PINX:BCST Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 10-Q
S           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

£           Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ________ to ________

Commission File No.0-13316
BROADCAST INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)

     
Utah
 
87-0395567
(State or other jurisdiction of
 
(IRS Employer
incorporation or organization)
 
Identification No.)

7050 Union Park Ave. #600, Salt Lake City, Utah 84047
(Address of principal executive offices and zip code)

(801) 562-2252
(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  S     No £
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to post such files). Yes S     No £

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.

£ Large accelerated filer   £ Accelerated filer    £ Non-accelerated filer    S  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   £    No   S

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
Class
Outstanding as of July 31, 2012
Common Stock, $.05 par value
107,227,820 shares
 


 
1

 
 
Broadcast International, Inc.
Form 10-Q

Table of Contents

PART I - FINANCIAL INFORMATION
Page
Item 1.
Financial Statements 
3
Item 2.
Management’s Discussion and Analysis of Financial Condition  
  and Results of Operations 
23
Item 3.
Quantitative and Qualitative Disclosures about Market Risk 
34
Item 4.
Controls and Procedures 
34
PART II -OTHER INFORMATION
 
Item 1.
Legal Proceedings 
35
Item 1A.
Risk Factors 
35
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds 
35
Item 3.
Defaults Upon Senior Securities 
35
Item 4.
[REMOVED AND RESERVED]
35
Item 5.
Other Information “Not Applicable”
35
Item 6.
Exhibits
35
Signatures
 
39
 
 
 
 
 
 
 
2

 
 
PART I. FINANCIAL INFORMATION

Item 1. Financial Statements
BROADCAST INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS

   
December 31,
2011
   
June 30,
2012
 
         
(Unaudited)
 
ASSETS:
           
     Current Assets
           
          Cash
  $ 961,265     $ 403,259  
          Trade accounts receivable, net
    1,239,903       1,219,163  
          Inventory
    60,851       331,572  
          Prepaid expenses
    203,973       149,247  
          Total current assets
    2,465,992       2,103,241  
     Property and equipment, net
    1,417,134       839,324  
     Other Assets, non current
               
          Debt offering costs
    123,278       64,371  
          Patents, net
    131,079       126,004  
          Deposits and other assets
    406,004       265,700  
          Total other assets, non current
    660,361       456,075  
                 
     Total assets
  $ 4,543,487     $ 3,398,640  
                 
LIABILITIES AND STOCKHOLDERS DEFICIT:
               
 
               
     Current Liabilities
               
          Accounts payable
  $ 1,252,538     $ 2,443,594  
          Payroll and related expenses
    390,206       476,468  
          Other accrued expenses
    175,008       273,279  
          Unearned revenue
    10,449       1,440  
          Current portion of notes payable (net of discount of $103,859
          and $101,416, respectively)
    2,068,016       798,584  
          Other current obligations
    1,067,649       276,455  
          Derivative valuation
    3,760,200       4,309,537  
          Total current liabilities
    8,724,066       8,579,357  
     Long-term Liabilities
               
          Long-term portion of notes payable (net of discount of $659,496
          and $492,828, respectively
    6,349,445       507,172  
          Total long-term liabilities
    6,349,445       507,172  
     Total liabilities
    15,073,511       9,086,529  
     Commitments and contingencies
               
     STOCKHOLDERS’ DEFICIT:
               
          Preferred stock, no par value, 20,000,000 shares authorized;
          none issued
    --       --  
          Common stock, $.05 par value, 180,000,000 shares authorized;   
          75,975,656 and 107,227,820 shares issued as of December 31,  
          2011 and June 30, 2012, respectively
    3,798,783       5,361,391  
          Additional paid-in capital
    96,859,058       99,476,870  
          Accumulated deficit
    (111,187,865 )     (110,526,150 )
          Total stockholders’ deficit
    (10,530,024 )     (5,687,889 )
                 
     Total liabilities and stockholders’ deficit
  $ 4,543,487     $ 3,398,640  

See accompanying notes to condensed consolidated financial statements.
 
 
3

 
 
BROADCAST INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

   
For the three months ended
   
For the six months ended
 
   
June 30,
   
June 30,
 
   
2011
   
2012
   
2011
   
2012
 
                         
Net sales
  $ 2,357,157     $ 1,999,988     $ 4,044,421     $ 3,745,085  
Cost of sales
    1,620,555       1,345,966       2,896,092       2,591,458  
Gross profit
    736,602       654,022       1,148,329       1,153,627  
                                 
Operating expenses:
                               
     Administrative and general
    1,236,328       1,259,320       3,844,700       2,588,601  
     Selling and marketing
    263,008       598,841       422,945       1,115,240  
     Research and development
    625,628       464,847       1,223,399       1,021,414  
     Depreciation and amortization
    167,366       164,043       348,159       326,675  
     Total operating expenses
    2,292,330       2,487,051       5,839,203       5,051,930  
Total operating loss
    (1,555,728 )     (1,833,029 )     (4,690,874 )     (3,898,303 )
                                 
Other income (expense):
                               
     Interest income
    1,198       1       1,986       1  
     Interest expense
    (188,689 )     (263,483 )     (569,878 )     (606,211 )
     Gain (loss) on derivative valuation
    2,186,900       2,959,155       6,406,200       4,588,480  
     Equity issuance costs related to warrants
    --       (18,836 )     (476,234 )     (1,095,309 )
     Gain (loss) on extinguishment of debt
    --       --       (970,033 )     1,672,575  
     Loss on sale of securities
    --       --       --       --  
     Loss on sale of assets
    240       (1,799 )     (362 )     (1,640 )
     Other income (expense), net
    (1,597 )     5,183       (5,446 )     2,122  
     Total other income (expense)
    1,998,052       2,680,221       4,386,233       4,560,018  
                                 
Profit (loss) before income taxes
    442,324       847,192       (304,641 )     661,715  
Provision for income taxes
    --       --       --       --  
Net profit (loss)
  $ 442,324     $ 847,192     $ (304,641 )   $ 661,715  
                                 
Net profit (loss) per share – basic
  $ 0.01     $ 0.01     $ (0.00 )   $ 0.01  
Net profit (loss) per share – diluted
  $ 0.01     $ 0.01     $ (0.00 )   $ 0.01  
                                 
Weighted average shares – basic
    75,576,100       107,193,974       74,916,500       94,167,466  
Weighted average shares –diluted
    78,516,174       114,128,974       74,916,500       104,042,079  

See accompanying notes to condensed consolidated financial statements.
 
 
4

 
 
BROADCAST INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

   
Six Months Ended
 
   
June 30,
 
   
2011
   
2012
 
Cash flows from operating activities:
           
Net loss
  $ (304,641 )   $ 661,715  
Adjustments to reconcile net loss to net cash used in operating activities:
               
    Depreciation and amortization
    749,312       723,194  
    Common stock issued for research and development
    903       137,500  
    Common stock issued for interest
    19,634       --  
    Accretion of discount on convertible notes payable
    166,668       265,636  
    Stock based compensation
    1,786,873       193,586  
    Loss on sale of assets
    362       1,640  
    Loss (gain) on extinguishment of debt
    970,033       (1,672,575 )
    Gain on derivative liability valuation
    (6,406,200 )     (4,588,480 )
    Warrants issued for interest
    157,400       --  
    Warrants issued for debt extinguishment costs
    404,000       --  
    Warrants issued and expensed for issuance costs
    --       1,095,309  
    Allowance for doubtful accounts
    (9,215 )     (5,618 )
Changes in assets and liabilities:
               
    Decrease in accounts receivable
    129,112       26,358  
    Increase in inventories
    (60,082 )     (270,721 )
    Decrease in debt offering costs
    --       58,907  
    Decrease in prepaid and other assets
    108,184       195,030  
    Increase (decrease) in accounts payable and accrued expenses
    (560,075 )     1,414,189  
    Decrease in deferred revenues
    (31,629 )     (9,009 )
                 
    Net cash used in operating activities
    (2,879,361 )     (1,773,339 )
                 
Cash flows from investing activities:
               
Purchase of equipment
    (281,583 )     (142,699 )
Proceeds from the sale of assets
    240       750  
                 
    Net cash used by investing activities
    (281,343 )     (141,949 )
                 
Cash flows from financing activities:
               
Proceeds from equity financing
    --       6,150,000  
Principal payments on debt
    (788,465 )     (3,741,194 )
Equity issuance costs
    (24,078 )     (776,483 )
Proceeds from the exercise of options and warrants
    18,304       --  
Payments for debt extinguishment costs
    --       (275,041 )
                 
    Net cash provided (used) by financing activities
    (794,239 )     1,357,282  
                 
Net decrease in cash
    (3,954,943 )     (558,006 )
                 
Cash beginning of period
    6,129,632       961,265  
                 
Cash end of period
  $ 2,174,689     $ 403,259  
                 
Supplemental disclosure of cash flow information:
               
    Interest paid
  $ 201,042     $ 248,643  
    Income taxes paid
  $ --     $ --  

See accompanying notes to condensed consolidated financial statements.
 
 
5

 
 
BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
June 30, 2012

Note 1 – Basis of Presentation

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Broadcast International, Inc. (“we” or the “Company”) contain the adjustments, all of which are of a normal recurring nature, necessary to present fairly our financial position at December 31, 2011 and June 30, 2012 and the results of operations for the three and six months ended June 30, 2011 and 2012, respectively, with the cash flows for each of the six months ended June 30, 2011 and 2012, in conformity with U.S. generally accepted accounting principles.

These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2011.  Operating results for the three and six months ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ended December 31, 2012.

Note 2 - Reclassifications

Certain 2011 financial statement amounts have been reclassified to conform to 2012 presentations.

Note 3 – Weighted Average Shares

Basic earnings per common share is computed by dividing net income or loss applicable to common shareholders by the weighted average number of shares outstanding during each period. The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year, plus the dilutive common stock equivalents that would rise from the exercise of stock options, warrants and restricted stock units outstanding during the period, using the treasury stock method and the average market price per share during the period, plus the effect of assuming conversion of the convertible debt.
 
The following table sets forth the computation of basic and diluted earnings per common share for the three and six month periods ended June 30, 2011 and 2012:

   
For the three months ended
   
For the six months ended
 
   
June 30,
   
June 30,
 
   
2011
   
2012
   
2011
   
2012
 
Numerator
                       
  Net income (loss)
  $ 442,324     $ 847,192     $ (304,641 )   $ 661,715  
Effect on earnings of dilutive
convertible debt
    --       (225,266 )     --       233,068  
Net income (loss) plus assumed
conversions
    442,324       621,926       (304,641 )     894,783  
Denominator
                               
  Basic weighted average shares
outstanding
    75,576,100       107,193,974       74,916,500       94,167,466  
  Effect of dilutive securities:
                               
  Stock options and warrants
    590,074       --       --       2,939,613  
  Restricted stock units
    2,350,000       2,935,000       --       2,935,000  
  Convertible debt
    --       4,000,000       --       4,000,000  
Diluted weighted average shares
outstanding
    78,516,174       114,128,974       74,916,500       104,042,079  
                                 
  Net income (loss) per common share
                               
    Basic
  $ 0.01     $ 0.01     $ (0.00 )   $ 0.01  
    Diluted
  $ 0.01     $ 0.01     $ (0.00 )   $ 0.01  
 
 
6

 
 
Potentially dilutive securities representing 24,070,976 shares of common stock were excluded from the computation of diluted earnings per common share for the six months ended June 30, 2011 because their effect would have been anti-dilutive. As a result of incurring a net loss for the six months ended June 30, 2011, no potentially dilutive securities are included in the calculation of diluted earnings per share because such effect would be anti-dilutive.

Note 4 – Stock-based Compensation

In accordance with ASC Topic 718, stock-based compensation cost is estimated at the grant date, based on the estimated fair value of the awards, and recognized as expense ratably over the requisite service period of the award for awards expected to vest.

Stock Incentive Plans

Under the Broadcast International, Inc. 2004 Long-Term Incentive Plan (the “2004 Plan”), the board of directors may issue incentive stock options to employees and directors and non-qualified stock options to consultants of the company.  Options generally may not be exercised until twelve months after the date granted and expire ten years after being granted. Options granted vest in accordance with the vesting schedule determined by the board of directors, usually ratably over a three-year vesting schedule upon the anniversary date of the grant.  Should an employee terminate before the vesting period is completed, the unvested portion of each grant is forfeited. We have used the Black-Scholes valuation model to estimate fair value of our stock-based awards, which requires various judgmental assumptions including estimated stock price volatility, forfeiture rates, and expected life.  Our computation of expected volatility is based on a combination of historical and market-based implied volatility.  The number of unissued stock options authorized under the 2004 Plan at June 30, 2012 was 2,678,131.

The Broadcast International, Inc. 2008 Equity Incentive Plan (the “2008 Plan”) has become our primary plan for providing stock-based incentive compensation to our eligible employees and non-employee directors and consultants of the company. The provisions of the 2008 Plan are similar to the 2004 Plan except that the 2008 Plan allows for the grant of share equivalents such as restricted stock awards, stock bonus awards, performance shares and restricted stock units in addition to non-qualified and incentive stock options. We continue to maintain and grant awards under our 2004 Plan which will remain in effect until it expires by its terms. The number of unissued shares of common stock reserved for issuance under the 2008 Plan was 1,065,000 at June 30, 2012.

Stock Options

We estimate the fair value of stock option awards granted beginning January 1, 2006 using the Black-Scholes option-pricing model. We then amortize the fair value of awards expected to vest on a straight-line basis over the requisite service periods of the awards, which is generally the period from the grant date to the end of the vesting period. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and expected option term.  Our computation of expected volatility is based on a combination of historical and market-based implied volatility.  The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the stock option award was granted with a maturity equal to the expected term of the stock option award. The expected option term is derived from an analysis of historical experience of similar awards combined with expected future exercise patterns based on several factors including the strike price in relation to the current and expected stock price, the minimum vest period and the remaining contractual period.

The fair values for the options granted for the six months ended June 30, 2011 and 2012 were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:
 
 
Six Months Ended
June 30, 2011
Six Months Ended
June 30, 2012
Risk free interest rate
1.91%
1.82%
Expected life (in years)
5.54
10.0
Expected volatility
82.03%
77.78%
Expected dividend yield
0.00%
0.00%
 
 
7

 
 
The weighted average fair value of options granted during the six months ended June 30, 2012 and 2011 was $0.37 and $0.69, respectively.

Warrants

We estimate the fair value of issued warrants on the date of issuance as determined using a Black-Scholes pricing model. We amortize the fair value of issued warrants using a vesting schedule based on the terms and conditions of each associated underlying contract, as earned. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and warrant expected exercise term.  Our computation of expected volatility is based on a combination of historical and market-based implied volatility.  The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the warrant was issued with a maturity equal to the expected term of the warrant.

The fair values for the warrants issued for the six months ended June 30, 2011 and 2012 estimated at the date of issuance using the Black-Scholes option-pricing model with the following weighted average assumptions:
 
 
Six Months Ended
June 30, 2011
Six Months Ended June
30, 2012
Risk free interest rate
2.04%
1.32%
Expected life (in years)
5.00
5.99
Expected volatility
85.82%
82.65%
Expected dividend yield
0.00%
0.00%

 
The weighted average fair value of warrants issued during the six months ended June 30, 2012 and 2011 was $0.27 and $0.79, respectively.
 
Results of operations for the six months ended June 30, 2011 and 2012 includes $1,786,873 and $193,585, respectively, of non-cash stock-based compensation expense. Restricted stock units and options issued to directors vest immediately. All other restricted stock units, options and warrants are subject to applicable vesting schedules. Expense is recognized proportionally as each award or grant vests.


Included in the $1,786,873 non-cash stock-based compensation expense for the six months ended June 30, 2011 are (i) $1,544,000 for 1,400,000 restricted stock units issued to all 5 members of the board of directors, (ii) $167,566 for 600,000 options issued to one individual and one corporation for consulting services, (iii) $14,433 for 426,700 options granted to 31 employees, (iv) $4,263 for 8,700 options granted to 15 of our non-employee installation technicians and (iv) $56,611 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2011.

Included in the $193,585 non-cash stock-based compensation expense for the six months ended June 30, 2012 are (i) $31,000 for 100,000 restricted stock units issued to one member of the board, (ii) $1,608 for 30,000 options granted to 2 employees and (iii) $160,977 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2012.

The impact on our results of operations for recording stock-based compensation for the six months ended June 30, 2011 and 2012 is as follows:

   
For the three months ended
June 30,
   
For the six months ended
June 30,
 
   
2011
   
2012
   
2011
   
2012
 
General and administrative
  $ 203,366     $ 61,098     $ 1,681,783     $ 120,228  
Research and development
    36,965       36,965       105,090       73,357  
                                 
Total
  $ 240,331       97,420     $ 1,786,873     $ 193,585  

Due to unexercised options and warrants outstanding at June 30, 2012, we will recognize an additional aggregate total of $362,503 of compensation expense over the next four years based upon option and warrant award vesting parameters as shown below:
 
 
8

 
 
       
2012
  $ 96,925  
2013
    178,427  
2014
    86,910  
2015
    241  
Total
  $ 362,503  

The following unaudited tables summarize option and warrant activity during the six months ended June 30, 2012.

   
Options
and
Warrants
Outstanding
   
Weighted
Average
Exercise
Price
 
             
Outstanding at December 31, 2011
    20,440,551     $ 1.10  
Options granted
    30,000       0.50  
Warrants issued
    18,717,900       0.35  
Expired
    (140,169 )     1.31  
Forfeited
    (537,542 )     1.09  
Exercised
    --       --  
                 
Outstanding at June 30, 2012                                                           
    38,510,740     $ 0.64  


The following table summarizes information about stock options and warrants outstanding at June 30, 2012.
 
     
Outstanding
   
Exercisable
 
           
Weighted
Average
Remaining
   
Weighted
Average
         
Weighted
Average
 
 
Range of
Exercise Prices
 
Number
Outstanding
   
Contractual
Life (years)
   
Exercise
Price
   
Number
Exercisable
   
Exercise
Price
 
$ 0.35-0.95       34,122,561         4.78     $ 0.53       33,497,561       $ 0.53  
 
1.00-1.65
      3,443,179         3.90       1.04       3,222,812         1.04  
 
2.25-5.00
      945,000         3.84       3.10       945,000         3.10  
$ $0.35-5.00       38,510,740         4.68     $ 0.64       37,665,373       $ 0.64  
 
Restricted Stock Units

The value of restricted stock units is determined using the fair value of our common stock on the date of the award and compensation expense is recognized in accordance with the vesting schedule. During the six months ended June 30, 2012 and 2011, we awarded 100,000 and 1,400,000 restricted stock units, respectively.
The following is a summary of restricted stock unit activity for the six months ended June 30, 2012.
 
 
9

 
 
   
Restricted
Stock Units
   
Weighted
Average
Grant
Date Fair
Value
 
             
Outstanding at December 31, 2011                                                           
    2,550,000     $ 1.25  
Awarded at fair value                                                        
    100,000       0.31  
Canceled/Forfeited                                                        
    --       --  
Settled by issuance of stock                                                        
    --       --  
Outstanding at June 30, 2012
    2,650,000     $ 1.22  
Vested at June 30, 2012                                                           
    2,650,000     $ 1.22  

Note 5 - Significant Accounting Policies

Cash and Cash Equivalents

We consider all cash on hand and in banks, and highly liquid investments with maturities of three months or less, to be cash equivalents. At June 30, 2012 and December 31, 2011, we had bank balances of $139,982 and $909,182, respectively, in excess of amounts insured by the Federal Deposit Insurance Corporation. We have not experienced any losses in such accounts, and believe we are not exposed to any significant credit risk on cash and cash equivalents.

Current financial market conditions have had the effect of restricting liquidity of cash management investments and have increased the risk of even the most liquid investments and the viability of some financial institutions.  We do not believe, however, that these conditions will materially affect our business or our ability to meet our obligations or pursue our business plans.

Accounts Receivable

Trade accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when collected.

Included in our $1,219,163 and $1,239,903 net accounts receivable for the six months ended June 30, 2012 and the year ended December 31, 2011, respectively, were (i) $1,184,804 and $1,269,579 for billed trade receivables, respectively; (ii) $80,625 and $23,814 of unbilled trade receivables (iii) $1,584 and $0 for employee travel advances and other receivables, respectively; less (iv) ($47,850) and ($53,490) for allowance for uncollectible accounts, respectively.

Inventories

Inventories consisting of electrical and computer parts are stated at the lower of cost or market determined using the first-in, first-out method.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the property, generally from three to five years.  Repairs and maintenance costs are expensed as incurred except when such repairs significantly add to the useful life or productive capacity of the asset, in which case the repairs are capitalized.
 
 
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Patents and Intangibles

Patents represent initial legal costs incurred to apply for United States and international patents on the CodecSys technology, and are amortized on a straight-line basis over their useful life of approximately 20 years.  We have filed several patents in the United States and foreign countries. As of June 30, 2012, the United States Patent and Trademark Office had approved four patents.  Additionally, eleven foreign countries had approved patent rights.  While we are unsure whether we can develop the technology in order to obtain the full benefits, the patents themselves hold value and could be sold to companies with more resources to complete the development. On-going legal expenses incurred for patent follow-up have been expensed from July 2005 forward.

Amortization expense recognized on all patents totaled $2,538 and $5,076 for both the three and six months ended June 30, 2012 and 2011, respectively. Estimated amortization expense, if all patents were issued at the beginning of 2012, for each of the next five years is as follows:

Year ending
December 31:
     
2012
  $ 11,588  
2013
    11,343  
2014
    10,121  
2015
    10,121  
2016
    10,121  

Long-Lived Assets

We review our long-lived assets, including patents, annually or whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, then the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets.  Fair value is determined by using cash flow analyses and other market valuations.

Income Taxes

We account for income taxes in accordance with the asset and liability method of accounting for income taxes prescribed by ASC Topic 740.  Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in the years in which those temporary differences are expected to be recovered or settled.

Revenue Recognition

We recognize revenue when evidence exists that there is an arrangement between us and our customers, delivery of equipment sold or service has occurred, the selling price to our customers is fixed and determinable with required documentation, and collectability is reasonably assured. We recognize as deferred revenue, payments made in advance by customers for services not yet provided.

When we enter into a multi-year contract with a customer to provide installation, network management, satellite transponder and help desk, or combination of these services, we recognize this revenue as services are performed and as equipment is sold. These agreements typically provide for additional fees, as needed, to be charged if on-site visits are required by the customer in order to ensure that each customer location is able to receive network communication. As these on-site visits are performed the associated revenue and cost are recognized in the period the work is completed. If we install, for an additional fee, new or replacement equipment to an immaterial number of new customer locations, and the equipment immediately becomes the property of the customer, the associated revenue and cost are recorded in the period in which the work is completed.

In instances where we have entered into license agreements with a third parties to use our technology within their product offering, we recognize any base or prepaid revenues over the term of the agreement and any per occurrence or periodic usage revenues in the period they are earned.
 
 
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Research and Development

Research and development costs are expensed when incurred.  We expensed $464,847 and $1,021,414 of research and development costs for the three and six months ended June 30, 2012, respectively. We expensed $625,628 and $1,223,399 of research and development costs for the three and six months ended June 30, 2011, respectively.

Concentration of Credit Risk

Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of trade accounts receivable. In the normal course of business, we provide credit terms to our customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have been within the range of management’s expectations.

For the six months ended June 30, 2012 and 2011, we had the same customer that individually constituted 86% and 91%, of our total revenues, respectively.  Although the contract for this customer has expired, we continue to provide services on a month to month basis during the time that the customer solicits requests for proposals (“RFP”) from competing vendors.  We are participating in the RFP process and have submitted our response to the customer.

Note 6 – Notes Payable

The recorded value of our notes payable (net of debt discount) for the six months ended June 30, 2012 and year ended December 31, 2011 was as follows:

   
December 31, 2011
   
June 30, 2012
 
             
Amended and Restated Senior 6.25% Convertible Note
  $ 6,180,816     $ --  
Unsecured Convertible Note
    340,504       507,172  
Bridge Loan Note Payable
    1,196,141       798,584  
Equipment Purchase and Sale Agreement
    700,000       --  
Total
    8,417,461       1,305,756  
Less Current Portion
    (2,068,016 )     (798,584 )
Total Long-term
  $ 6,349,445     $ 507,172  

Amended and Restated Senior 6.25% Convertible Note

On December 24, 2007, we entered into a securities purchase agreement in which we raised $15,000,000.  We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes.  Pursuant to the financing, we issued a senior secured convertible note in the principal amount of $15,000,000.  The senior secured convertible note was originally due December 21, 2010, but was extended to December 21, 2013 and has been subsequently retired as discussed below.
 
On March 26, 2012, we closed on an equity financing (the “2012 Equity Financing”), as well as a restructuring of our outstanding senior convertible indebtedness (the “2012 Debt Restructuring”), resulting in complete satisfaction of our senior indebtedness under the Amended and Restated Note.

A portion of the net proceeds from the 2012 Equity Financing was used to close on the 2012 Debt Restructuring. The Company paid $2,750,000 and issued 2,000,000 shares of common stock valued at $760,000 in satisfaction of the Amended and Restated Note and remaining interest value of $680,816. In consideration of negotiating the 2012 Debt Restructuring and amending our agreement with our placement agent, we paid $275,041 and issued to it 586,164 shares of our common stock valued at $222,742 and recognized a $2,173,033 gain on extinguishment of debt as a result of this retirement.

With the retirement of the Amended and Restated Note we recorded no aggregate derivative liability at March 31, 2012, however at the date of retirement we recorded a derivative valuation gain of $203,700, related to the conversion feature of the Amended and Restated Note to reflect the change in value of the aggregate derivative from December 31, 2011 to the date of retirement. The derivative value of $81,500 at the date of retirement was recorded as additional paid in capital.
 
 
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As of March 31, 2011 we recorded an aggregate derivative liability of $1,711,100, related to the conversion features of the Amended and Restated Note and the conversion feature and warrants related to the Original Note.  A derivative valuation gain of $896,300 was recorded during the three months ended March 31, 2011, to reflect the change in value of the aggregate derivative liability from December 31, 2010 to March 31, 2011.


Unsecured Convertible Note
 
On September 29, 2006, we entered into a letter of understanding with Triage Capital Management, or Triage, dated as of September 25, 2006.  The letter of understanding provided that Triage loan $1,000,000 to us in exchange for us entering into, on or prior to October 30, 2006, a convertible note securities agreement.  It was intended that the funding provided by Triage be replaced by a convertible note and accompanying warrants, as described below.  Effective November 2, 2006, we entered into securities purchase agreement, a 5% convertible note, a registration rights agreement, and four classes of warrants to purchase our common stock, all of which were with an individual note holder, the controlling owner of Triage, who caused our agreement with Triage to be assigned to him, which satisfied our agreement with Triage. Pursuant to the securities purchase agreement, we sold to the convertible note holder a three-year convertible note in the principal amount of $1,000,000 representing the funding received by us on November 2, 2006.
 
On December 23, 2009 we entered into an amendment with the holder of our unsecured convertible note which increased the annual rate of interest from 5% to 8% commencing October 16, 2009.
 
On December 24, 2010 we closed on a Debt Restructuring. In connection with that Debt Restructuring the maturity date of an amended note was extended to December 31, 2013.
 
During March 2011, we issued 135,369 shares of common stock to the holder of our unsecured convertible note in satisfaction of $81,221 of accrued interest on the unsecured convertible note.  Also in connection with the satisfaction of the accrued interest we granted to the holder a warrant to acquire up to 221,758 additional shares of our common stock at an exercise price of $0.96 per share.  The warrant is exercisable at any time for a five-year period. For the year ended December 31, 2011, the $157,400 value of the warrant was included in interest expense.
 
We recorded an aggregate derivative liability of $326,400 and $769,300 as of June 30, 2012 and 2011, respectively, related to the conversion feature of the note. A derivative valuation loss of $26,400 and a derivative valuation gain of $623,600, respectively, were recorded to reflect the change in value of the aggregate derivative liability since December 31, 2011 and December 31, 2010, respectively.  The aggregate derivative liability of $326,400 for the conversion feature of the note was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate .26%, (ii) expected life (in years) of 1.5; (iii) expected volatility of 68.50%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25.
 
In connection with the amendment mentioned above, the principal value of the note is being accreted due to the difference in the value of the conversion feature before and after the amendment. The principal value of $1,000,000 of the unsecured convertible note was accreted over the amended term of the obligation, for which $83,334 and $166,668 was included in interest expense for both the three and six months ended June 30, 2012 and 2011, respectively.  The note bears an 8% annual interest rate payable semi-annually, and for both the three and six months ended June 30, 2012 and 2011, $20,000 and $40,000, respectively was included in interest expense.
 
Accounts Receivable Purchase Agreements
 
During the year ended December 31, 2010 we entered into two Accounts Receivable Purchase Agreements with one individual for an aggregate amount of $775,000. In these agreements, we pledged certain outstanding accounts receivable in exchange for advanced payment and a commitment to remit to the purchaser the amount advanced upon collection from our customer. Terms of the first agreement under which we were advanced $275,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which we were advanced $500,000 include a 10% discount with a 0.5% interest fee for every 30 days the advances remain outstanding.
 
During the three months March 31, 2011 we remitted $100,000 of the principal balance plus accrued interest of $8,360 and converted the remaining $675,000 of principal balance plus $109,292 of accrued and unpaid interest into 1,307,153 shares of our common stock and warrants to purchase an additional 653,576 shares of our common stock. The warrants contain anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than $1.00 per share.
 
 
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At June 30, 2012 and 2011 we recorded an aggregate derivative liability of $50,200 and $348,200 related to the warrant reset provision. A derivative valuation gain of $106,100 and $101,900 was recorded to reflect the change in value of the aggregate derivative liability since December 31, 2010 and 2011, respectively.  The aggregate derivative liability of $50,200 for the reset provision of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.49%, (ii) expected life (in years) of 3.7; (iii) expected volatility of 78.72%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25.
 
Bridge Loan
 
On December 28, 2011 we entered into a Note and Warrant Purchase and Security Agreement with seven individuals for an aggregate of $1,300,000 (“Bridge Loan”) to be used as working capital. The note bears an annual interest rate of 18%, payable monthly in cash. Additionally, we granted to the holders of the Bridge Loan warrants with a five year term to purchase an aggregate of 357,500 shares of our common stock at an exercise price of $0.65 and subsequently reset to $0.53, per share which expires five years after the issuance date. The note was due on February 28, 2012, but the term was subsequently extended to the earlier of the date nine months from the original maturity date or the date we close on an additional sale of our securities that results in gross proceeds to us of $12 million.  In consideration of the extension of the maturity date of the Bridge Loan, we granted the holders of the Bridge Loan warrants with a six year term to purchase 247,500 shares of our common stock at an exercise price of $0.35 per share. This note is collateralized by a security interest in all of our accounts receivable
 
In connection with the Bridge Loan, we paid an $84,500 placement fee and issued warrants to purchase 65,000 shares of our common stock at an exercise price of $0.65 per share and subsequently reset to $0.53, to our investment banker for services in completing the above transaction and paid a $3,000 escrow fee to the Escrow Agent in exchange for holding the funds prior to their disbursement to us.
 
On March 26, 2012, we closed on the 2012 Equity Financing and under the terms of the associated securities purchase agreement, two of the above described bridge lenders converted the principal balance of their portion of the bridge loan in the amount of $400,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing, reducing the outstanding principal balance to $900,000. The warrants issued had a total value of $222,426 which resulted in a loss on extinguishment of debt of $222,426. The aggregate derivative liability and valuation gain or loss for the warrants issued for the converted portion of the principal balance are included in the aggregate of 2012 Equity Financing information. See Note 7.

All warrants mentioned above were issued with price protection provisions and were accounted for as derivative liabilities and valued using a Black Scholes pricing model.
 
At June 30, 2012 we recorded an aggregate derivative liability of $46,700 related to the reset provision for the original and placement warrants issued. A derivative valuation gain of $97,000 was recorded to reflect the change in value of the aggregate derivative liability from December 31, 2011.  The aggregate derivative liability of $46,700 for the reset provision of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.72%, (ii) expected life (in years) of 4.5; (iii) expected volatility of 79.87%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25.
 
At June 30, 2012 we recorded an aggregate derivative liability of $34,700 related to the reset provision for the warrants issued for an extension of the maturity date. A derivative valuation gain of $61,825 was recorded to reflect the change in value of the aggregate derivative liability from the time the warrants were issued.  The aggregate derivative liability of $34,700 for the reset provision of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.72%, (ii) expected life (in years) of 4.5; (iii) expected volatility of 79.74%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25.
 
The principal value of the note is being accreted over the amended term of the obligation, for which $51,848 and $98,968 were included in interest expense for the three and six months ended June 30, 2012, respectively.  The note bears an 18% annual interest rate, and for the three and six months ended June 30, 2012, $40,389 and $95,130, respectively were included in interest expense.
 
 
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Equipment Purchase and Sale Agreement
 
In October 2011, we entered into an Equipment Purchase and Sale Agreement with a lender whereby we use the funds advanced to purchase certain electronic receiving and digital signage equipment along with installation costs.  A 3% fee was due each month the amount remained outstanding.
 
On March 26, 2012, we closed on the 2012 Equity Financing and under the terms of the associated securities purchase agreement the above described lender converted the principal balance of its portion of the loan in the amount of $500,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing, the remaining $200,000 principal balance plus $105,000 of interest due was paid in cash. Of the $105,000 paid, $42,000 was accrued from 2011 and $63,000 was included in interest expense for the three months ended March 31, 2012. The warrants issued had a total value of $278,032 which resulted in a loss on extinguishment of debt of $278,032. The aggregate derivative liability and valuation gain or loss for the warrants issued for the converted portion of the principal balance are included in the aggregate of 2012 Equity Financing information. See Note 7.

Note 7 – 2012 Equity Financing and the Debt Restructuring
 
On March 26, 2012, we closed on an equity financing (the “2012 Equity Financing”) as well as a restructuring of our outstanding senior convertible indebtedness (the “2012 Debt Restructuring”) resulting in complete satisfaction of our senior indebtedness.

We entered in to an Engagement Agreement, dated October 28, 2011, with MDB Capital Group, LLC (“MDB”), pursuant to which MDB agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $6,000,000, subsequently verbally increased to $10,000,000, of the Company’s securities, subject to a minimum gross consideration of $3,000,000.  The Company agreed to pay to MDB a commission of 10% of the gross offering proceeds received by the Company, to grant to MDB warrants to acquire up to 10% of the shares of our common stock and warrants issued in the financing, and to pay the reasonable costs and expenses of MDB related to the offering.

Pursuant to the Engagement Agreement, we entered into a Securities Purchase Agreement (“SPA”) dated March 23, 2012 with select institutional and other accredited investors for the private placement of 27,800,000 units of our securities.  The SPA included a purchase price of $0.25 per unit, with each unit consisting of one share of common stock and two forms of Warrant: (1) The “A” Warrant grants the investors the right to purchase an additional share of common stock for each two shares of common stock purchased, for a term of six years and at an exercise price of $0.35 per share; and (2) The “B” Warrant will not be exercisable unless and until the occurrence of a future issuance of stock at less than $0.25 per share, but, in the event of such issuance, grants the investors the right to acquire additional shares at a price of $0.05 to reduce the impact of the dilution caused by such issuance, but in no event shall the number of shares to be issued under the B Warrant cause us to exceed the number of authorized shares of common stock. The shares in excess of our authorized shares that would have been issuable under the B Warrant shall be “net settled” by payment of cash in an amount equal to the number of shares in excess of the authorized common shares multiplied by the closing price of our common stock as of the trading day immediately prior to the applicable date of the exercise of such B Warrant. The B Warrant shall be extinguished upon the earlier of: (a) a subsequent financing of at least $5 million on terms no more favorable than that received by the investors in the 2012 Equity Financing; (b) after the effective date of the registration statement registering securities issued in the Equity Financing if the volume-weighted average closing price of the Company’s common stock exceeds $.50 per share for a period of 30 trading days and no Volume Failure (as defined in the B Warrant) (measuring the daily average dollar volume of our Common Stock against a minimum volume of $500,000 per day) exists during such period, and the Company is then current in its public filings; or (c) 78 months.

Net proceeds from the 2012 Equity Financing, after deducting the commissions and the estimated legal, printing and other costs and expenses related to the financing, were approximately $6.1 million.  Coincident to the closing of the 2012 Equity Financing, we also closed on the 2012 Debt Restructuring.  In connection therewith, the Company paid $2,750,000 to Castlerigg Master Investment Ltd. (“Castlerigg”), and issued to Castlerigg 2,000,000 shares of common stock in full and complete satisfaction of the senior convertible note and all accrued interest. In consideration of negotiating the 2012 Debt Restructuring, we issued to one of our placement agents 586,164 shares of our common stock and paid them $275,041.
 
 
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In December 2011, we entered into a loan with 7 accredited individuals and entities under the terms of which we borrowed $1,300,000 to be used as working capital (“Bridge Loan”).  The Bridge Loan bears an interest rate of 18% per annum and had a maturity date of February 28, 2012, which was subsequently extended to the earlier of the date nine months from the original maturity date or the date we close on an additional sale of our securities that results in gross proceeds to us of $12 million.  In consideration of the Bridge Loan we granted to the holders of the Bridge Loan warrants with a five year term to purchase 357,500 shares of our common stock at an exercise price of $0.65 per share.  In consideration of the extension of the maturity date of the Bridge Loan, we granted the holders of the Bridge Loan warrants with a six year term to purchase 247,500 shares of our common stock at an exercise price of $0.35 per share.

In connection with the 2012 Equity Financing and under the terms of the SPA, two of the above described bridge lenders converted the principal balance of their portion of the bridge loan in the amount of $400,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing.  In addition, one other entity converted the amount owed by us for equipment purchases in the amount of $500,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing. The proceeds from these conversions were treated as funds raised with respect to the financing.

In connection with the 2012 Equity Financing and under the terms of the SPA, the Company agreed to prepare and file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants.  The Company filed the registration statement on April 9, 2012 and it was declared effective on August 1, 2012.

On April 5, 2012 we secured an additional $154,000 from 1 company and 4 individuals (three of which are members of our Board of Directors) on the same terms and conditions as the investors of the 2012 Equity Financing. As a result of this funding we issued 616,000 shares of our common stock and A warrants totaling 400,400 of which 308,000 were issued to investors and 92,400 were issued to our investment banker.

All warrants listed below were issued with price protection provisions and were accounted for as derivative liabilities. The A Warrants were valued using the Black Scholes pricing model and the B Warrants were valued using the Geometric Brownian Motion methodology with a risk neutral Monte Carlo approach.

                               
   
Common
Shares
Issued
   
Number of
A Warrants
   
Value of A
Warrants
   
Value of
B
Warrants
   
Total
Warrant
Value
 
Investors
    24,816,000       12,408,000     $ 1,985,280     $ 98,263     $ 2,083,543  
Bridge Loan Conversion
    1,600,000       800,000       128,000       6,335       134,335  
Equipment Finance
Conversion
    2,000,000       1,000,000       160,000       7,919       167,919  
Agency
    --       4,262,400       681,984       33,756       729,995  
Total
    28,416,000       18,470,400     $ 2,955,264     $ 146,273     $ 3,101,537  

We recorded an aggregate derivative liability of $3,101,537 as of June 30, 2012, related to the reset feature of the A warrants and the B warrants mentioned above. A derivative valuation gain of $1,659,855 was recorded to reflect the change in value of the aggregate derivative liability from the time the warrants issued.  The aggregate derivative liability of $3,101,537 was calculated as follows: (1) $2,955,264 for the reset feature of the A warrants using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.92%, (ii) expected life (in years) of 5.7; (iii) expected volatility of 84.37%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25 and (2) $146,273 for the B warrants using the Geometric Brownian Motion methodology with a risk neutral Monte Carlo approach and with the following assumptions: (i) risk free interest rate 0.92%, (ii) expected life (in years) of 5.7; (iii) expected volatility of 84.37%; (iv) maximum percent of B warrants allowed 4.99%, and (v) stock trading price of $0.25.
 
Note 8 – 2010 Equity Financing and the Debt Restructuring
 
On December 24, 2010, we closed on an equity financing (the “Equity Financing”) as well as a restructuring of our outstanding convertible indebtedness (the “Debt Restructuring”).  The Equity Financing and the Debt Restructuring are described as follows.
 
 
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We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000.  The units consisted of two shares of our common stock and one warrant to purchase a share of our common stock.  The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering.  The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the Equity Financing and the simultaneous Debt Restructuring.

Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities.  The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock.  The warrants have a term of five years and had an exercise price of $1.00 per share which was reset to $0.78 pursuant to the 2012 Equity Financing.

Net proceeds from the Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million.  We used a portion of the net proceeds of the Equity Financing to pay down debt and the remainder is being used for working capital.

On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million.  Upon the closing of the Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.

In connection with the Equity Financing and under the terms of the Subscription Agreements, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the warrants.  The registration statement was declared effective June 16, 2011 satisfying the obligation contained in the Subscription Agreements.

On December 24, 2010, we also closed on the Debt Restructuring.  In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the “Amended and Restated Note”) to Castlerigg Master Investment Ltd. (“Castlerigg”), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents were issued (the “Loan Restructuring Agreement”), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010.  As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.

The Amended and Restated Note, dated December 23, 2010, was a senior, unsecured note that matured in three years from the closing and bore interest at an annual rate of 6.25%, payable semi-annually.  We paid the first year’s interest of $350,434 at the closing.  The Amended and Restated Note was convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment.  The Amended and Restated Note was convertible in whole or in part at any time upon notice by Castlerigg to us.  The Amended and Restated Note also contained various restrictions, acceleration provisions and other standard and customary terms and conditions.  Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.

The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg.  These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied.  The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
 
 
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During the three months ended March 31, 2011, we issued Castlerigg 400,000 warrants pursuant to a waiver agreement dated March 10, 2011 allowing the issuance of shares and warrants for the conversion of the AR Note Payable without adjusting the conversion price of the Amended and Restated Senior 6.25% Convertible Note.  These warrants contain full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above and were accounted for as embedded derivatives and valued on the transaction date using a Black Scholes pricing model. During the three and six months ended June 30 ,2011 the warrant holder exercised these warrants using a cashless provision resulting in the company issuing 372,272 shares of our common stock. A valuation gain of $144,000 was recorded to reflect the change in value of the aggregate derivative from the time of issue to the date of conversion.

In connection with the Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We also issued 150,000 shares and 75,000 warrants to acquire our common stock at $.90 per share to the holder of this note as consideration to extend the term of the note.

On March 26, 2012, we closed on an equity financing (the “2012 Equity Financing”) as well as a restructuring of our outstanding senior convertible indebtedness (the “2012 Debt Restructuring”) resulting in complete satisfaction our senior indebtedness.

A portion of the net proceeds from the 2012 Equity Financing was used to close on the 2012 Debt Restructuring therewith. The Company paid $2,750,000 and issued 2,000,000 shares of common stock valued at $760,000 in satisfaction of the $5,500,000 senior convertible note and $72,570 of accrued interest.  In addition, the remaining accrued interest value of $608,066 was satisfied.

Investor warrants totaling 12,499,980 issued under the Placement Agency Agreement contain price protection adjustments in the event we issue new common stock or common stock equivalents in certain transactions at a price less than $1.00 per share and were accounted for as embedded derivatives and valued on the transaction date using a Black Scholes pricing model. Pursuant to the 2012 Equity Financing the exercise price was reset to $0.78 per share.

We recorded an aggregate derivative liability of $750,000 and $6,625,000 as of June 30, 2012 and 2011, respectively, related to the reset feature of the warrants issued under the Placement agency Agreement. A derivative valuation gain of $2,125,000 and $4,125,000, respectively, were recorded to reflect the change in value of the aggregate derivative liability since December 31, 2011 and December 31, 2010, respectively.  The aggregate derivative liability of $750,000 for the conversion feature of the note was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.49%, (ii) expected life (in years) of 3.5; (iii) expected volatility of 74.05%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.25.
 

Note 9 – Fair Value Measurements

The Company has certain financial instruments that are measured at fair value on a recurring basis. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-tier fair value hierarchy has been established which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements).  These tiers include:

 
·
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
 
·
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
 
·
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
 
 
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We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2012:

               
Significant
       
         
Quoted Prices in
   
Other
   
Significant
 
         
Active Markets for
   
Observable
   
Unobservable
 
         
Identical Assets
   
Inputs
   
Inputs
 
   
Total
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Assets
                       
None
  $ --     $ --     $ --     $ --  
Total assets measured at fair value
  $ --     $ --     $ --     $ --  
                                 
Liabilities
                               
Derivative valuation (1)
  $ 4,309,537     $ --     $ --     $ 4,309,537  
Total liabilities measured at fair value
  $ 4,309,537     $ --     $ --     $ 4,309,537  
 
(1) See Note 6 for additional discussion.
 
The table below presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at June 30, 2012.  We classify financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model.

   
Derivative
 
   
Valuation
 
   
Liability
 
Balance at December 31, 2011
  $ (3,760,200 )
Total gains or losses (realized and unrealized)
       
Included in net loss
    4,588,480  
Valuation adjustment
    --  
Purchases, issuances, and settlements, net
    (5,137,817 )
Transfers to Level 3
    --  
Balance at June 30, 2012
  $ (4,309,537 )

Fair Value of Other Financial Instruments

The carrying amounts of our accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their immediate or short-term maturities.  The aggregate carrying amount of the notes payable approximates fair value as the individual notes bear interest at market interest rates and there has not been a significant change in our operations and risk profile.

Note 10 – Equipment Financing

On August 27, 2009, we completed an equipment lease financing transaction with a financial institution.  Pursuant to the financing, we entered into various material agreements with the financial institution. These agreements are identified and summarized below.

We entered into a Master Lease Agreement dated as of July 28, 2009 with the financial institution pursuant to which we sold to the financing institution certain telecommunications equipment to be installed at 1,981 (subsequent additional locations have increased the customer’s network to an aggregate of approximately 2,100 locations) of our customer’s retail locations in exchange for a one time payment of $4,100,670 by the financial institution. We will pay to the financial institution 36 monthly lease payments of approximately $144,000 plus applicable sales taxes. We had the right to terminate the lease after making 33 payments for a termination fee of the higher of approximately 10% of the original equipment value (approximately $410,000) or the then “in-place fair market value” after which payment we would own all of the equipment. We gave timely notice of exercise of this option and are currently in the process of determining by independent appraisal the final purchase price.  Although we continue to make the lease payments those payments will be applied to the purchase price.  We continue to account for this arrangement as a capital lease pending final resolution of the purchase option.
 
 
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We also entered into a security agreement with the financial institution pursuant to which we granted a first priority security interest in the equipment, whether now owned or hereafter acquired, and in our customer service agreement and service payments thereunder during the term of the equipment lease.

During the three and six months ended June 30, 2012, we made lease payments totaling approximately $422,096 and $844,191 of which $402,614 and $791,195 was applied toward the outstanding lease with $19,482 and $52,996, respectively, included in interest expense. Additionally, we recognized amortization of the lease acquisition fee of $12,567 and $25,134 which was included in interest expense for the three and six months ended June 30, 2012, respectively.

During the three and six months ended June 30, 2011, we made lease payments totaling approximately $422,096 and $844,191 of which $349,351 and $686,524 was applied toward the outstanding lease with $72,745 and $157,667, respectively, included in interest expense. Additionally, we recognized amortization of the lease acquisition fee of $12,567 and $25,134 which was included in interest expense for the three and six months ended June 30, 2011, respectively.

Note 11 – Interact Devices Inc. (IDI)

We began investing in and advancing monies to IDI in 2001. IDI was developing technology which became CodecSys.
 
On October 23, 2003, IDI filed for Chapter 11 Federal Bankruptcy protection. We desired that the underlying patent process proceed and that the development of CodecSys technology continue. Therefore, we participated in IDI’s plan of reorganization, whereby we agreed to satisfy the debts of the creditors and obtained certain licensing rights.  On May 18, 2004, the debtor-in-possession’s plan of reorganization for IDI was confirmed by the United States Bankruptcy Court. As a result of this confirmation, we issued to the creditors of IDI approximately 111,800 shares of our common stock, and cash of approximately $312,768 in exchange for approximately 50,127,218 shares of the common stock of IDI, which increased our aggregate common share equivalents in IDI to approximately 51,426,719 shares.
 
Since May 18, 2004, we have acquired an aggregate of 4,470,450 additional common share equivalents IDI. As of June 30, 2012, we owned approximately 55,897,169 IDI common share equivalents, representing approximately 94% of the total outstanding IDI share equivalents.
 
Since May 18, 2004, we have advanced additional cash to IDI for the payment of operating expenses, which continues development and marketing of the CodecSys technology. As of June 30, 2012 we have advanced an aggregate amount of $3,251,668 pursuant to a promissory note that is secured by assets and technology of IDI.
 
Note 12 – Recent Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Presentation of Comprehensive Income. This Update defers certain paragraphs of ASU 2011-05 so that reclassifications out of accumulated other comprehensive income on the components of net income and other comprehensive income. All other requirements of ASU 2011-05 are not affected. This Update is effective for fiscal years beginning after December 15, 2011 for public entities and for fiscal years ending after December 15, 2012 for private companies to be consistent with ASU 2011-05. The Company will not present reclassifications in and out of other comprehensive income in accordance with this Update in 2012, but will present other comprehensive income as per ASU 2011-05 starting with the first quarter of 2012.
 
 
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In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220) – Presentation of Comprehensive Income. This Update eliminates the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity in order to increase the prominence of other comprehensive income items and to facilitate convergence with IFRS. The Update requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements (a statement of income and statement of other comprehensive income).  Additionally, adjustments for items reclassified from other comprehensive income to net income must be presented on the face of the financial statements.  This Update should be applied retrospectively. For public entities, the Update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the Update is effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. Early adoption is permitted, because compliance with the amendments is already permitted. The amendments do not require any transition disclosures. This impacts how items for Other Comprehensive Income are presented and the Company will follow the guidance starting in Q1 2012.

In December 2011, the FASB issued ASU 2011-11, Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities. This Update is applicable to all entities that have financial instruments and derivative instruments that are either 1) offset in accordance with current guidance or 2) subject to an enforceable master netting arrangement.  The Update requires an entity with these types of instruments to disclose information about offsetting and related arrangements. Both net and gross information for these assets and liabilities is required to be disclosed. This Update is effective for fiscal years beginning on or after January 1, 2013. The Company doesn’t expect this Update to impact the Company’s financials since it does not currently have any financial instruments or derivative instruments that are offset.

In September 2011, the FASB issued ASU 2011-08, Intangibles - Goodwill and Other  (Topic 350)- Testing Goodwill for Impairment. The objective of this Update is to simplify how entities test goodwill for impairment. This Update now allows entities to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step process of (1) comparing the fair value of the reporting unit to its carrying value and (2) test to measure the amount of the impairment loss if the fair value is less than the carrying value.  The more likely than not threshold is defined as having a likelihood of more than 50%.  The option to first assess qualitative factors can be bypassed and an entity can proceed directly to performing the first step of the two-step goodwill impairment test. Some examples of circumstances to consider are 1) macroeconomic conditions, 2) industry and market conditions, 3) cost factors that have a negative impact on earnings, 4) overall financial performance such as negative or declining cash flows 5) other relevant entity specific events and 6) sustained decrease in stock price. The Update is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011 if the financial statements have not been issued.  If necessary, the Company will evaluate whether or not it will utilize the qualitative assessment option prior to performing the first goodwill impairment test in 2012, typically done during the 4th quarter.

Note 13 – Supplemental Cash Flow Information

2012

During the six months ended June 30, 2012, we issued 250,000 shares of our common stock valued at $137,500 to one consultant in consideration for cancellation of a warrant issued for consulting services rendered.

For the six months ended June 30, 2012 an aggregate non-cash expense of $265,636 was recorded for the accretion of notes payable as follows: (i) $166,668 for the unsecured convertible note and (ii) $98,968 for the Bridge Loan.

For the six months ended June 30, 2012, we recognized $723,194 in depreciation and amortization expense from the following: (i) $396,520 related to cost of sales for equipment used directly by or for customers, (ii) $321,599 related to other property and equipment, and (iii) $5,075 for patent amortization.

2011
During the six months ended June 30, 2011, we granted options to acquire up to 600,000 shares of our common stock valued at $389,000 to two consultants in consideration of consulting services to be rendered by the consultants over a one year period pursuant to a written consulting agreement. The value of options is being recognized over the contract period and for the six months ended June 30, 2011, $167,566 was included in stock based compensation.
 
 
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On March 21, 2011, the Company, converted $784,292 of its short-term debt into equity through the issuance of common stock and warrants to two lenders at the same unit pricing as the Equity Financing. In consideration of converting the short- term loans on the basis of $1.20 for two shares of common stock plus one warrant at an exercise price of $1.00, the Company issued 1,307,153 shares of common stock and warrants to acquire up to 653,576 shares of common stock, which warrants have a five year term and are exercisable at $1.00 per share. The Company’s objective for converting the short-term debt into equity was to conserve cash for further market development.
 
In March 2011, we granted to the holder of our senior unsecured convertible note a warrant to acquire 400,000 shares of our common stock at an exercise price of $.05 per share in consideration of a waiver of the holder’s reset provision that allowed us to convert certain short terms loans to equity without causing an adjustment in the conversion price of our senior note.  The warrants have a 5 - year life from the date of grant, contain full-ratchet anti-dilution price protection provisions and were valued $404,000 using a Black Scholes pricing model on the date of grant.

For the six months ended June 30, 2011 an aggregate non-cash expense of $166,668 was recorded for the accretion of the unsecured convertible note.

For the six months ended June 30, 2011, we recognized $749,312 in depreciation and amortization expense from the following: (i) $401,152 related to cost of sales for equipment used directly by or for customers, (ii) $343,084 related to equipment other property and equipment, and (iii) $5,076 for patent amortization.

Note 14 – Subsequent Events

On July 13, 2012, we entered into a note and warrant purchase and security agreement with 7 investors and broke escrow on the initial funding under a convertible debt offering, the principal amount of which was $1,900,000, which included the conversion of $900,000 of previously issued short term debt.

We evaluated subsequent events pursuant to ASC Topic 855 and have determined that there are no additional events that need to be reported.
 
 
 
 
 
 
 
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Item 2.      MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Note Regarding Forward-Looking Statements
 
This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risk and uncertainties.  Any statements about our expectations, beliefs, plans, objectives, strategies or future events or performance constitute forward-looking statements.  These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend” and similar words or phrases.  Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed or implied therein.  All forward-looking statements are qualified in their entirety by reference to the factors discussed in this report and to the following risk factors discussed more fully in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2011:
 
 
·
dependence on commercialization of our CodecSys technology;
 
 
·
our need and ability to raise sufficient additional capital;
 
 
·
uncertainty about our ability to repay our outstanding convertible notes;
 
 
·
our continued losses;
 
 
·
delays in adoption of our CodecSys technology;
 
 
·
concerns of OEMs and customers relating to our financial uncertainty;
 
 
·
restrictions contained in our outstanding convertible notes;
 
 
·
general economic and market conditions;
 
 
·
ineffective internal operational and financial control systems;
 
 
·
rapid technological change;
 
 
·
intense competitive factors;
 
 
·
our ability to hire and retain specialized and key personnel;
 
 
·
dependence on the sales efforts of others;
 
 
·
dependence on significant customers;
 
 
·
uncertainty of intellectual property protection;
 
 
·
potential infringement on the intellectual property rights of others;
 
 
·
extreme price fluctuations in our common stock;
 
 
·
price decreases due to future sales of our common stock;
 
 
·
future shareholder dilution; and
 
 
·
absence of dividends.
 
Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed or implied in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statement.  Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments.  New factors emerge from time to time, and it is not possible for us to predict which factors will arise.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
 
 
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Critical Accounting Policies
 
The preparation of financial statements in conformity with U.S. GAAP requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our assumptions and estimates, including those related to recognition of revenue, valuation of investments, valuation of inventory, valuation of intangible assets, valuation of derivatives, measurement of stock-based compensation expense and litigation. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss our critical accounting policies in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011. There have been no other significant changes in our critical accounting policies or estimates since those reported in our Annual Report.
 
Executive Overview
 
The current recession and market conditions have had substantial impacts on the global and national economies and financial markets.  These factors, together with soft credit markets, have slowed business growth and generally made potential funding sources more difficult to access.  We continue to be affected by prevailing economic and market conditions, which present considerable risks and challenges to us.

On July 1, 2010, we released CodecSys 2.0, which has been installed in various large telecoms and labs for evaluation by potential customers. In 2011 we continued development of additional sales channel partners by integrating CodecSys on hardware manufactured and sold by Fujitsu, which has adopted CodecSys as its compression technology for use in its NuVola cloud initiative and has commenced sales and marketing efforts including CodecSys as an integral part of the products.  We continue to make sales presentations and respond to requests for proposals at other large telecoms, cable companies and broadcasting companies.  These presentations have been made with our technology partners which are suppliers of hardware and software for video transmission applications in media room environments such as IBM, HP Fujitsu and Microsoft. In October 2011, we completed our first sale of CodecSys to a small cable operator in Mexico as part of its Over the Top (“OTT”) product offering operating on Fujitsu hardware.  It is currently in operation and demonstrates that the CodecSys product offering does operate to its operating specifications in a working environment, which we believe will help in our sales and marketing efforts.  Although license revenue from the CodecSys technology has been minimal to date, we believe we have made significant progress and continue to believe that our CodecSys technology holds substantial revenue opportunities for our business.  We have continued to market our products to the industry and have recently entered into sales agreements with four additional cable, satellite and broadcast companies for their OTT initiatives.  Revenues from these sales will be first recorded in the third and fourth quarters of 2012.

On July 31, 2009, we entered into a $10.1 million, three-year contract with Bank of America, a Fortune 10 financial institution, to provide technology and digital signage services to approximately 2,100 of its more than 6,000 retail and administrative locations throughout North America.  This contract has expired.  BofA is in the process of expanding its network to additional locations and we now furnish services to approximately 33,000 screens at more than 2,500 locations.  In addition, BofA selected us to be its vendor for certain additional audio visual services.  A factor in securing this contract was the benefits of the CodecSys technology in delivering our services.  For the quarter ended June 30, 2012, we realized approximately $1,693,679 in revenue from this contract, which contributed approximately 85% of our revenues for the quarter.  We continue to provide services to our customer on a month to month basis. BofA is in the process of soliciting requests for proposals from competing vendors, to which we have responded as well.

Our revenues for the quarter ended June 30, 2012 decreased by approximately $357,169 or 15% compared to the quarter ended June 30, 2011. The decrease in our revenues and a decrease of approximately $82,580 or 11% in our gross margin for the quarter ended June 30, 2012 compared to the same period in 2011 contributed to the continued depletion of our available cash and increased our need for future equity and debt financing as we continue to spend more money than we generate from operations.
 
 
24

 
 
To fund operations through the remainder of the current year, we engaged our investment banker to raise funds through the issuance of convertible promissory notes.  We anticipate issuing promissory notes with a principal amount of up to $3,000,000 (later amended to $5,000,000) (“2012 Convertible Debt Offering”) due and payable on or before July 13, 2013.  The notes will bear interest at 12% per annum and be convertible to common stock at a $.25 per share conversion price.  We will also grant to holders of the notes warrants with a five year life to acquire up to 200,000 shares of our common stock for each $100,000 of principal amount of the convertible notes.  The notes will be secured by all of our assets with the exception of the equipment and receivables secured by Hitachi Bank related to our largest customer’s digital signage network.  On July 13, 2012, we entered into a note and warrant purchase and security agreement with individual investors and broke escrow on the initial funding under the 2012 Convertible Debt Offering, the principal amount of which was $1,900,000, which included the conversion of $900,000 of previously issued short term debt (See Bridge Loan described below) to the 2012 convertible Debt Offering.  We realized $1,000,000 of cash in the initial closing and issued warrants to acquire 3,800,000 shares of our common stock.  We paid $76,825 in investment banking fees and costs of the offering.

On March 26, 2012, we closed on an equity financing (the “2012 Equity Financing”) as well as a restructuring of our outstanding senior convertible indebtedness (the “2012 Debt Restructuring”), resulting in complete satisfaction of our senior indebtedness.

We entered in to an Engagement Agreement, dated October 28, 2011, with MDB Capital Group, LLC (“MDB”), pursuant to which MDB agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of the Company’s securities of up to a maximum gross consideration of $6,000,000, subsequently verbally increased to $10,000,000, subject to a minimum gross consideration of $3,000,000.  The Company agreed to pay to MDB a commission of 10% of the gross offering proceeds received by the Company, to grant to MDB warrants to acquire up to 10% of the shares of our common stock issued in the financing, and to pay the reasonable costs and expenses of MDB related to the offering.
 
Pursuant to the Engagement Agreement, we entered into a Securities Purchase Agreement (“SPA”) dated March 23, 2012 with select institutional and other accredited investors for the private placement of 27,800,000 units of its securities.  The SPA included a purchase price of $.25 per unit, with each unit consisting of one share of common stock and two forms of Warrant: (1) The “A” Warrant grants the investors the right to purchase an additional share of common stock for each two shares of common stock purchased, for a term of six years and at an exercise price of $.35 per share; and (2) The “B” Warrant will not be exercisable unless and until the occurrence of a future issuance of stock at less than $0.25 per share, but, in the event of such issuance, grants the investors the right to acquire additional shares at a price of $0.05 to reduce the impact of the dilution caused by such issuance, but in no event shall the number of shares to be issued under the B Warrant cause us to exceed the number of authorized shares of common stock. The shares in excess of our authorized shares that would have been issuable under the B Warrant shall be “net settled” by payment of cash in an amount equal to the number of shares in excess of the authorized common shares multiplied by the closing price of our common stock as of the trading day immediately prior to the applicable date of the exercise of such B Warrant. The B Warrant shall be extinguished upon the earlier of: (a) a subsequent financing of at least $5 million on terms no more favorable than that received by the investors in the 2012 Equity Financing; (b) after the effective date of the registration statement registering securities issued in the Equity Financing if the volume-weighted average closing price of the Company’s common stock exceeds $.50 per share for a period of 30 trading days and no Volume Failure (as defined in the B Warrant) (measuring the daily average dollar volume of our Common Stock against a minimum volume of $500,000 per day) exists during such period, and the Company is then current in its public filings; or (c) 78 months.

Net proceeds from the 2012 Equity Financing, after deducting the commissions and the estimated legal, printing and other costs and expenses related to the financing, were approximately $6.1 million.  Coincident to the closing of the 2012 Equity Financing, we also closed on the 2012 Debt Restructuring.  In connection therewith, the Company paid $2.75 million to Castlerigg Master Investment Ltd. (“Castlerigg”), and issued to Castlerigg 2,000,000 shares of common stock in full and complete satisfaction of the remaining principal balance and all accrued interest of the Amended and Restated Note.  In consideration of negotiating the 2012 Debt Restructuring, we issued to one of our placement agents 586,164 shares of our common stock and paid $275,041.

In December 2011, we entered into a loan with 7 accredited individuals and entities under the terms of which we borrowed $1,300,000 to be used as working capital (“Bridge Loan”).  The Bridge Loan bears an interest rate of 18% per annum and had a maturity date of February 28, 2012, which was subsequently extended to the earlier of the date nine months from the original maturity date or the date we close on an additional sale of our securities that results in gross proceeds to us of $12 million.  In consideration of the Bridge Loan we granted to the holders of the Bridge Loan warrants with a five year term to purchase 357,500 shares of our common stock at an exercise price of $0.65 per share.  In consideration of the extension of the maturity date of the Bridge Loan, we granted the holders of the Bridge Loan warrants with a six year term to purchase 247,500 shares of our common stock at an exercise price of $0.35 per share.
 
 
25

 
 
In connection with the 2012 Equity Financing and under the terms of the SPA, two of the above described bridge lenders converted the principal balance of their portion of the bridge loan in the amount of $400,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing.  In addition, one other entity converted the amount owed by us for equipment purchases in the amount of $500,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing. The proceeds from these conversions were treated as funds raised with respect to the financing.

In connection with the 2012 Equity Financing and under the terms of the SPA, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants.  The Company did file the registration statement on April 9, 2012 and it was declared effective on August 1, 2012.

In April 2012, an additional investment was accepted by us as part of the 2012 Equity Financing in the aggregate amount of $154,000, which included cash of $100,000 and the conversion of $54,000 of director fees owed to two of our directors to stock and warrants on the same terms as the offering.  This resulted in the issuance of 616,000 shares of common stock and the issuance of warrants to acquire up to 308,000 shares of our common stock.  In connection with this part of the transaction we paid a commission of $15,400 to our investment banker and issued to the broker warrants to acquire 92,400 shares of our common stock on the same terms as in the financing.

During 2010 we sold 1,601,666 shares of our common stock to 19 separate investors at a purchase price of $1.00 per share together with a warrant to purchase additional shares of our stock for $1.50 per share. The warrant expires at the end of three years. The net proceeds from the sale of these shares were used for general working capital purposes. Each of the investors was given the right to adjust their purchase in the event we sold additional equity at a price and on terms different from the terms on which their equity was purchased.  Upon completion of the 2010 Equity Financing described below, each of the investors converted their purchase to the terms contained in the 2010 Equity Financing.  This resulted in the issuance of an additional 2,083,374 shares of common stock and the cancellation of 2,495,075 warrants with an exercise price of $1.50 and the issuance of 2,079,222 warrants with an exercise price of $1.00 and an expiration date of five years from the conversion.

On December 24, 2010, we closed on an equity financing (the “2010 Equity Financing”) as well as a restructuring of our outstanding convertible indebtedness (the “2010 Debt Restructuring”).  The 2010 Equity Financing and the 2010 Debt Restructuring are described as follows.

We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000.  The Units consisted of two shares of our common stock and one warrant to purchase a share of our common stock.  The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering.  The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the 2010 Equity Financing and the simultaneous 2010 Debt Restructuring.

Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities.  The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock.  The warrants have a term of five years and had an exercise price of $1.00 per share, but are now exercisable at $0.78 per share pursuant to the 2012 Equity Financing.

Net proceeds from the 2010 Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million.  We used a portion of the net proceeds of the Equity Financing to pay down debt and the remainder was used for working capital.

On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million.  Upon the closing of the 2010 Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the 2010 Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.
 
 
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In connection with the 2010 Equity Financing and under the terms of the Subscription Agreements, the Company agreed to prepare and file and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants.  The registration statement continues to be effective.

On December 24, 2010, we also closed on the 2010 Debt Restructuring.  In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the “Amended and Restated Note”) to Castlerigg Master Investment Ltd. (“Castlerigg”), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents were issued (the “Loan Restructuring Agreement”), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010.  As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.

The Amended and Restated Note, dated December 23, 2010, was a senior, unsecured note that matured in three years from the closing and bore interest at an annual rate of 6.25%, payable semi-annually.  We paid the first year’s interest of approximately $344,000 at the closing.  The Amended and Restated Note was fully satisfied as described above.

In connection with the 2010 Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013.  We also issued 150,000 shares to the holder of this note and a warrant to acquire up to 75,000 shares of our common stock as consideration to extend the term of the note. The warrant is exercisable for $0.90 per share and has a five year life.

Results of Operations for the Six Months ended June 30, 2012 and June 30, 2011

Revenues

We generated $3,745,085 in revenue during the six months ended June 30, 2012.  During the same six-month period in 2011, we generated revenue of $4,044,442.  The decrease in revenue of $299,336 or 8% was due primarily to the installation of fewer new bank locations for our major customer servicing its digital signage contract, which accounted for approximately 86% of our revenues for the six months ending June 30, 2012. Except for one other customer whose revenues increased by $130,000, revenues from our other customers were basically unchanged.

Sales revenues from our largest customer accounted for approximately 86% of total revenues for the six months ended June 30, 2012 and approximately 91% for the six months ended June 30, 2011. The revenues from our largest digital signage customer have materially affected our results of operations, financial condition and liquidity.  Although this customer’s contract has expired we continue to provide services to it on a month to month basis.  It has requested proposals from competing vendors, to which we have also submitted our proposal for a contract renewal.

Cost of Revenues

Cost of revenues decreased by approximately $304,634 to $2,591,458 for the six months ended June 30, 2012 from $2,896,092 for the six months ended June 30, 2011. The gross margin from operations increased $5,298 from a gross margin of $1,148,329 in the six months ended June 30, 2011 to a gross margin of $1,153,627 for the six months ended June 30, 2012. The decrease in cost of revenues was due primarily to fewer installations for our largest customer’s digital signage network and other smaller customers, which accounted for approximately $224,306 of the total decrease in cost of revenues and a decrease in the general operations department costs of $73,041, due to the decrease in installation activity.  Although the total revenues and costs of revenues decreased, the gross margin from operations increased due to higher margin work being completed.
 
 
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Expenses

General and administrative expenses for the six months ended June 30, 2012 were $2,588,601 compared to $3,844,700 for the six months ended June 30, 2011. The decrease of approximately $1,256,099 resulted from a decrease totaling $1,561,556 in granted option and warrant expenses primarily related to grant of restricted stock options for officers and directors in 2011, that was not repeated in 2012, which was partially offset by an increase of $201,245 in employee and temporary help expenses and an increase of $50,044 in consulting expenses.  Research and development in process decreased by $201,985 for the six months ended June 30, 2012 to $1,021,414 from $1,223,399 for the six months ended June 30, 2011. The continued high level of development expenditures is the result of the CodecSys development plan and is expected to continue in the foreseeable future as the product is refined for commercial deployment and adapted for use on additional hardware platforms and customer delivery systems. The decrease resulted primarily from a decrease of $117,526 in consulting fees, $53,293 in travel and related expenses and $45,113 in employee related expenses when compared to such expenses incurred in 2011.  Sales and marketing expenses increased $692,296 to $1,115,240 for the six months ending June 30, 2012 from $422,945 for the six months ending June 30, 2011.  The increase reflects increased employee related expenses of $400,824, an increase in conventions and related travel expenses of $204,005 and an increase in consulting expenses of $66,131.

Interest Expense

For the six months ended June 30, 2012, we incurred interest expense of $606,211 compared to interest expense for the six months ended June 30, 2011 of $569,878.  The increase of $36,333 resulted primarily from interest expense of approximately $241,144 related to the interest accrued on short term promissory notes used for working capital issued before consummating the 2012 Equity Financing and interest of $63,000 related to short term equipment financing partially offset by a one-time charge to interest in 2011 of $157,400 related to payment of by issuing interest to common stock to the holder of our unsecured convertible note and a decrease $104,671 in finance costs related to leased equipment for our largest customer.

Net Income

We realized net income for the six months ended June 30, 2012 of $661,715 compared with a net loss for the six months ended June 30, 2011 of $304,641 resulting in a change in net income of $966,356. The increase in net income resulted primarily from a decrease in operating expenses of $787,273. The loss from operations of $3,898,303 for the six months ended June 30, 2012 was offset by a gain of $4,588,840 related to our derivative valuation gain calculation and a gain from the sale of securities of $1,672,575 related to debt extinguishment partially offset by an unrealized loss on securities of $1,095,309, also related to extinguishment of debt, and interest expense of $606,211, as explained above.

Results of Operations for the Three Months ended June 30, 2012 and June 30, 2011

Revenues

We generated $1,999,988 in revenue during the three months ended June 30, 2012.  During the same three-month period in 2011, we generated revenue of $2,357,158.  The decrease in revenue of $357,169 or approximately 18% was due primarily to fewer expansion sites being installed with digital signage equipment for our largest customer in 2012 than in 2011.  The revenue generated for this customer aggregated $1,692,029 for the three months ended June 30, 2012 compared to $2,201,952 for the three months ended June 30, 2011.  The decrease of $509,923 in revenues from this customer was partially offset by an increase in revenues from existing customers that increased their purchases of services from us.

Our largest customer accounted for approximately 85% of our revenues for the three months ended June 30, 2012 compared to 93% of our revenues for the three months ended June 30, 2011.  Any material reduction in revenues generated from our largest customer could harm the Company’s results of operations, financial condition and liquidity or if we are not successful in obtaining a renewal of this contract our operations, financial condition and liquidity will be materially impacted.

Cost of Revenues

Costs of revenues decreased by $274,589 to $1,345,966 for the three months ended June 30, 2012, from $1,620,556 for the three months ended June 30, 2011.  The decrease was primarily due to a reduction in the number of expansion locations at which we installed equipment and commenced operations for our largest customer’s digital signage network.  In addition, the expenses incurred by the operations department decreased by $45,085, which was primarily the result of our decreased activity for our digital signage customer.
 
 
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Expenses

General and administrative expenses for the three months ended June 30, 2012 were $1,259,320 compared to $1,236,328 for the three months ended June 30, 2011.  The net decrease of $22,992 resulted primarily from an increase in employee and temporary help expenses of $121,729 offset by a decrease of $142,268 in option and warrant expense.  Research and development in process decreased by $160,781 for the three months ended June 30, 2012 to $464,847 from $625,628 for the three months ended June 30, 2011, which resulted primarily from a decrease of $79,649 in consulting fees, a decrease of $78,137 in employee and related expenses including one-time hiring expenses incurred in 2011 and a decrease of $58,939 in expenses for tradeshows and related travel.  Sales and marketing expenses increased by $335,834, which increase was composed mainly of increases of $172,723 in employee related expenses, $88,082 in tradeshow and related travel expenses and $51,690 in consulting expenses.

Interest Expense

For the three months ended June 30, 2012, the Company incurred interest expense of $263,483 compared to interest expense for the three months ended June 30, 2011 of $188,689.  The increase of $74,794 resulted primarily from interest of $92,237 related to the 2011 Bridge Note financing and amortization of debt offering costs of $32,909, which was partially offset by a decrease of $53,264 in interest incurred for equipment financing for our largest digital signage network customer.

Net Income

The Company realized net income for the three months ending June 30, 2012 of $847,192 compared with net income for the three months ended June 30, 2011 of $442,324. The increase in net income of $404,868 was primarily the result of the increase in our derivative valuation of $772,255 partially offset by the increased loss from operations of $277,301 and increased interest expense of $74,794 as explained above.

Liquidity and Capital Resources

At June 30, 2012, we had cash of $403,259, total current assets of $2,103,241, total current liabilities of $8,579,357 and total stockholders' deficit of $5,687,889.  Included in current liabilities is $4,309,537 relating to the value of the embedded derivatives for our unsecured convertible note, and warrants issued in connection with our 2012 Equity Financing.
 
Cash used in operations during the six months ended June 30, 2012 was $1,777,339 compared to cash used in operations for the six months June 30, 2011 of $2,879,361. Although the net cash used in operations decreased it was partially due to an increase in accounts payable of $1,414,189.  The negative cash flow was sustained by cash reserves from the equity offering completed in March 2012.  We expect to continue to experience negative operating cash flow as long as we continue our technology commercialization and development program or until we increase our sales and/or licensing revenue.
 
To fund operations through the remainder of the current year, we engaged Philadelphia Brokerage Corporation to raise funds through the issuance of convertible promissory notes.  We anticipate issuing promissory notes with an aggregate principal amount of up to $3,000,000 (later amended to $5,000,000) (“2012 Convertible Debt Offering”).  The notes are due and payable on or before July 13, 2013.The notes will bear interest at 12% per annum and be convertible to common stock at a $.25 per share conversion price.  We will also grant to holders of the notes warrants with a five year life to acquire up to 200,000 shares of our common stock for each $100,000 of principal amount of the convertible notes.  The notes will be secured by all of our assets with the exception of the equipment and receivables secured by Hitachi Bank related to our largest customer’s digital signage network.  On July 13, 2012, we entered into a note and warrant purchase and security agreement with individual investors and broke escrow on the initial funding under the 2012 Convertible Debt Offering. The principal amount of the initial notes issued was $1,900,000, which included the conversion of $900,000 of previously issued short term debt (See Bridge Loan described below) to the 2012 Convertible Debt Offering.  At the initial escrow break, we realized $1,000,000 of cash and issued warrants to acquire 3,800,000 shares of our common stock.  We paid $76,825 in investment banking fees and costs of the offering.

 
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On March 26, 2012, we closed on an equity financing (the “2012 Equity Financing”) as well as a restructuring of our outstanding senior convertible indebtedness (the “2012 Debt Restructuring”) resulting in complete satisfaction our senior indebtedness.
 
We entered into an Engagement Agreement, dated October 28, 2011, with MDB Capital Group, LLC (“MDB”), pursuant to which MDB agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $6,000,000, subsequently verbally increased to $10,000,000, of the Company’s securities, subject to a minimum gross consideration of $3,000,000.  The Company agreed to pay to MDB a commission of 10% of the gross offering proceeds received by the Company, to grant to MDB warrants to acquire up to 10% of the shares of our common stock and warrants issued in the financing, and to pay the reasonable costs and expenses of MDB related to the offering.
 
Pursuant to the Engagement Agreement, we entered into a Securities Purchase Agreement (“SPA”) dated March 23, 2012 with select institutional and other accredited investors for the private placement of 27,800,000 units of its securities.  The SPA included a purchase price of $.25 per unit, with each unit consisting of one share of common stock and two forms of Warrant: (1) The “A” Warrant grants the investors the right to purchase an additional share of common stock for each two shares of common stock purchased, for a term of six years and at an exercise price of $.35 per share; and (2) The “B” Warrant will not be exercisable unless and until the occurrence of a future issuance of stock at less than $0.25 per share, but, in the event of such issuance, grants the investors the right to acquire additional shares at a price of $0.05 to reduce the impact of the dilution caused by such issuance, but in no event shall the number of shares to be issued under the B Warrant cause us to exceed the number of authorized shares of common stock. The shares in excess of our authorized shares that would have been issuable under the B Warrant shall be “net settled” by payment of cash in an amount equal to the number of shares in excess of the authorized common shares multiplied by the closing price of our common stock as of the trading day immediately prior to the applicable date of the exercise of such B Warrant. The B Warrant shall be extinguished upon the earlier of: (a) a subsequent financing of at least $5 million on terms no more favorable than that received by the investors in the 2012 Equity Financing; (b) after the effective date of the registration statement registering securities issued in the Equity Financing if the volume-weighted average closing price of the Company’s common stock exceeds $.50 per share for a period of 30 trading days and no Volume Failure (as defined in the B Warrant) (measuring the daily average dollar volume of our Common Stock against a minimum volume of $500,000 per day) exists during such period, and the Company is then current in its public filings; or (c) 78 months.

Net proceeds from the 2012 Equity Financing, after deducting the commissions and the estimated legal, printing and other costs and expenses related to the financing, were approximately $6.1 million.  Coincident to the closing of the 2012 Equity Financing, we also closed on the 2012 Debt Restructuring.  In connection therewith, the Company paid $2.75 million to Castlerigg Master Investment Ltd. (“Castlerigg”), and issued to Castlerigg 2,000,000 shares of common stock in full and complete satisfaction of the senior convertible note and all accrued interest then owing. In consideration of negotiating the 2012 Debt Restructuring, we issued to one of our placement agents 586,164 shares of our common stock and paid cash of $275,041.

In December 2011, we entered into a loan with 7 accredited individuals and entities under the terms of which we borrowed $1,300,000 to be used as working capital (“Bridge Loan”).  The Bridge Loan bears interest at the rate of 18% per annum and had a maturity date of February 28, 2012, which was subsequently extended to the earlier of the date nine months from the original maturity date or the date we close on an additional sale of our securities that results in gross proceeds to us of $12 million.  In consideration of the Bridge Loan we granted to the holders of the Bridge Loan warrants with a five year term to purchase 357,500 shares of our common stock at an exercise price of $0.65 per share.  In consideration of the extension of the maturity date of the Bridge Loan, we granted the holders of the Bridge Loan warrants with a six year term to purchase 247,500 shares of our common stock at an exercise price of $0.35 per share.

In connection with the 2012 Equity Financing and under the terms of the Subscription Agreements, two of the above described bridge lenders converted the principal balance of their portion of the bridge loan in the amount of $400,000 to common stock and warrants as part of and on the same terms as the 2012 Equity Financing. The proceeds from this conversion were treated as funds raised with respect to the financing.   In July, the remaining $900,000 of the bridge loan principal was converted to debt as part of the 2012 Convertible Debt Offering.

In connection with the 2012 Equity Financing and under the terms of the SPA, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants.  The registration statement was declared effective August 1, 2012.
 
 
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In October 2011, we secured favorable terms with a single company on purchases of certain equipment installed and sold to our customers in the amount of $700,000, which was outstanding at the end of the year.  The payment for the equipment was deferred for a 90 day period for a 10% premium to the amounts advanced.  This company converted $500,000 of the amount owed by us to common stock and warrants as part of and on the same terms as the 2012 Equity Financing. The proceeds from this conversion were treated as funds raised with respect to the financing.
 
We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000.  The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering.  The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the 2010 Equity Financing and simultaneous 2010 Debt Restructuring.

Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities.  The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock.  The warrants have a term of five years and had an exercise price of $1.00 per share when issued, but are now exercisable at $0.78 per share due to adjustments in price incident to the 2012 Equity Financing.

Net proceeds from the 2010 Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million.  We used a portion of the net proceeds of the 2010 Equity Financing to pay down our senior debt, brought our accounts payable current,  and the remainder was used for working capital.
On December 24, 2010, we also closed on the 2010 Debt Restructuring.  In connection therewith, we (i) issued the Amended and Restated Note in the principal amount of $5.5 million to Castlerigg, (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement with Castlerigg dated December 23, 2010 pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the Loan Restructuring Agreement, and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010.  As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.

The Amended and Restated Note, dated December 23, 2010, was a senior, unsecured note that matured in three years from the closing and bore interest at an annual rate of 6.25%, payable semi-annually.  We paid the first year’s interest of approximately $344,000 at the closing.  The Amended and Restated Note was fully satisfied as described above.

The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg.  These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied.  The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.

In connection with the 2010 Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013.  We also issued 150,000 to the holder of this note as consideration to extend the term of the note and issued to the holder a warrant to acquire up to 75,000 shares of our common stock.  The warrant is exercisable at $.90 per share and the term of the warrant is for five years.
 
 
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On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million.  Upon the closing of the 2010 Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.

In connection with the 2010 Equity Financing and under the terms of the Subscription Agreements, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants.  During March 2010 through October 2010, we raised approximately $2.485 million through the sale of common stock and the issuance of convertible notes to purchasers at an investment or conversion price of $1.00 per share. The financing included the sale of 1,535,000 shares of our common stock and the issuance of convertible notes in the aggregate principal amount of $950,000. We also issued to these purchasers warrants to acquire shares of our common stock at an exercise price of $1.50 per share, which are exercisable anytime during a three year period.  At the time of these sales, we agreed to certain price protection provisions whereby if we were to sell equity at a price lower than $1.00 per share before December 31, 2010, the purchasers would be able to elect to exchange and receive equity on the same financial terms and conditions as the new investors.

All holders of the convertible notes converted the notes and aggregate accrued interest of $10,075 into 960,075 shares of our common stock at a conversion price of $1.00 per share.  In addition, the holders received warrants to acquire up to 960,075 shares our common stock at an exercise price of $1.50 per share.  The shares issued upon conversion of the notes, together with the 1,535,000 shares issued to the purchasers of the common stock, total 2,495,075 shares of our common stock.  In addition, warrants to purchase an aggregate of 2,495,075 shares at an exercise price of $1.50 were held by the purchasers in this financing.  The warrants could be exercised at any time for a period of three years.

Upon completion of the 2010 Equity Financing, each of the investors in these sales elected to treat their purchases according to the terms contained in the 2010 Equity Financing.  This resulted in the issuance of an additional 2,083,374 shares of common stock and the cancellation of 2,495,075 warrants with an exercise price of $1.50 and the issuance of 2,079,222 warrants with an exercise price of $1.00 and an expiration date of five years from the conversion.

During 2010, we entered into two Accounts Receivable Purchase Agreements with one individual for an aggregate amount of $775,000. In these agreements, we pledged certain outstanding accounts receivable in exchange for an advance payment and a commitment to remit to the purchaser the amount advanced upon collection from our customer. Terms of the first agreement under which we were advanced $275,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which we were advanced $500,000 include a 10% discount with a 0.5% interest fee for every 30 days the advances remain outstanding.

During 2010, we entered into a $500,000 line of credit for equipment financing to purchase equipment for our largest customer’s digital signage network.  The terms of the line of credit include a 3% interest fee for every 30 days the advances on the line of credit remain outstanding.  We received total advances on the line of credit of $500,000 and subsequent to the completion of the Equity Financing repaid the line of credit.  We used the proceeds to purchase and install the equipment at our customer’s locations.

In August 2009, we entered into a sale and leaseback agreement which financed the purchase and installation of equipment to retrofit our new customer’s approximately 2,100 retail sites with our digital signage product offering.  We received approximately $4,100,000 from the sale of the equipment in exchange for making lease payments over a 36 month period of approximately $144,000 per month.

On December 24, 2007, we entered into a securities purchase agreement in connection with our senior secured convertible note financing in which we raised $15,000,000 (less $937,000 of prepaid interest).  We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes.  The senior secured convertible note has been retired as described above.  During 2010, we capitalized interest of $1,491,161 related to the senior secured convertible note.
 
 
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On November 2, 2006, we closed on a convertible note securities agreement dated October 28, 2006 with an individual that provided we issue to the convertible note holder (i) an unsecured convertible note in the principal amount of $1,000,000 representing the funding received by us from an affiliate of the convertible note holder on September 29, 2006, and (ii) four classes of warrants (A warrants, B warrants, C warrants and D warrants) which gave the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock.  The holder of the note no longer has any warrants to purchase any of our stock.  The unsecured convertible note was due October 16, 2009 and was extended to December 22, 2010 and the annual interest rate was increased to 8%, payable semi-annually in cash or in shares of our common stock if certain conditions are satisfied The unsecured convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share, convertible any time during the term of the note, and is subject to standard anti-dilution rights.  The term of the convertible note has been extended and now is due December 31, 2013.  In connection with the extension of the note, we issued to the holder of the note 150,000 shares of common stock and a five year warrant to acquire up to 75,000 shares of our common stock and an exercise price of $.90 per share to extend the term of the note.  In addition, we committed to pay accrued interest due on the convertible note through the issuance of common stock and warrants on the same terms as the Equity Financing.

The conversion feature and the prepayment provision of our $5.5 million Amended and Restated Note and our $1.0 million unsecured convertible note have been accounted for as embedded derivatives and valued on the respective transaction dates using a Black-Scholes pricing model.  The warrants related to the $1.0 million unsecured convertible notes have been accounted for as derivatives and were valued on the respective transaction dates using a Black-Scholes pricing model as well.  At the end of each quarterly reporting date, the values of the embedded derivatives and the warrants are evaluated and adjusted to current market value.  The conversion features of the convertible notes and the warrants may be exercised at any time and, therefore, have been reported as current liabilities.  Prepayment provisions contained in the convertible notes limit our ability to prepay the notes in certain circumstances.  For all periods since the issuance of the senior secured convertible note and the unsecured convertible note, the derivative values of the respective prepayment provisions have been nominal and have not had any offsetting effect on the valuation of the conversion features of the notes.  For a description of the accounting treatment of the senior secured convertible note financing, see Note 7 to the Notes to Condensed Consolidated Financial Statements (Unaudited) included elsewhere herein.

On March 21, 2011, we converted $784,292 of our short-term debt into equity through the issuance of common stock and warrants to two lenders at the same unit pricing as the 2010 Equity Financing. In consideration of converting the short- term loans on the basis of $1.20 for two shares of common stock plus one warrant at an exercise price of $1.00, we issued 1,307,153 shares of common stock and warrants to acquire up to 653,576 shares of common stock, which warrants have a five year term and are exercisable at $1.00 per share. Our objective for converting the short-term debt into equity was to conserve cash.

Our monthly operating expenses, including our CodecSys technology research and development expenses, exceeded our monthly net sales by approximately $475,000 per month during the six months ended June 30, 2012.  We did not have sufficient capital resources at June 30, 2012 to fund our negative cash flow for the remainder of the year without raising additional capital and therefore commenced the 2012 Convertible Debt Offering.  The foregoing estimates, expectations and forward-looking statements are subject to change as we make strategic operating decisions from time to time and as our expenses and sales fluctuate from period to period.

The amount of our operating deficit could decrease or increase significantly depending on strategic and other operating decisions, thereby affecting our need for additional capital.  We expect our operating expenses will continue to outpace our net sales until we are able to generate additional revenue.  Our business model contemplates that sources of additional revenue include (i) sales from our private communication network services, (ii) sales resulting from new customer contracts, and (iii) sales, licensing fees and/or royalties related to commercial applications of our CodecSys technology, including sales resulting from marketing efforts by companies such as Fujitsu, IBM, HP and Microsoft.

Our long-term liquidity is dependent upon execution of our business model and the realization of additional revenue and working capital as described above, and upon capital needed for continued commercialization and development of the CodecSys technology.  Commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $2.0 million annually for the foreseeable future.  This estimate will increase or decrease depending on specific opportunities and available funding.
To date, we have met our working capital needs primarily through funds received from sales of our common stock and from convertible debt financings.  Until our operations become profitable, we will continue to rely on proceeds received from external funding.  We expect additional investment capital may come from (i) the exercise of outstanding warrants to purchase our capital stock currently held by existing warrant holders; (ii) additional private placements of our common stock with existing and new investors; and (iii) the private placement of other securities with institutional investors similar to those institutions that have provided funding in the past.
 
 
33

 
 
Off-Balance Sheet Arrangements
 
We have no off-balance sheet arrangements.

Item 3.    Quantitative and Qualitative Disclosures about Market Risk
 
Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates.  We do not issue financial instruments for trading purposes or have any derivative financial instruments.  As discussed above, however, the embedded conversion feature and prepayment option of our senior secured convertible notes and our related warrants are deemed to be derivatives and are subject to quarterly “mark-to-market” valuations.

Our cash and cash equivalents are also exposed to market risk.  However, because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our cash and cash equivalent investments.  We currently do not hedge interest rate exposure and are not exposed to the impact of foreign currency fluctuations.

Item 4.    Controls and Procedures

Disclosure Controls and Procedures
 
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act.  As of June 30, 2012, an evaluation was performed, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures.  Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of June 30, 2012, were effective in ensuring that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and in ensuring that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
 
Management’s Annual Report on Internal Control Over Financial Reporting
 
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our system of internal control over financial reporting within the meaning of Rules 13a-15(f) and 15d-15(f) of the Exchange Act is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of our published financial statements in accordance with U.S. generally accepted accounting principles.
 
Our management, including the chief executive officer and the chief financial officer, assessed the effectiveness of our system of internal control over financial reporting as of June 30, 2012.  In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework.  Based on our assessment, we believe that, as of June 30, 2012, our system of internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
 
Changes in Internal Control Over Financial Reporting
 
There were no changes in our internal control over financial reporting for the quarter ended June 30, 2012 that have materially affected, or are reasonably likely to materially affect, such control.
 
Limitations on Controls and Procedures
 
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud.  Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time.  Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
 
 
34

 
 
The foregoing limitations do not qualify the conclusions set forth above by our chief executive officer and our chief financial officer regarding the effectiveness of our disclosure controls and procedures and our internal control over financial reporting as of June 30, 2012.
 

Part II – Other Information

Item 1.     Legal Proceedings

The Company is a defendant in one lawsuit, the total amount in dispute in which is approximately $105,000. The Company was named as a defendant in a lawsuit related to the payment of amounts due at the termination of an equipment lease.  No answer has been filed in the matter as the Company was only recently notified of the dispute.  Management does not believe that this lawsuit will affect the amount payable at the termination of the lease, which will be determined by appraisal.  To the knowledge of management, no other litigation has been filed or threatened.

Item 1A.  Risk Factors
`
There have been no material changes in risk factors from those described in our Annual Report of Form 10-K for the year ended December 31, 2011.

Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds

On June 11, 2012 we granted 100,000 restricted stock units to a new member of our board of directors.  The restricted stock units are convertible into shares of common stock at such time as the director ceases to serve as one of our directors.  The director was an accredited investor and was fully informed regarding the investment. In the transaction, we relied on the exemptions from registration under the Securities Act set forth in Section 4(2) thereof.

Item 3.    Defaults Upon Senior Securities

None.
Item 4.    Submission of Matters to Vote of Security Holders.

None.

Item 5.    Other Information

(a) None.

(b) None.

Item 6.    Exhibits

Exhibit Index
 
(a)           Exhibits
Exhibit
Number
Description of Document
   
3.1
Amended and Restated Articles of Incorporation of Broadcast International.   (Incorporated by reference to Exhibit No. 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
 
 
35

 
 
3.2
Amended and Restated Bylaws of Broadcast International.  (Incorporated by reference to Exhibit No. 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
   
4.1
Specimen Stock Certificate of Common Stock of Broadcast International.  (Incorporated by reference to Exhibit No. 4.1 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
   
10.1*
Employment Agreement of Rodney M. Tiede dated April 28, 2004.  (Incorporated by reference to Exhibit No. 10.1 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)
   
10.2*
Broadcast International 2004 Long-Term Incentive Plan.  (Incorporated by reference to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 filed with the SEC on March 30, 2004.)
   
10.3
Securities Purchase Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel.  (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
   
10.4
5% Convertible Note dated October 16, 2006 issued by Broadcast International to Leon Frenkel.  (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
   
10.5
Registration Rights Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel.  (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
   
10.7
Securities Purchase Agreement dated as of December 21, 2007, by and among Broadcast International and the investors listed on the Schedule of Buyers attached thereto. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
   
10.8
Registration Rights Agreement dated as of December 21, 2007, by and among Broadcast International and the buyers listed therein.  (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
   
10.9
6.25% Senior Secured Convertible Promissory Note dated December 21, 2007 issued to the holder listed therein.  (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
   
10.10
Warrant to Purchase Common Stock dated December 21, 2007 issued to the holder listed therein.  (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
   
10.11
Loan Restructuring Agreement between the Company and Castlerigg Master Investments Ltd., dated December 16, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
   
10.12
Amendment to 8% Convertible Note Due 2010 between the Company and Leon Frenkel, dated December 22, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
 
 
36

 
 
10.13
Placement Agency Agreement between the Company and Philadelphia Brokerage Corporation, dated December 17, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.14
Form of Subscription Agreement (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.15
Form of Warrant (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.16
Amended and Restated Senior Convertible Note issued by the Company to Castlerigg master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.17
Investor Rights Agreement between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.18
Letter between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
   
10.19
Form of Securities Purchase Agreement dated March 13, 2012 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.20
Form of A Warrant (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.21
Form of B Warrant (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.22
Loan Satisfaction Agreement between the Company and Castlerigg Master Investments Ltd. dated March 13, 2012 (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.23
Registration Rights Agreement dated March 13, 2012 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.24
Form of Placement Agent Warrant (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the SEC on March 13, 2012.)
   
10.25
Form of Note and Warrant Purchase and Security Agreement dated July 16, 2012 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2012.)
   
10.26
Form of Promissory Note dated July 16, 2012 (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2012.)
   
10.27
Form of Warrant (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on July 18, 2012.)
   
14.1
Code of Ethics.  (Incorporated by reference to Exhibit No. 14 of the Company’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004.)
   
21.1
Subsidiaries.  (Incorporated by reference to Exhibit No. 21.1 of the Company’s Annual Report on Form 10-KSB filed with the SEC on April 1, 2005.)
   
23.1
Consent of HJ & Associates, LLC, independent registered public accountant.
 
 
37

 
 
24.1
Power of Attorney.  (Included on page II-15).
   
31.1
Rule 13a-14(a)/15d-14(a) Certification of Principal Executive Officer.
   
31.2
Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
   
32.1
Principal Executive Officer Certification Pursuant to 18 USC, Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
32.2
Chief Financial Officer Certification Pursuant to 18 USC, Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   
101.INS
XBRL Instance Document.
   
101.SCH
XBRL Taxonomy Extension Schema Document.
   
101.CAL
Taxonomy Extension Calculation Linkbase Document.
   
101.DEF
Taxonomy Extension Definition Linkbase Document.
   
101.LAB
Extension Labels Linkbase Document.
   
101.PRE
Taxonomy Extension Presentation Linkbase Document.

*   Management contract or compensatory plan or arrangement.
 
 
 
 
 
 
 
38

 
 
SIGNATURES

Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 
Broadcast International, Inc.
 
     
Date: August 13, 2012
 /s/ Rodney M. Tiede  
 
By:  Rodney M. Tiede
 
 
Its: President (Principal Executive Officer)
 
     
     
Date: August 13, 2012  /s/ James E. Solomon  
 
By:  James E. Solomon
 
 
Its: Chief Financial Officer (Principal Financial and Accounting
Officer)
 
 
 
 
 
 
 39

PINX:BCST Quarterly Report 10-Q Filling

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