solutions internationally through over 20 offices globally, including principal locations in Atlanta, Beijing, Boston, Chennai, Cologne, Delhi, Dubai, Ely (UK), Grenoble (France), London, Madrid, Melbourne (Australia), Mumbai, New York, Paris, Prague, San Francisco, Singapore, and Sydney. In support of our KIT Platform deployments, we provide systems integration, broadcast engineering services, content transformation services and integrated marketing services.

  

Set forth below is a discussion of the financial condition and results of operations of KIT digital, Inc. and its consolidated subsidiaries (collectively, “we,” “us” or “our”), for the three and six months ended June 30, 2012 and 2011. The following discussion should be read in conjunction with the information set forth in the consolidated financial statements and the related notes thereto appearing elsewhere in this report.

 

Critical Accounting Policies and Estimates

 

The policies discussed below are considered by our management to be critical to an understanding of our financial statements because their application places the most significant demands on our management’s judgment, with financial reporting results relying on our estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies are described below. For these policies, we caution that future events rarely develop as forecast, and that best estimates may routinely require adjustment.

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make judgments and estimates. On an ongoing basis, we evaluate our estimates, the most significant of which include establishing allowances for doubtful accounts and determining the recoverability of our long-lived tangible and intangible assets. The basis for our estimates are historical experience and various assumptions that are believed to be reasonable under the circumstances, given the available information at the time of the estimate, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. We caution that future events rarely develop as forecast, and that best estimates may routinely require adjustment. Actual results may differ from the amounts estimated and recorded in our financial statements.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

 

Revenue Recognition.  We recognize revenue in accordance with the accounting standard, which requires that four basic criteria be met before revenue can be recognized: (i) persuasive evidence that an arrangement exists; (ii) the price is fixed or determinable; (iii) collectability is reasonably assured; and (iv) product delivery has occurred or services have been rendered. We recognize revenue, net of sales taxes assessed by any governmental authority. Our material revenue streams are related to the delivery of IP video software solutions, including software-as-a-service (“SaaS”) fees, software usage fees, enterprise license fees, set-up/support services, storage, hardware components, content delivery and content syndication. Our solutions also include technical integration services, interface design, branding, strategic planning, creative production, online marketing, media planning and analytics. We enter into revenue arrangements that may consist of multiple deliverables of components and services due to the needs of its customers. In addition to these general revenue recognition criteria, the following specific revenue recognition policies are followed:

 

Multiple-Element Arrangements — Arrangements with customers may include multiple deliverables, including any combination of hardware components, software and services and make up less than 10% of our revenue arrangements. For our multiple-element arrangements, deliverables are separated into more than one unit of accounting when (i) the delivered element(s) have value to the customer on a stand-alone basis, and (ii) delivery of the undelivered element(s) is probable and substantially in our control. Based on the new accounting guidance adopted July 1, 2010 and applied retrospectively to January 1, 2010, revenue is then allocated to each unit of accounting based on the estimated selling price determined using a hierarchy of evidence based first on Vendor-Specific Objective Evidence (“VSOE”) if it exists, based next on Third-Party Evidence (“TPE”) if VSOE does not exist, and finally, if both VSOE and TPE do not exist, based on best estimate of selling price (“BESP”). The general timing of the delivery of components and performance of services within our multiple-element arrangements are completed within three to six months of commencement. Our arrangements generally do not include any provisions for cancellation, termination, or refunds that would impact recognized revenue.

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We determine BESP for a deliverable in a multiple element arrangement by collecting all reasonably available data points including sales, cost and margin analysis of the product, and other inputs based on our normal pricing practices. We have experience selling components, installation and integration services at a standard combined price and consider this to be BESP when contracting with customers. The determination of BESP is a formal process within our company that includes review and approval by our management.

 

After determination of the estimated selling price of each deliverable in a multiple-element arrangement, the arrangement consideration is then allocated using the relative selling price method. Under the relative selling price method, the estimated selling price for each deliverable is compared to the sum of the estimated selling price for all deliverables. The percentage that is calculated for each deliverable is then multiplied by the total contractual value of the multiple-element arrangement to determine the revenue allocated to each deliverable.

 

The revenue allocated to each deliverable will then be recorded in accordance with existing revenue recognition guidance for stand-alone component sales and services.

 

Services — Revenue for services is generally recognized when the contractually required services have been delivered and approved by the customer.

 

Software – Software revenue is recognized separately if it has stand-alone value, works on customer available hardware and does not require any significant production, modification or customization. When the software does require significant production, modification or customization, the revenue is recognized when the software and modifications are delivered and accepted. Delivery constitutes the customer having access to the software and evidence of acceptance from the customer. If the software is available on-line or delivered electronically, evidence may also include the provision of authorization codes for use.

 

Hardware Components — For hardware component sales (one deliverable only), revenue recognition generally occurs when products or equipment have been shipped, risk of loss has transferred to the customer, objective evidence exists that customer acceptance provisions have been met, no significant obligations remain and an allowance for discounts, returns and customer incentives can be reliably estimated. If software is delivered as an integral functional part of the hardware then the revenue for the hardware and software is recognized as a single unit of revenue. Recorded revenues are reduced by these allowances. We base our estimates of these allowances on historical experience taking into consideration the type of products sold, the type of customer and the specific type of transaction in each arrangement.

 

Allowance for Doubtful Accounts.  We maintain an allowance for doubtful accounts based on the expected collectability of our accounts receivable, which requires a considerable amount of judgment in assessing the creditworthiness of customers and related aging of past due balances. The allowance for doubtful accounts as of June 30, 2012 and December 31, 2011 was $2,821 and $2,943, respectively. Charges for bad debts recorded on the statement of operations for the three and six months ended June 30, 2012 was $5,067 and $7,027, respectively. Included in the three months June 30, 2012, the Company recorded a write-off for approximately $6,490 related to certain receivables the Company has determined are no longer collectible. For the three and six months June 30, 2011, bad debt expense was $250 and $1,255, respectively. Based on historical information, we believe that our allowance is adequate. Changes in general economic, business and market conditions could result in an impairment in the ability of our customers to make their required payments, which would have an adverse effect on cash flows and our results of operations.

 

Impairment of Goodwill. We evaluate the carrying value of our goodwill annually at the end of December and whenever events or circumstances make it more likely than not that an impairment may have occurred. Accounting standard on Goodwill and Other Intangible Assets, prescribes a two-step method for determining goodwill impairment. In the first step, we compare the estimated fair value of each reporting unit to its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the estimated fair value, step two is completed to determine the amount of the impairment loss. Step two requires the allocation of the estimated fair value of the reporting unit to the assets, including any unrecognized intangible assets, and liabilities in a hypothetical purchase price allocation. Any remaining unallocated fair value represents the implied fair value of goodwill, which is compared to the corresponding carrying value of goodwill to compute the goodwill impairment amount.

 

 As part of our impairment analysis for each reporting unit, we estimate the fair value of each unit utilizing the income approach and market approach. The income approach requires management to estimate a number of factors for each reporting unit, including projected future operating results, economic projections, anticipated future cash flows, discount rates, and the allocation of shared service or corporate items. The market approach was used as a test of reasonableness of the conclusions reached in the income approach. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry grouping.

 

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in each business combination. During the second quarter ended June 30, 2012, our market capitalization declined significantly. As this measure is our significant indicator of the fair value of our business unit, management considered this decline to be a triggering event, requiring us to perform an interim impairment analysis. As of June 30, 2012, we completed this interim analysis and our management has concluded that an impairment charge of $55,718 should be recognized. This is a noncash charge and has been recorded in the second quarter ended June 30, 2012. As of December 31, 2011, approximately $32,169 of goodwill was part of discontinued operations and is included in long-term assets held for sale

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The determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within those reporting units requires management to make significant estimates and assumptions. These estimates and assumptions primarily include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions in the industries in which we compete; the discount rate; terminal growth rates; and forecasts of net sales, operating income, depreciation and amortization and capital expenditures. Although we believe our estimates of fair value are reasonable, actual financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes in assumptions concerning future financial results or other underlying assumptions could have a significant impact on the fair value of the reporting units.

 

 

Long-Lived Assets.  Long-lived assets, including property, plant and equipment, and intangible assets with determinable lives, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be fully recoverable. An impairment is assessed if the undiscounted expected future cash flows generated from an asset are less than its carrying amount. Impairment losses are recognized for the amount by which the carrying value of an asset exceeds its fair value. The estimated useful lives of all long-lived assets are periodically reviewed and revised if necessary.

 

 

Results of Operations - Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011

 

Revenue. Consolidated revenue increased by $6,197 from $44,952 for the three months ended June 30, 2011 to $51,149 for the three months ended June 30, 2012, an increase of approximately 14%. This increase was primarily due to increased spending by existing customers, an increase in customers and revenue from the acquired companies not included in prior period results. In 2012, our average monthly revenue per client increased, reflecting the company’s focus on higher-end opportunities in the market and large, multi-year contracts in emerging geographies. The primary contributors to inorganic growth in 2012 over 2011 were the acquisitions of ioko, Megahertz and Polymedia.

 

Variable and Direct Third Party Costs

 

Cost of Goods and Services (Exclusive of Depreciation shown separately below). These costs increased by $6,613 from $9,799 for the three months ended June 30, 2011 to $16,412 for the three months ended June 30, 2012, an increase of approximately 67%. These costs represent the costs of equipment and services for the supply of digital media and IPTV solutions, services and components. The increase was primarily due to the timing of the sale of services for the supply of digital media solutions, services and components in the three months ended June 30, 2012. These costs will increase in 2012 due to the increase in the sale of services for the supply of digital media solutions, services and components..

 

Hosting, Delivery, Reporting and Content Costs. These costs increased by $464 from $2,650 for the three months ended June 30, 2011 to $3,114 for the three months ended June 30, 2012, an increase of approximately 18%. These costs increased primarily due to the increase in revenue over 2011 and costs relating to the acquisition of ioko in May 2011 for hosting, delivery and reporting. We expect these costs to decrease as an overall percentage of revenue through the continued consolidation of our data centers and price negotiations with our content delivery providers due to our increased size and bargaining power.

 

Direct Third Party Creative Production Costs. Direct third party creative production costs increased by $79 from $317 for the three months ended June 30, 2011 to $396 for the three months ended June 30, 2012, an increase of 25% attributable to an increase in revenue requiring creative production costs.

 

General and Administrative Expenses

 

Compensation, Travel and Associated Costs (Including Non-Cash Stock-Based Compensation). These costs increased by $23,715 from $21,108 for the three months ended June 30, 2011 to $44,823 for the three months ended June 30, 2012, an increase of approximately 112%.  The increase was primarily due to the acquisitions in 2011, increase in non-cash stock based compensation and increase in consulting fees which was offset in part by continuing cost cutting measures as we integrated the acquired businesses. Non-cash stock-based compensation expense increased by 88% or $3,870 to $8,254 for the three months ended June 30, 2012, from $4,384 for the three months ended June 30, 2011. This increase in non-cash stock based compensation is primarily driven by expenses incurred as part of certain executive termination. 

 

Legal, Accounting, Audit and Other Professional Services Fees. These expenses increased by $2,985 from $767 for the three months ended June 30, 2011 to $3,752 for the three months ended June 30, 2012, an increase of over 300%. These costs increased primarily due to increases in legal fees in association with litigation, board and executive restructurings, and audit fees combined with an overall increase in these expenses from the acquisitions.

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Office, Marketing and Other Corporate Costs. These expenses increased by $7,310 from $4,405 for the three months ended June 30, 2011 to $11,715 for the three months ended June 30, 2012, an increase of 165%.  The increase was primarily due to a write-off of bad debt for items determined to be no longer collectible for approximately $6,490 during second quarter of 2012 and an increase in offices and related facility costs through acquisitions.

 

Merger and Acquisition Related Expenses. Merger and acquisition related expenses decreased by $13,157 from $10,916 for the three months ended June 30, 2011 to a credit of $2,241 for the three months ended June 30, 2012, a decrease of approximately 120%. The decrease was primarily due to the significant acquisitions in the three months ended June 30, 2011 as compared to one in the three months ended June 30, 2012. Included in the three months ended June 30, 2012 are reversals of approximately $3,995 for previously recorded earn-outs which will no longer be achieved.

 

Depreciation and Amortization. Depreciation and amortization expense increased by $1,098 from $3,096 for the three months ended June 30, 2011 to $4,194 for the three months ended June 30, 2012, an increase of 36%. The increase was primarily due to the acquisitions in 2011. We expect these costs to remain relatively stable for the rest of 2012.

 

Restructuring Charges. Restructuring charges was $3,349 for the three months ended June 30, 2011. These charges reflect the 2012 plan that was initiated in the second quarter of 2012 and consists primarily of employee termination costs. Restructuring charges in the three months ended June 30, 2012 were minimal.

 

Impairment of Goodwill. During the three months ended June 30, 2012, the Company recorded an impairment of goodwill of approximately $55,718. This charge was based on the results of the Company’s interim impairment test performed during the second quarter of 2012 as the Company experienced a significant decrease in the market price of its shares.

 

Integration Expenses. Integration expenses were $9,710 for the three months ended June 30, 2011. There were no integration charges for the three months ended June 30, 2012. Integration expenses in 2011 consisted of cost overlap due to the integration of acquisitions.

  

Interest Expense. Interest expense increased by $820 from $383 for the three months ended June 30, 2011 to $1,203 for the three months ended June 30, 2012, an increase of 214%. This increase was mainly due to the issuance of secured notes in May 2011.

 

Derivative Income (Expense). Derivative expense was $3,173 for the three months ended June 30, 2012 as compared to derivative income of $433 for the three months ended June 30, 2011. Derivative income or expense is the change in the period based on the fair value of warrants containing reset provisions. 

 

 Other Income/(Expense). Other income/(expense) changed by $8,955 from $378 in other expense for the three months ended June 30, 2011 to other expense of $9,333 for the three months ended June 30, 2012. This majority of this increase relates to the receivable reserve recorded of approximately $6,432 against the receivable from the 2010 sale of subsidiary, $1,200 charge related to the write-down of investments and approximately $1,435 expense related to a share price guaranteed to be issued related to acquisitions.

 

 Income Tax Income/(Expense). Income tax income/(expense) changed by $2,115 from $796 expense in the three months ended June 30, 2011 to a benefit of $1,319 for the three months ended June 30, 2012. This tax benefit is primarily driven by the reversal of deferred tax liabilities from acquisition related intangibles. Prior period’s tax expense relates to estimated tax payments for state and local.

 

Loss from Discontinued Operations. Loss from the discontinued operations for the three months ended June 30, 2012 totaled $48,506 which is comprised of the activity from the divesture of Sezmi and Content Solutions. Sezmi’s loss from operations for the period total $4,310 and a loss of $28,578 from disposal. Content Solutions divesture includes a loss from operations of $156 and a loss from disposal of $15,462. During the three months ended June 30, 2011, the $822 loss related primarily from loss from operations from the Content Solutions Business. The Sezmi acquisition did not occur until December 2011.

 

Net Loss. As a result of the factors described above, we reported net loss available to common shareholders of $151,082 for the three months ended June 30, 2012 compared to a net loss available to common shareholders of $19,803 for the three months ended June 30, 2011.

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Results of Operations - Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011

 

Revenue. Consolidated revenue increased by $31,528 from $75,739 for the six months ended June 30, 2011 to $107,267 for the six months ended June 30, 2012, an increase of approximately 42%. This increase was primarily due to increased spending by existing customers, an increase in customers and revenue from the acquired companies not included in prior period results. In 2012, our average monthly revenue per client increased, reflecting the company’s focus on higher-end opportunities in the market and large, multi-year contracts in emerging geographies. The primary contributors to inorganic growth in 2012 over 2011 were the acquisitions of ioko, Megahertz and Polymedia.

 

Variable and Direct Third Party Costs

 

Cost of Goods and Services (Exclusive of Depreciation shown separately below). These costs increased by $15,431 from $17,841 for the six months ended June 30, 2011 to $33,272 for the six months ended June 30, 2012, an increase of approximately 86%. These costs represent the costs of equipment and services for the supply of digital media and IPTV solutions, services and components. The increase was primarily due to the timing of the sale of services for the supply of digital media solutions, services and components in the six months ended June 30, 2012. These costs will increase in 2012 due to the increase in the sale of services for the supply of digital media solutions, services and components.

 

Hosting, Delivery, Reporting and Content Costs. These costs increased by $2,320 from $3,883 for the six months ended June 30, 2011 to $6,203 for the six months ended June 30, 2012, an increase of approximately 60%. These costs increased primarily due to the increase in revenue over 2011 and costs relating to the acquisition of ioko in May 2011 for hosting, delivery and reporting. We expect these costs to decrease as an overall percentage of revenue through the continued consolidation of our data centers and price negotiations with our content delivery providers due to our increased size and bargaining power.

 

Direct Third Party Creative Production Costs. Direct third party creative production costs increased by $331 from $682 for the six months ended June 30, 2011 to $1,013 for the six months ended June 30, 2012, an increase of 49% attributable to an increase in revenue requiring creative production costs.

 

 

General and Administrative Expenses

 

Compensation, Travel and Associated Costs (Including Non-Cash Stock-Based Compensation). These costs increased by $51,957 from $32,443 for the six months ended June 30, 2011 to $84,400 for the six months ended June 30, 2012, an increase of approximately 160%.  The increase was primarily due to the acquisitions in 2011, increase in non-cash stock based compensation, consulting fees and by non-cash stock-based compensation expense, which was offset in part by continuing cost cutting measures as we integrated the acquired businesses and some of these costs were included in integration expenses. Non-cash stock-based compensation expense increased by 143% or $9,147 to $15,557 for the six months ended June 30, 2012, from $6,410 for the six months ended June 30, 2011. This increase in non-cash stock based compensation is primarily driven by expenses incurred as part of certain executive termination.

 

Legal, Accounting, Audit and Other Professional Services Fees. These expenses increased by $3,191 from $1,344 for the six months ended June 30, 2011 to $4,535 for the six months ended June 30, 2012, an increase of over 200%. These costs increased primarily due to increases in legal fees in association with litigation, board and executive restructurings, and audit fees combined with an overall increase in these expenses from the acquisitions.

 

Office, Marketing and Other Corporate Costs. These expenses increased by $10,784 from $8,145 for the six months ended June 30, 2011 to $18,929 for the six months ended June 30, 2012, an increase of approximately 132%.  The increase was primarily due to a write-off of bad debt for items determined to be no longer collectible for approximately $6,490 during second quarter of fiscal 2012 and an increase in offices and related facility costs through acquisitions.

 

Merger and Acquisition Related Expenses. Merger and acquisition related expenses decreased by $13,917 from $16,166 for the six months ended June 30, 2011 to $2,249 for the six months ended June 30, 2012, a decrease of approximately 86%. The decrease was primarily due to the significant acquisitions in the six months ended June 30, 2011 as compared to one in the six months ended June 30, 2012. are reversals of approximately $3,995 for previously recorded earn-outs which will no longer be achieved.  

 

Depreciation and Amortization. Depreciation and amortization expense increased by $2,885 from $5,469 for the six months ended June 30, 2011 to $8,354 for the six months ended June 30, 2012, an increase of approximately 53%. The increase was primarily due to the acquisitions in 2011. We expect these costs to remain relatively stable for the rest of 2012.

 

Restructuring Charges. Restructuring charges was $3,349 for the six months ended June 30, 2012. These charges reflect the 2012 plan that was initiated in the second quarter of 2012 and consists primarily of employee termination costs. Restructuring charges in the six months ended June 30, 2011 of $3,352 relates to restructuring plans initiated in the first quarter of 2011.

 

Impairment of Goodwill. During the six months ended June 30, 2012, the Company recorded an impairment of goodwill of approximately $55,718. This charge was based on the results of the Company’s interim impairment test performed during the second quarter of 2012 as the Company experienced a significant decrease in the market price of its shares.

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Integration Expenses. Integration expenses was $18,398 for the six months ended June 30, 2011. There were no integration charges for the six months ended June 30, 2012. Integration expenses in 2011 consisted of cost overlap due to the integration of acquisitions.

  

Interest Expense. Interest expense increased by $1,256 from $636 for the six months ended June 30, 2011 to $1,892 for the six months ended June 30, 2012, an increase of 197%. This increase was mainly due to the issuance of secured notes in May 2011.

 

Derivative Income (Expense). Derivative expense was $2,986 for the six months ended June 30, 2012 as compared to derivative income of $3,042 for the six months ended June 30, 2011. Derivative income or expense is the change in the period based on the fair value of warrants containing reset provisions. Derivative income or expense is the change in the period based on the fair value of warrants containing reset provisions.

 

 Other Income/(Expense). Other income/(expense) changed by $9,089 from $448 in other expense for the six months ended June 30, 2011 to other expense of $9,537 for the six months ended June 30, 2012 This majority of this increase relates to the receivable reserve recorded of approximately $6,432 against the receivable from the 2010 sale of subsidiary, $1,200 charge related to the write-down of investments and approximately $1,435 expense related to a share price guaranteed to be issued related to acquisitions.

 

 Income Tax Income/(Expense). Income tax income/(expense) changed by $2,169 from $910 expense in the six months ended June 30, 2011 to a benefit of $1,259 for the six months ended June 30, 2012. This tax benefit is primarily driven by the reversal of deferred tax liabilities from acquisition related intangibles. Prior period’s tax expense relates to estimated tax payments for state and local.

 

Loss from Discontinued Operations. Loss from the discontinued operations for the three months ended June 30, 2012 totaled $51,894 which is comprised the activity from the divesture of Sezmi and Content Solutions. Sezmi’s loss from operations for the period total $7,880 and a loss of $28,578 from disposal. Content Solutions divesture includes income from operations of $26 and a loss from disposal of $15,462. During the six months ended June 30, 2011, the $1,415 loss relates primarily from loss from operations from the Content Solutions Business. The Sezmi acquisition did not occur until December 2011.

 

Net Loss. As a result of the factors described above, we reported net loss available to common shareholders of $175,961 for the six months ended June 30, 2012 compared to a net loss available to common shareholders of $32,304 for the six months ended June 30, 2011.

 

  

  

 Liquidity and Capital Resources

 

As of June 30, 2012, we had cash and cash equivalents of $30,562 and working capital deficit of approximately $12,572. Excluding the current portions of derivatives liabilities and the current portion of acquisition liabilities as the majority will not be paid in cash but in the Company’s common stock, working capital would have been $32,848. Management anticipates that it has enough cash reserves and cash flows from its operating activities to be sufficient to fund its operations, anticipated capital expenditures and debt repayment obligations for at least the next 12 months.

 

On May 15, 2012, the Company entered into a definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting placement agents’ fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares of the Company’s common stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May 17, 2012) with an effective strike price of $5.00. After deducting the fees of the placement agent and other estimated offering expenses, the net proceeds to the Company from the private placement were approximately $27,174.

 

During the six months ended June 30, 2012 and in conjunction with this share issuance, the Company record a liability of approximately $10,512 representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the stock purchase agreement. This amount consists of approximately 2,588,408 shares and approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 14 and 16.

 

The warrants issued as part of the Securities Purchase Agreement contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair value. On May 17, 2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in capital.

 

The Warrants were valued using a Monte Carlo simulation model at $14,333.

 

As of June 30, 2012, we were in compliance with our debt covenants on all of our secured notes payable.

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Our ability to meet our short and long-term liquidity needs depends on our future operating performance and on economic, financial, competitive and other factors. See “Risks Related to Our Business” under Item 1A. Risk Factors in our 2011 Form 10-K for more detail. Our financial projections are based on assumptions, which we believe are reasonable but contain significant uncertainties. These projections include an increase in revenue, improved operating margins and significant decreases in costs related to the restructuring and integration of acquired companies.

 

Net cash used by continuing operating activities was $17,020 for the six months ended June 30, 2012, compared to $10,184 for the six months ended June 30, 2011, a decrease of $6,836. This was primarily due the increased net loss in the period as opposed to the prior period offset by non-cash charges and funding from working capital in period. Net used by discontinued operating activities increase to $8,116 from a use of $1,075 due to the cash support need to support the Sezmi operations during the six months ended June 30, 2012. Sezmi was not purchased until December 2011 and had no effect during the six months ended June 30, 2011.

 

Net cash used by continuing investing activities was $7,783 for the six months ended June 30, 2012, compared to $111,944 for the six months ended June 30, 2011, a decrease in net cash used in investing activities of $104,161. The decrease in net cash used in investing activities was primarily attributable to the decrease in cash paid in acquisitions in 2012 of $114,781. Net cash used by discontinued investing activities was minimal in each period.

 

Net cash from continuing financing activities was $18,983 for the six months ended June 30, 2012, compared to net cash from continuing financing activities of $17,677 for the six months ended June 30, 2011. The increase is due to the issuance of equity of approximately $27,173 offset by payments of notes in the period as opposed to proceeds from the secured notes in 2011 of $15,000. Net cash used by discontinued financing activities was minimal in each period.

 

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, results of operations, liquidity or capital expenditures.

 

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

 

This Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”).  We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the United States Private Securities Litigation Reform Act of 1995.  All statements, other than statements of historical facts, included in this Form 10-Q regarding our strategy, future operations, financial position, future revenues, projected costs, prospects, plans and objectives of management are forward-looking statements.  The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We cannot guarantee that we actually will achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements.  There are a number of important factors that could cause our actual results to differ materially from those indicated by these forward-looking statements.  These important factors include risks related to our history of net losses and accumulated deficits, integration of acquired businesses, future capital requirements, competition and technological advances, dependence on the market for digital advertising, and other factors that we identify in this Form 10-Q and in other filings we make with the SEC.  For additional factors that can affect these forward-looking statements, see the “Risk Factors” section in our Annual Report on Form 10-K for the year ended December 31, 2011.  You should read these factors and other cautionary statements made in this Form 10-Q as being applicable to all related forward-looking statements wherever they appear in the Form 10-Q.  Except to the extent required by federal securities laws, we do not assume any obligation to update any forward-looking statements made by us.

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 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

We conduct our operations in primary functional currencies: the United States dollar, the Euro, the British pound, the Czech koruna, the Australian dollar, the Indian rupee and the Swedish krona We currently do not hedge any of our foreign currency exposures and are therefore subject to the risk of exchange rate fluctuations.

 

However, we attempt to employ a “natural hedge” by matching as much as possible in like currencies our customer revenues with associated customer delivery costs. We invoice our international customers primarily in U.S. dollars, British pounds, Australian dollars and Euros. 

 

We are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars in consolidation and as our foreign currency consumer receipts are converted into U.S. dollars. Our exposure to foreign exchange rate fluctuations also arises from payables and receivables to and from our foreign subsidiaries, vendors and customers.

 

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and trade accounts receivable. We endeavor to place our cash and cash equivalents with high credit quality institutions to limit credit exposure. We have obtained callable cash collateral wherever we have identified credit risk exists with respect to these investments.

 

Concentrations of credit risk with respect to trade accounts receivable are limited due to the wide variety of our customers who are dispersed across many geographic regions. We routinely assess the financial strength of customers and, based upon factors concerning credit risk, we establish an allowance for uncollectible accounts. Our management believes that accounts receivable credit risk exposure beyond such allowance is limited.

 

ITEM 4. CONTROLS AND PROCEDURES.

 

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are still not effective with respect to the material weakness disclosed in our 2011 Form 10-K to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (1) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure; and (2) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

 

Changes in Internal Control Over Financial Reporting

 

There was no change to our internal controls or in other factors that could affect these controls during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

Status of Remediation Efforts

 

 Prior to the filing date of this Form 10-Q, we have undertaken and completed the following activities as part of our remediation plan for the Material Weakness disclosed in our 2011 Form 10-K filing. Items completed include:

 

  · Hired a new Chief Financial Officer with extensive technology and software public company experience.

 

  · Hired a new Regional Finance Director with extensive US GAAP and SEC experience to bolster regional finance oversight.

 

  · Established an internal audit function and hired a Director of Internal Audit.

 

  · Hired a new Corporate Controller with extensive US GAAP and SEC experience.

 

  · Appointed a “Big-4” accounting/consulting firm to provide best practices and remediation assistance.

 

  · Selected HSBC as our global financial service provider to support our regional and corporate cash management and pooling functions.

 

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Items undertaken and in progress include:

 

  · Continued recruiting and hiring of both senior and support finance personnel trained in US GAAP.

 

  · Improvements and enhancements of senior level disclosure reviews including the establishment of an internal disclosure committee
     
  · Planning and performing risk-based audits and walk-throughs of regional/local controls and procedures.

 

  · Updating and enhancing the documentation and training of regional/local finance personnel about US GAAP reporting and compliance.

 

  · Enhancing corporate reviews of material balances and estimates from regional/local offices.

 

  · Continue to work with previously appointed “Big-4” accounting/consulting firm in improving on the Company’s controls and remediation efforts.

 

 

Management is committed to aggressively remediating and strengthening our internal controls in order to remediate the material weakness reported in our 2011 Form 10-K.

 

 

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PART II - OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS.

 

Other than as set forth below, we are not a party to any pending legal proceeding or is any of our property the subject of a pending legal proceeding that is not in the ordinary course of business or is otherwise material to the financial condition of our business.

  

In December 2007, two former consultants of ROO Media Corporation (ROO Media) (currently KIT Media Corporation) sued that entity together with ROO Group, Inc. (now KIT digital, Inc.) and its founder and former Vice Chairman and ROO Media’s former President and Chief Operating Officer in New York Supreme Court, New York County, New York, alleging breach of an oral employment agreement, fraudulent inducement and other claims relating to the plaintiffs’ employment at ROO Media. In March 2009, the court dismissed all of plaintiffs’ claims except their breach of contract claim on the grounds that it is based on an alleged oral agreement, which, according to the court, plaintiffs may be able to prove. In July 2011, following the completion of discovery, defendants made a motion for summary judgment dismissing the remaining claim in the case. By decision and order dated July 2, 2012, the court denied defendants’ motion. Trial was scheduled for July 23, 2012 but was adjourned to October 9, 2012. On August 9, 2012, defendants filed a motion for leave to reargue the court’s denial of their summary judgment motion, and oral argument on such motion has been scheduled for August 24, 2012. We believe that there is no merit to this suit and we intend to continue to defend it vigorously.

 

In November 2007, our wholly-owned subsidiary, ROO HD, Inc., now KIT HD, Inc. (“KIT HD”), was named as the defendant in a purported class action lawsuit entitled Julie Vittengl et al. vs. ROO HD, Inc. in New York Supreme Court, Saratoga County, New York. The suit, brought by four former employees of Wurld Media, Inc. (“Wurld”), purportedly on behalf of themselves and “others similarly situated,” claims that KIT HD’s acquisition of certain assets of Wurld was a fraudulent conveyance and that KIT HD is the alter-ego of Wurld. Plaintiffs seek the appointment of a receiver to take charge of our property in constructive trust for plaintiffs and payment of plaintiffs’ unpaid wages and costs of suit, both in an unspecified dollar amount. KIT HD filed its answer to the complaint in January 2008. In December 2009, plaintiffs served an amended complaint, dropping the class action allegations and joined by 15 additional former employees of Wurld, added us as a defendants and purport to seek to enforce judgments plaintiffs had obtained against Wurld as the result of an arbitration against Wurld in March 2009. In February 2010, we and KIT HD answered the amended complaint, and the case is currently in discovery. We believe that the suit is without merit, and we and KIT HD intend to defend ourselves vigorously.

 

In May 2009, a former employee of Wurld filed suit against ten shareholders of Wurld, ROO HD (now KIT HD), and ROO Group, Inc. (now KIT digital, Inc.) in New York Supreme Court, Albany County, New York. Plaintiff seeks to hold the ten largest shareholders of Wurld liable under Business Corporation Law §630, for $100 in wages that Wurld allegedly failed to pay plaintiff. She further asserts a variety of claims based on the allegation that KIT HD’s acquisition of certain assets of Wurld was a fraudulent conveyance, and that KIT HD is the successor to Wurld and liable for Wurld’s debts. Based on these allegations, plaintiff seeks payment of her wages, the (unspecified) fair market value of her shares of stock in Wurld, rescission of the asset purchase agreement between Wurld and KIT HD, plus attorney’s fees. In October 2009, the court dismissed plaintiff's claims against three shareholder/defendants on the grounds that BCL §630 does not apply to Wurld because it is not a New York corporation, a decision that plaintiff unsuccessfully appealed. Consequently, all of plaintiff’s claims against the Wurld shareholder defendants are, or will be, finally dismissed; and this case should move into the discovery phase with respect to plaintiff’s claims against us and KIT HD. We and KIT HD have been served and answered. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

On May 29, 2012, McHardy, a shareholder, filed a purported securities class action complaint against the Company and certain former executive officers alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder in connection with purchases of our common stock between November 8, 2011 and May 3, 2012.  The complaint alleges, among other things, that certain prior statements regarding the Company’s past and expected future results of operations were false and misleading. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

On July 13, 2012, Stephen Conrad, through Pershing LLC, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and other misconduct from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

 

On July 18, 2012, Venkata, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and in connection with prior statements regarding the Company’s past and expected future results of operations from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

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The Company and its former chairman and chief executive officer have been responding to SEC subpoenas seeking, in general, documents related to June 2010 transactions in Company common stock and a related Form 4 filing by our former chairman and chief executive officer that reported a purchase of 54,745 shares of Company common stock, as well as certain emails that may have been deleted from his computer but were maintained in the Company’s system.  We are cooperating with the SEC in its investigation, however, we cannot be certain of the scope or outcome of the investigation.  Also, we have disagreements with our former chairman and chief executive officer concerning amounts purportedly owed him under arrangements entered into prior to his departure from those roles earlier this year.  It is uncertain whether those disagreements will be resolved or whether litigation may be filed.

 

The Audit Committee of our Board of Directors has retained independent professional advisors in connection with an investigation it is directing in respect of certain transactions that gave rise to impairments that have been taken by the Company as well as some of the foregoing issues.

 

ITEM 1A. RISK FACTORS.

 

 

You should carefully consider the risks and uncertainties described below, as well as other information provided to you in this report, including information at the beginning of this document entitled “Special Note Regarding Forward-Looking Information,” and in other documents that we subsequently file with the SEC that update, supplement or supersede such information. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties not presently known to us or which we consider immaterial based on information currently available to us may also materially adversely affect us. If any of the events anticipated by the risks and uncertainties described occur, our results of operations and financial condition could be adversely affected, which could result in a decline in the market price of our common stock.

 

Risks Related to Our Business

 

We have a history of net losses which may continue and which may negatively impact our ability to achieve our business objectives.

 

For the six months ended June 30, 2012, we had revenue of $107,267 and a net loss of $175,961. There can be no assurance that, even if our revenue increases, our future operations will result in net income. Our failure to increase our revenues or improve our gross margins will harm our business. We may not be able to sustain or increase profitability on a quarterly or annual basis in the future. If our revenues grow more slowly than we anticipate, our gross margins fail to improve or our operating expenses exceed our expectations, our operating results will suffer. The prices we charge for our Internet software and services may decrease, which would reduce our revenues and gross margins, and harm our business. If we are unable to sell our solutions at acceptable prices relative to our costs, or if we fail to develop and introduce on a timely basis new products from which we can derive additional revenues, our financial results will suffer.

 

Our ability to raise equity financing in the near term may be limited.

 

We may wish to attempt to sell additional shares of our common stock, and securities exercisable or convertible into shares of our common stock, in the future to satisfy our capital and operating needs. If we sell shares in the future, the prices at which we sell these future shares will vary, and these variations may be significant. Pursuant to the terms of a private placement of common stock and warrants to four institutional investors that closed in May 2012 (the “May 2012 private placement”), as described under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" in Item 2 of Part I of this Form 10-Q, we have agreed not to make any offers or sales of any of our (or our subsidiaries') equity or equity-equivalent securities in a subsequent placement until February 17, 2013, without the approval of the majority private placement investor (subject to certain permitted offers and sales including the incurrence of non-convertible debt together with warrants), or to file any new registration statement, other than as required by the May 2012 private placement, until September 13, 2012. Additionally, we are required to deliver to each May 2012 private placement investor a written notice of any proposed issuance, sale or exchange of securities being offered in a subsequent placement through November 17, 2013, and offer to issue and sell to or exchange with such private placement investors 25% of the offered securities. These agreements may make it more difficult to obtain additional financing.

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Our operations have limited histories and therefore we cannot ensure the long-term successful operation of our business or the execution of our business plan.

 

Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets, such as the software and services markets in which we operate. We must meet many challenges including:

 

·establishing and maintaining broad market acceptance of our products and services and converting that acceptance into direct and indirect sources of revenue;

 

·establishing and maintaining adoption of our technology on a wide variety of platforms and devices;

 

·timely and successfully developing new products, product features and services and increasing the functionality and features of existing products and services;

 

·developing services and products that result in high degrees of corporate client satisfaction and high levels of end-customer usage;

 

·successfully responding to competition, including competition from emerging technologies and solutions;

 

·developing and maintaining strategic relationships to enhance the distribution, features, content and utility of our products and services; and

 

·identifying, attracting and retaining talented technical and creative services staff at reasonable compensation rates in the markets in which we employ.

 

Our business strategy may be unsuccessful and we may be unable to address the risks we face in a cost-effective manner, if at all. If we are unable to successfully address these risks, our business will be harmed.

 

Our resources may not be sufficient to manage our expected growth; failure to properly manage our potential growth would be detrimental to our business.

 

We may fail to adequately manage our anticipated future growth. Any growth in our operations will place a significant strain on our administrative, financial and operational resources, and increase demands on our management and on our operational and administrative systems, controls and other resources. We cannot assure you that our existing personnel, systems, procedures or controls will be adequate to support our operations in the future or that we will be able to successfully implement appropriate measures consistent with our growth strategy. As part of this growth, we may have to implement new operational and financial systems, procedures and controls to expand, train and manage our employee base and maintain close coordination among our technical, accounting, finance, marketing and sales staff. We cannot guarantee that we will be able to do so, or that if we are able to do so, we will be able to effectively integrate them into our existing staff and systems. There may be greater strain on our systems mainly because we have acquired a number of businesses over the last three years and have had to devote significant management time and expense to the ongoing integration and alignment of management, systems, controls and marketing. To the extent we acquire other businesses, we will also need to integrate and assimilate new operations, technologies and personnel. If we are unable to manage growth effectively, such as if our sales and marketing efforts exceed our capacity to install, maintain and service our products or if new employees are unable to achieve performance levels, our business, operating results and financial condition could be materially and adversely affected.

 

We may not have successfully integrated recent acquisitions to realize the full benefits of the combined businesses.

 

Our recent acquisitions involve the integration of businesses that have previously operated separately. The difficulties of combining the operations of these businesses include:

 

·the challenge of effecting technical and staff integration while carrying on the ongoing businesses;

 

·the necessity of coordinating geographically separate organizations; and

 

·effective integration of personnel with diverse business backgrounds.

 

The process of completing the integration of these businesses could cause an interruption of, or loss of momentum in, the activities of our company and the loss of key personnel. The multinational nature of our operations can make it especially challenging to successfully integrate our recent acquisitions. The diversion of management’s attention and any delays or difficulties encountered in connection with the acquisitions and the integration of these operations could have an adverse effect on our business, financial condition or results of operations.

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The market price of our common stock could be subject to significant fluctuation in response to rumors or developments relating to possible transactions and our strategic transaction process.

 

As we have previously disclosed, we have from time to time received expressions of interest concerning the possible purchase of our company. The company has not made a decision to pursue a strategic transaction nor has it entered into any agreement with a prospective purchaser with regard to any such transaction.

 

Our competitors may have greater financial and other resources than we do and those advantages could make it difficult for us to compete with them.

 

The market for IP video content management is relatively new and constantly changing. We expect that competition in this industry will intensify. Increased competition may result in price reductions, reduced margins, loss of customers and changes in our business and marketing strategies, any of which could harm our business. Current and potential competitors may have longer operating histories, greater name recognition, more employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. In addition, new competitors with potentially unique or more desirable products or services may enter the market at any time. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology. Price concessions or the emergence of other pricing, licensing and distribution strategies or technology solutions of competitors may reduce our revenue, margins or market share. Other changes we have to make in response to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price.

 

If other market participants in the general video management market enter into social media and IP-based VAMs (“video asset management systems”), we may be negatively impacted.

 

If dedicated firmware vendors were to enter into our space, they may have longer operating histories, greater name recognition, more employees and greater financial, technical, marketing, public relations and distribution resources than we do. The competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology. Price concessions or the emergence of other pricing, licensing and distribution strategies or technology solutions of competitors may reduce our revenue, margins or market share. Other changes we have to make in response to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price.

 

If we do not successfully develop new software products and solutions, our business may be harmed.

 

Our business and operating results may be harmed if we fail to expand our software and services suite (either through internal product or capability development initiatives or through strategic partnerships and acquisitions) in such a way that achieves widespread market acceptance or that generates significant revenue and gross profits to offset our operating and other costs. We may not successfully identify, develop and market new product and service opportunities in a timely manner. If we introduce new products and services, they may not attain broad market acceptance or contribute meaningfully to our revenue or profitability. Competitive or technological developments may require us to make substantial, unanticipated investments in new products and technologies or in new strategic partnerships, and we may not have sufficient resources to make these investments. Because the markets for our solutions are subject to rapid change, we may need to expand and/or evolve our product and service offerings quickly. Delays and cost overruns could affect our ability to respond to technological changes, evolving industry standards, competitive developments or customer requirements and harm our business and operating results.

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If we are unable to maintain or expand our direct sales capabilities, we may not be able to generate anticipated revenues.

 

We rely primarily on our direct sales force to sell a substantial portion of our software and services (although we also use channels and partnerships for sales). As of June 30, 2012, we had a team of approximately 120 dedicated sales and sales support professionals. We generally expand our sales force to generate increased revenue from new customers. Failure to hire or retain qualified sales personnel may preclude us from expanding our business and generating anticipated revenue. Competition for such personnel is intense, and there can be no assurance that we will be able to retain our existing sales personnel or attract, assimilate or retain enough highly qualified sales personnel. Certain companies with which we compete for experienced personnel may have greater resources than we have. New sales hires require training and take time to achieve full productivity. If we experience high turnover in our sales force in the future, we cannot be certain that new hires will become as productive as necessary to maintain or increase our revenue within anticipated timeframes.

 

Our business depends substantially on customers renewing and upgrading their subscriptions for our services. Any decline in our customer renewals and upgrades would harm our future operating results.

 

We typically maintain multi-year working relationships with our customers. Most of our customer contracts cover multi-year periods and contain an automatic renewal clause; however, optional notification of non-renewal is permitted to be given by customers at the end of the contract term. Maintaining the renewal rate of our contracts is important to our future success. Our customers have no obligation to renew their relationship with us after the expiration of the term of their agreements, and occasionally customers have elected not to do so. We cannot guarantee that customer agreements will be renewed at the same pace as they have been previously. Our renewal rates, which have been very high, may decline due to a variety of factors, including:

 

·the performance and functionality of the KIT Video Platform;

 

·the availability, price, performance and functionality of competing platforms and services;

 

·our ability to demonstrate to new customers the value of our platform within initial contract terms;

 

·the relative ease of moving to a competing software platform or service;

 

·the effects of economic downturns, including the current global economic recession; or

 

·reductions in our customers’ spending levels.

 

If our renewal rates are lower than anticipated or decline for any reason, or if customers renew on terms less favorable to us, our revenue may be negatively impacted and our profitability and gross margin may be harmed, which would have a material adverse effect on our business, results of operations and financial condition.

 

The average sales price of the KIT Video Platform or our services may decrease, which may reduce our profitability.

 

Although we have been able to maintain or increase our prices historically, the average sales price for the KIT Video Platform or our services may decline for a variety of reasons, including competitive pricing pressures, a change in the mix of our services, anticipation of the introduction of new solutions or promotional programs. Competition continues to increase in the market for end-to-end VAMS and related services and we expect competition to further increase in the future, thereby leading to increased pricing pressures. We cannot assure you that we will be successful maintaining our prices at levels that will allow us to reach profitability. Failure to maintain our prices could have an adverse effect on our business, results of operations and financial condition.

 

Any failure of major elements of our system and operations could lead to significant disruptions in our ability to serve customers, which could damage our reputation, reduce our revenues or otherwise harm our business.

 

Our business is dependent upon providing our customers with fast, efficient and reliable services. A reduction in the performance, reliability or availability of our network infrastructure may harm our ability to distribute our software to our customers, as well as our reputation and ability to attract and retain customers and content providers. Our systems and operations are susceptible to, and could be damaged or interrupted by outages caused by fire, flood, power loss, telecommunications failure, Internet or mobile network breakdown, earthquake and similar events. Our systems are also subject to human error, security breaches, power losses, computer viruses, break-ins, “denial of service” attacks, sabotage, intentional acts of vandalism and tampering designed to disrupt our computer systems and network communications. A sudden and significant increase in traffic on our customers’ websites or demand from mobile users could strain the capacity of the software, hardware and telecommunications systems that we deploy or use. This could lead to slower response times or system failures. Our failure to protect our network against damage from any of these events could harm our business.

 

Our operations also depend on web browsers, ISPs (Internet service providers) and mobile networks to provide our clients’ end-users access to websites, IPTV (Internet protocol television) and mobile content. Many of these providers have experienced outages in the past, and could experience outages, delays and other difficulties due to system failures unrelated to our systems. Any such outage, delay or difficulty could adversely affect our ability to effectively provide our software and services, which would harm our business.

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Our success depends on our customers’ continued high-speed access to the Internet and the continued reliability of the Internet infrastructure.

 

Our future sales growth depends on our customers’ high-speed access to the Internet, as well as the continued maintenance and development of the Internet infrastructure. The future delivery of our services will depend on third-party Internet service providers to expand high-speed Internet access, to maintain a reliable network with the necessary speed, data capacity and security, and to develop complementary products and services, including high-speed modems, for providing reliable and timely Internet access and services. The success of our business depends directly on the continued accessibility, maintenance and improvement of the Internet as a convenient means of customer interaction, as well as an efficient medium for the delivery and distribution of information among businesses and by businesses to their employees. All of these factors are out of our control. If for any reason the Internet does not remain a widespread communications medium and commercial platform, the demand for our services would be significantly reduced, which would harm our business, results of operations and financial condition.

 

To the extent that the Internet continues to experience increased numbers of users, frequency of use or bandwidth requirements, the Internet may become congested and be unable to support the demands placed on it, and its performance or reliability may decline. Any future Internet outages or delays could adversely affect our ability to provide services to our customers, which could adversely affect our business.

 

We depend on various third parties to maintain much of our content delivery, storage and computer hardware operations. If the third parties’ hardware or operations fail, our business will be harmed.

 

A portion of our content delivery, storage and computer hardware operations are operated or safeguarded by third parties such as Akamai Technologies, Equinix, Internap, Limelight, RRSat, Satlink and various other content delivery and transport, hosting and telecommunications providers. If these providers’ operations, networks, hardware or security systems fail, particularly if they fail in unison, our reputation and business may suffer. A problem with, or failure of, these systems or operations could result in interruptions or increases in response times for our customers. If we cannot maintain our system in the event of unexpected occurrences, make necessary modifications and/or improvements to the technology, such deficiencies could have a material adverse effect upon our business, financial condition and results of operations.

 

We license technology from third parties. If we are unable to maintain these licenses, our operations and financial condition may be negatively impacted.

 

We license technology from third parties. The loss of, or our inability to maintain, these licenses could result in increased costs or delay sales of our software and services. We anticipate that we will continue to license technology from third parties in the future. This technology may not continue to be available on commercially reasonable terms, if at all. Although we do not believe that we are substantially dependent on any individual licensed technology, some of the component technologies that we license from third parties could be difficult for us to replace. The impairment of these third-party relationships, especially if this impairment were to occur in unison, could result in delays in the delivery of our software and services until equivalent technology, if available, is identified, licensed and integrated. This delay could adversely affect our operating results and financial condition.

 

Certain of our service delivery and content handling services are subject to industry regulations, certifications and approvals.

 

The commercialization of certain of the service delivery and content handling services we provide at times require or are made more costly due to industry acceptance and regulatory processes, such as ISO certification and strict content security handling standards for Hollywood studios, such as those required by the Motion Picture Association of America (MPAA). If we are unable to obtain or retain these or other formal and informal industry certifications in a timely manner, or at all, our operating results could be adversely affected.

 

If we do not adequately protect our intellectual property rights, we may experience a loss of revenue and our operations may be materially harmed.

 

Historically, we have not had a mandatory practice of registering patents or copyrights on the software and technology we have developed. We believe our intellectual property is better protected by the long-term usage precedent for our software solutions than by patent filings, and we rely upon confidentiality agreements signed by our employees, consultants and third parties, and trade secret laws of general applicability, as an ongoing safeguard for our software and technology. We cannot assure you that we can adequately protect our intellectual property or successfully prosecute potential infringement of our intellectual property rights. Also, we cannot assure you that others will not assert rights in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve these types of conflicts to our satisfaction. Our failure to protect our intellectual property rights may result in a loss of revenue and could materially harm our operations and financial condition.

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If we are found to infringe on the proprietary rights of others, we could be required to redesign aspects of the KIT Video Platform, pay significant royalties or enter into license agreements with third parties, which may significantly increase our costs or adversely affect our results of operations.

 

Although we believe that our core intellectual property is protected by usage precedents that supersede the statute of limitation for copyright infringement claims in most jurisdictions worldwide, a third-party may assert that our technology or services violates its intellectual property rights. Any claims, regardless of their merit, could:

 

·be expensive and time-consuming to defend;

 

·force us to temporarily or permanently stop providing services that incorporate the challenged intellectual property;

 

·require us to redesign our technology and services;

 

·divert management’s attention and other company resources; and

 

·require us to enter into royalty or licensing agreements in order to obtain the right to use necessary technologies, which may not be available on terms acceptable to us, if at all.

 

We may be subject to legal liability for providing third-party content.

 

We have certain arrangements to offer third-party content via certain of our clients’ websites. Although we believe we are in compliance with all legal requirements for content use in all jurisdictions, we may be subject to claims concerning this content by virtue of our involvement in marketing, branding, broadcasting or providing access to it, even if we do not ourselves host, operate or provide access to the content. While our agreements with these parties most often provide that we will be indemnified against such liabilities, such indemnification may not be adequate or available. Investigating and defending any of these types of claims can be expensive, even if the claims do not result in liability. While to date we have not been subject to material claims, if any potential claims do result in liability, we could be required to pay damages or other penalties, which could harm our business and operating results.

 

Fluctuations in foreign currency exchange rates affect our operating results in U.S. dollar terms.

 

A portion of our revenues arises from international operations. Revenues generated and expenses incurred by our international subsidiaries are often denominated in the currencies of the local countries. While we seek to roughly match client revenues with associated costs of delivery and client service (“natural hedging,” which is oriented to maximizing predictability of operating cash flow), our consolidated U.S. dollar financial statements are subject to fluctuations due to changes in exchange rates as the financial results of our international subsidiaries are translated from local currencies into U.S. dollars. In addition, our financial results are subject to changes in exchange rates that impact the settlement of transactions in non-local currencies.

 

A significant portion of our operations is conducted through our subsidiaries, and we therefore rely on our subsidiaries to make funds available to us.

 

A significant portion of our operations is conducted through our subsidiaries. We, therefore, will be dependent upon the receipt of dividends or other distributions from our subsidiaries. The declaration of dividends by our subsidiaries will be subject to the discretion of their boards of directors and will depend on a number of factors, including their results of operations, financial condition, liquidity requirements and indebtedness and restrictions imposed by applicable law. Our inability to receive funds from our operating subsidiaries would adversely affect our ability to meet our obligations and to make dividend payments and other distributions, if any, to holders of our common stock.

 

Our operating results may fluctuate from quarter to quarter, which could make them difficult to predict.

 

Our quarterly operating results are tied to certain financial and operational metrics that have fluctuated in the past and may fluctuate significantly in the future. As a result, you should not rely upon our past quarterly operating results as indicators of future performance.

 

Our operating results depend on numerous factors, many of which are outside of our control. In addition to the other risks described in this Risk Factors section, the following risks could cause our operating results to fluctuate:

 

·our ability to retain existing customers and attract new customers;

 

·the mix of annual and monthly customers at any given time;

 

·the timing and amount of costs of new and existing marketing and advertising efforts;

 

·the timing and amount of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure;

 

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·the cost and timing of the development and introduction of new product and service offerings by us or our competitors; and

 

·system or service failures, security breaches or network downtime.

 

 

 

We may be required to record a significant charge to earnings if our goodwill or amortizable intangible assets become impaired.

 

We are required under U.S. generally accepted accounting principles to test goodwill for impairment at least annually and to review our amortizable intangible assets for impairment when events or changes in circumstance indicate the carrying value may not be recoverable. Factors that could lead to impairment of goodwill and amortizable intangible assets include a significant decline in market capitalization, which we experienced in the second quarter ended June 30, 2012. We recognized a non-cash impairment charge of $55,718 in the second quarter of 2012. We may be required in the future to record additional charges to earnings if a portion of our goodwill or amortizable intangible assets becomes impaired. Any such charge would adversely impact our financial results.

 

Our international operations are subject to increased risks, which could harm our business, operating results and financial condition.

 

In addition to uncertainty about our ability to continue to generate revenues from our foreign operations and expand our international market position, there are risks inherent in doing business internationally, including:

 

·trade barriers and changes in trade regulations;

 

·difficulties in developing, staffing and simultaneously managing a large number of varying foreign operations as a result of distance, language and cultural differences;

 

·the need to comply with varied local laws and regulations;

 

·longer payment cycles;

 

·possible credit risk and higher levels of payment fraud;

 

·import or export regulations;

 

·compliance with U.S. laws (such as the Foreign Corrupt Practices Act) and local laws prohibiting corrupt payments to government officials;

 

·laws and business practices that favor local competitors or prohibit foreign ownership of certain businesses; and

 

·different and more stringent user protection, data protection, privacy and other laws.

 

Violations of complex foreign and U.S. laws and regulations that apply to our international operations could result in fines, criminal sanctions against us, our officers or our employees, prohibitions on the conduct of our business and damage to our reputation.

 

Although we have implemented policies and procedures designed to promote compliance with these laws, there can be no assurance that our employees, contractors or agents will not violate our policies. These risks inherent in our international operations and expansion increase our costs of doing business internationally and could result in harm to our business, operating results and financial condition.

 

If we fail to maintain proper and effective internal controls in the future, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, investors’ views of our company and, as a result, the value of our common stock.

 

Ensuring that we have effective internal control over financial reporting and disclosure controls and procedures in place is a costly and time-consuming effort that needs to be frequently evaluated. As a public company, we conduct an annual management assessment of the effectiveness of our internal controls over financial reporting and receive a report from our independent registered public accounting firm addressing the effectiveness of our internal controls over financial reporting for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. If we are not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or if we or our independent registered public accounting firm identify ongoing deficiencies in our internal controls over financial reporting that could rise to the level of a material weakness, we may not be able to complete our evaluation, testing and any required remediation in a timely fashion. During the evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial reporting, we will be unable to assert that our internal controls over financial reporting are effective. If we are unable to assert that our internal controls over financial reporting are effective, or if our independent registered public accounting firm is unable to express an opinion on the effectiveness of our internal controls over financial reporting, we could be subject to investigations or sanctions by the U.S. Securities and Exchange Commission or other regulatory authorities, and we could lose investor confidence in the accuracy and completeness of our financial reports, which could cause an adverse effect on the market price of our common stock, our business, reputation, financial position and results of operation. In addition, we could be required to expend significant management time and financial resources to correct any material weaknesses that may be identified or to respond to any regulatory investigations or proceedings.

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We have had a material weakness in internal control over financial reporting in the past and cannot assure you that additional material weaknesses will not be identified in the future. Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements in our financial statements which could require us to restate financial statements, cause investors to lose confidence in our reported financial information and have a negative effect on our stock price.

 

During theyear ended December 31, 2011, management identified a material weakness in our internal controls over financial reporting as defined in the Public Company Accounting Oversight Board’s Auditing Standard No. 5. While we have significantly improved our internal controls over financial reporting, our disclosure controls and procedures were still not effective as of June 30, 2012 with respect to such material weakness. We cannot assure you that additional significant deficiencies or material weaknesses in our internal control over financial reporting will not be identified and persist in the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter in their implementation, could result in additional significant deficiencies or material weaknesses, cause us to fail to meet our periodic reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely affect the results of periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our internal control over financial reporting required under Section 404. The existence of a material weakness could result in our financial statements that could result in a restatement of financial statements, cause us to fail to meet our reporting obligations and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.

 

Our use of "open source" software could negatively affect our ability to sell our services and subject us to possible litigation.

 

A small portion of the technology licensed by us incorporates "open source" software, and we may incorporate open source software in the future. Such open source software is generally licensed by its authors or other third parties under open source licenses. If we fail to comply with these licenses, we may be subject to certain conditions, including requirements that we offer our services that incorporate the open source software for no cost, that we make available source code for modifications or derivative works we create based upon, incorporating or using the open source software and that we license such modifications or alterations under the terms of the particular open source license. If an author or other third party that distributes such open source software were to allege that we had not complied with the conditions of one or more of these licenses, we could be required to incur legal expenses defending against such allegations and could be subject to damages, enjoined from the sale of our services that contained the open source software and required to comply with the foregoing conditions, which could disrupt the distribution and sale of some of our services.

 

Unfavorable results of legal proceedings, disputes, and investigations could harm our business and result in substantial costs.

 

We are involved in various legal proceedings, disputes and investigations, including those described under “Legal Proceeding” in Item 1 of Part II of this Form 10-Q. Additional legal claims or regulatory matters may arise in the future, including as a result of such ongoing disputes and investigations. Litigation is inherently unpredictable. Regardless of the merit of the claims, litigation may be costly, time consuming and disruptive to our business. Therefore, we could incur judgments or enter into settlements of claims that could adversely affect our business, operating results or cash flows. We may also become subject to costly indemnification obligations to current and former officers, directors or employees, which may not be covered by insurance.

 

Risks Related to Our Common Stock

 

Our historic stock price has been volatile and the future market price for our common stock is likely to continue to be volatile.

 

The public market for our common stock has historically been volatile. Any future market price for our shares is likely to continue to be volatile. This price volatility may make it more difficult for you to sell shares when you want at prices you find attractive. The stock market in general has experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of specific companies. Broad market factors and the investing public’s negative perception of our business may reduce our stock price, regardless of our operating performance. Further, the market for our common stock is limited and we cannot assure you that a larger market will ever be developed or maintained.

 

Shares of common stock issuable upon exercise of our outstanding stock options, restricted stock awards and warrants may adversely affect the market price of our common stock.

 

As of June 30, 2012, we had outstanding under our 2004 Stock Option Plan and 2008 Incentive Stock Plan stock options to purchase 5,820,194 shares of common stock and 2,114,772 of restricted stock awards, and outstanding warrants to purchase 6,688,549 shares of common stock. The issuance of common stock pursuant to the stock options, restricted stock awards and warrants would reduce a stockholder’s percentage voting and ownership interest in our company. The stock options and warrants are likely to be exercised when our common stock is trading at a price that is higher than the exercise price of these stock options and warrants.

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Future sales of our common stock issued and issuable in connection with our May 2012 private placement may depress the market price of our common stock and make it difficult to raise additional equity capital.

 

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market. On May 18, 2012, pursuant to a Securities Purchase Agreement dated as of May 15, 2012, we issued 7,000,000 shares of common stock and warrants to purchase 5,250,000 shares of common stock to four institutional investors. We also agreed to issue certain additional shares of our common stock, if and to the extent the trading price of our common stock is below certain levels on specified dates. We are obligated to issue an additional 2,588,427 shares of common stock to those investors and approximately $3,000 in cash. All of the shares are freely tradeable. The terms of the Securities Purchase Agreement and the warrants, including the dilution adjustment provision in the Securities Purchase Agreement which expires if our registration statement on behalf of the investor remains effective until October 12, 2012, and full-ratchet dilution provision in the warrants which reduces the exercise price but does not increase the underlying number of shares, may make it difficult for us to raise additional equity capital consistent with prevailing market terms in the near term, if at all, while these provisions are effective.

 

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

 

The trading market for our common stock relies in part on the research and reports that equity research analysts publish about us and our business. We do not control these analysts. The price of our common stock could decline if one or more equity analysts downgrade our common stock or if analysts issue other unfavorable commentary or cease publishing reports about us or our business.

 

We have provisions in our certificate of incorporation that substantially eliminate the personal liability of members of our board of directors for violations of their fiduciary duty of care as a director and that allow us to indemnify our officers and directors. This could make it very difficult for you to bring any legal actions against our directors for such violations or could require us to pay any amounts incurred by our directors in any such actions.

 

Pursuant to our certificate of incorporation, members of our board of directors will have no liability for violations of their fiduciary duty of care as a director, except in limited circumstances. This means that you may be unable to prevail in a legal action against our directors even if you believe they have breached their fiduciary duty of care. In addition, our certificate of incorporation allows us to indemnify our directors from and against any and all expenses or liabilities arising from or in connection with their serving in such capacities with us. This means that if you were able to enforce an action against our directors or officers, in all likelihood we would be required to pay any expenses they incurred in defending the lawsuit and any judgment or settlement they otherwise would be required to pay.

 

Provisions of Delaware law and our charter documents could delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders, and could make it more difficult for you to change management.

 

Provisions of Delaware law and our certificate of incorporation, as amended, and by-laws, as amended, may discourage, delay or prevent a merger, acquisition or other change in control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium for their shares. These provisions may also prevent or delay attempts by stockholders to replace or remove our current management or members of our board of directors. These provisions include:

 

·advance notice requirements for stockholder proposals and nominations;

 

·limitations on the ability of stockholders to call special meetings; and

 

·the ability of our board of directors to adopt, amend or repeal our by-laws.

 

 

 

In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more difficult for stockholders or potential acquirers to acquire us without negotiation. These provisions may apply even if some stockholders may consider the transaction beneficial to them.

 

As a result, these provisions could limit the price that investors are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for our common stock.

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Our officers and directors have significant voting power and may take actions that may not be in the best interests of other stockholders.

 

Our executive officers and directors currently beneficially own 15% of our common stock. If these stockholders act together, they will be able to exert significant control over our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our common stock. This concentration of ownership may not be in the best interests of all of our stockholders.

 

We do not anticipate paying dividends in the foreseeable future.

 

We currently intend to retain our future earnings to support operations and to finance expansion and, therefore, we do not anticipate paying any cash dividends on our capital stock in the foreseeable future. Additionally, under our term loan, we may not pay cash dividends on our common stock without the consent of the lender. You should not buy our stock if you are expecting to receive cash dividends.

 

 

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

 

None

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

 

None

 

ITEM 4. MINE SAFETY DISCLOSURES

 

None

 

ITEM 5. OTHER INFORMATION.

 

None

 

ITEM 6. EXHIBITS.

 

Exhibit No.   Description
31.1   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1   Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2   Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  KIT DIGITAL, INC.  
       
Dated:  August 14, 2012 By: /s/ Barak Bar-Cohen  
    Barak Bar-Cohen  
   

Chief Executive Officer

(principal executive officer)

 

 

 

Dated:  August 14, 2012 By: /s/ Fabrice Hamaide  
    Fabrice Hamaide  
   

Chief Financial Officer

(principal financial and accounting officer)

   

45
 

XNAS:KITD Quarterly Report 10-Q Filling

XNAS:KITD Stock - Get Quarterly Report SEC Filing of XNAS:KITD stocks, including company profile, shares outstanding, strategy, business segments, operations, officers, consolidated financial statements, financial notes and ownership information.

XNAS:KITD Quarterly Report 10-Q Filing - 6/30/2012
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