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PART I.   FINANCIAL INFORMATION

Item 1. Financial Statements

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

See accompanying notes to condensed consolidated financial statements.

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BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

June 30, 2011

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, 2010 and June 30, 2011 and the results of operations for the three and six months ended June 30, 2010 and 2011, respectively, with the cash flows for each of the six month periods ended June 30, 2010 and 2011, 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, 2010.  Operating results for the three and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ended December 31, 2011.

Note 2 - Reclassifications

Certain 2010 financial statement amounts have been reclassified to conform to 2011 presentations.

Note 3 – Weighted Average Shares

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 2010:

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The table below presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at June 30, 2011.  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.

Money Market Funds and Treasury Securities

The money market funds and treasury cash reserve securities balances are classified as cash and cash equivalents on our condensed consolidated balance sheet.

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 9 – 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 and at the expiration of the equipment lease will pay the greater of the then in place fair market value of the equipment or 10% of the original purchase price.

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. We received a waiver from our 6.25% convertible note holder releasing their security interest in the equipment purchased under our sale lease back financing. See Note 6.

The sale leaseback financing arrangement with the financial institution related to the purchase and deployment of certain digital signage equipment for a new customer.  As a result of this financing, we incurred an obligation to make 36 monthly payments of approximately $144,000 plus applicable sales taxes. The proceeds of the financing are being used to purchase and install the digital signage equipment for our customer and for general working capital purposes.  We have the right to terminate the lease after making 33 payments for a termination fee of approximately $451,000 after which time we would own all of the equipment.  We have accounted for this arrangement as a capital lease.

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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.

During the three and six months ended June 30, 2010, we made lease payments totaling approximately $422,096 and $844,191 of which $303,133 and $595,701 was applied toward the outstanding lease with $118,962 and $248,490, 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, 2010, respectively.

Note 10 – 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 would 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.

During the six months ended June 30, 2011, we acquired 14,571 IDI common share equivalents in exchange for 971 shares of our common stock valued at $903.

Since May 18, 2004, we have acquired an aggregate of 4,070,849 additional common share equivalents IDI. As of June 30, 2011, we owned approximately 55,497,568 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, 2011 we have advanced an aggregate amount of $2,987,745 pursuant to a promissory note that is secured by assets and technology of IDI.

Note 11 – Recent Accounting Pronouncements

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 nonowner 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 will impact how items for Other Comprehensive Income are presented and the Company will plan on following the guidance in the Update as of January 1, 2012.

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurements and Disclosure Requirements in US GAAP and IFRS. The Amendments in this Update will improve the comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with US GAAP and IFRSs.  The Boards of both organizations worked together to ensure fair value has the same meaning and the measurement and disclosures would be the same other than minor

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differences in wording. The Amendments explain how to measure fair value and do not require any additional fair value measurements. A few of the more significant changes are; 1) Clarification that quantitative information about unobservable inputs categorized as Level 3 should be disclosed, 2) Specification that premiums and discounts should be applied in the absence of Level 1 input if market participants would do so, but that premiums or discounts related to size/quantity should not be considered, and 3) Additional disclosure requirements for fair value measurements categorized as Level 3, an entity’s use of a nonfinancial asset in a way that differs from the asset’s highest and best use and the categorization by level for items not measured at fair value in the statement of financial position, but for which fair value disclosure is required. The amendments in this Update are to be applied prospectively. The Update is effective during interim and annual periods beginning after December 15, 2011.  The Company does not expect this guidance to have a significant impact on its financials since the amount of items disclosed at fair value is minimal, but will ensure the guidance is followed for items disclosed at fair value.

In April 2011, the FASB issued ASU 2011-02, Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This Update provides clarification to creditors on what is considered a troubled-debt restructuring. This Update applies to all creditors that restructure receivables that fall within the scope of Subtopic 301-40, Receivables – Troubled Debt Restructuring by Creditors.  In evaluating whether it is considered a troubled-debt restructuring a creditor must conclude that both of the following exist: 1) The restructuring constitutes a concession and 2) The debtor is experiencing financial difficulties.  The unit provides clarification on when a concession is granted and also indicates that a debtor may experience financial difficulties, even though the debtor is not currently in payment default. The Amendments in this Update are effective for the first interim or annual period beginning on or after June 15, 2011 and should be applied retrospectively to the beginning of the annual period of adoption. An entity should disclose the necessary disclosures delayed in ASU 2011-01 for interim and annual period ending after June 15, 2011. The Company does not expect this guidance to have an impact on its financials since it is not a debt creditor.

In January 2011, the FASB issued ASU 2011-01, Receivables (Topic 310) – Deferral of the Effective Date of Disclosure about Troubled Debt Restructurings in Update 2010-20. The amendments in this Update delay the effective date of the disclosures about troubled debt restructurings in Update 2010-20 for public-entity creditors and is intended to allow the Board to complete its deliberations on what constitutes a troubled-debt restructuring. The effective date of the disclosures per Update 2010-20 for public-entity creditors will be coordinated with the new proposed Update that is expected to be effective for interim and annual periods ending after June 15, 2011. The Company does not expect this guidance to have an impact on its financials since it is not a debt creditor.

The following updates were issued in 2010 or 2009, but became, or will become effective on or after January 1, 2011, therefore are included below.  Only significant updates that may impact the Company are included herein.

In August 2010, the FASB issued ASU No 2010-22, Accounting for Various Topics. Technical Corrections to SEC Paragraphs- An announcement made by the staff of US Securities and Exchange Commission. This Update makes changes to several of the SEC guidance literature within the Codification.  Some of the changes relate to (1) Oil and Gas Exchange Offers, (2) Accounting for Divestiture of a Subsidiary or Other Business Operations, (3) Replaces “Push Down” basis accounting references with “New” basis of accounting to be used in the acquired companies financial statements, (4) Fees paid to an investment banker in connection with an acquisition or asset purchase, when the investment banker is also providing interim financing or underwriting services must be allocated between the related service and debt issue costs. The amendments in this Update are effective immediately.  The Company does not expect this guidance to have a significant impact on its financials since there are no changes to accounting that were not already being applied by the Company.

In July 2010, the FASB issued ASU No 2010-20, Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This Update requires additional disclosures for financing receivables, excluding short-term trade accounts receivables and or receivables measured at fair value.  The new disclosures are designed to allow a user to better evaluate a company’s credit risk in the portfolio of financing receivables, how the risk is analyzed and in allowing for credit losses and the reason for the changes in the allowance for credit losses.  Some of the additional disclosures required are to provide a rollforward of allowance for credit losses by portfolio segment basis, credit quality of indicators of financing receivables by class of financing receivables, the aging of financing receivables by class of financing receivable, significant purchases and sales of financing receivables by portfolio segment, amongst other requirements.  The amendments in this Update are effective for reporting periods ending on or after December 15, 2010 for disclosures as of the end of the reporting period and disclosures related to activity are effective for reporting periods beginning on or after December 15, 2010 for public entities.  For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011. Comparative disclosures for earlier reporting periods are

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encouraged, but not required.  This guidance does not have a significant impact on its financials since it does not have any finance receivables.  The receivables are short-term trade receivables.

In October 2009, the FASB issued Accounting Standard Update No 2009-14, Software (Topic 985) – Certain Revenue Arrangement that Include Software Elements. This Update affects vendors that sell or lease tangible products in an arrangement that contains software that is more than incidental to the tangible product as a whole.  This Update does not provide guidance on when revenue should be recognized; however, it is likely that vendors affected by this Update will recognize revenue earlier than current practice because of the different revenue guidance, including the ASU 2009-13.  This Update does not affect software revenue arrangements that do not include tangible products and does not affect arrangements with software that includes services if the software is essential to the functionality of the services.  The Update indicates that tangible products containing software components and nonsoftware components that function together to deliver the tangible product’s essential functionality are no longer with in the scope of the software revenue recognition guidance (subtopic 985-605).  The Update provides guidance on how to determine which software, if any, relating to the tangible product should be excluded from the scope of software revenue recognition.  This Update is effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 (January 1, 2011).  The Company has adopted this guidance but it is not expected to have a material impact in periods subsequent to adoption, but will evaluate if there are new arrangements entered into that might be impacted.

Note 12 – Supplemental Cash Flow Information

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.

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 is 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.

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2010

During the six months ended June 30, 2010, we issued 289,990 shares of our common stock valued in aggregate at $295,768 to three companies and three individuals for consulting services rendered the expense for which is included in our general and administrative expense.

During the six months ended June 30, 2010 we issued 200,000 shares our common stock valued at $216,000 to a corporation for the purchase of a H.264 codec software license to be used in our CodecSys product development. We have included it as an asset on our balance sheet and are amortizing it as part of cost of sales.

During the six months ended June 30, 2010 we issued 1,000,000 shares our common stock valued at $990,000 to our senior secured 6.25% convertible note holder as part of the note due date extension. We included it as an asset on our balance sheet as additional note acquisition costs and will amortize it over the remaining term of the note.

For the six months ended June 30, 2010 an aggregate non-cash expense of $2,163,406 was recorded for the accretion of our convertible notes as follows, (i) $2,095,650 for the senior secured 6.25% convertible note and (ii) $67,756 for our unsecured 3% convertible notes.

For the six months ended June 30, 2010, we recognized $784,925 in depreciation and amortization expense from the following: (i) $399,282 related to cost of sales for equipment used directly by or for customers, (ii) $380,135 related to equipment other property and equipment, and (iii) $4,875 for patent amortization.

Note 13 – Subsequent Events

During July 2011 we issued 200,000 restricted stock units to one employee and options to purchase 220,000 shares of our common stock to three additional employees.

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, 2010:

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dependence on commercialization of our CodecSys technology;

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our need and ability to raise sufficient additional capital;

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uncertainty about our ability to repay our outstanding convertible notes;

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our continued losses;

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delays in adoption of our CodecSys technology;

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concerns of OEMs and customers relating to our financial uncertainty;

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restrictions contained in our outstanding convertible notes;

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general economic and market conditions;

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ineffective internal operational and financial control systems;

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rapid technological change;

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intense competitive factors;

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our ability to hire and retain specialized and key personnel;

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dependence on the sales efforts of others;

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dependence on significant customers;

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uncertainty of intellectual property protection;

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potential infringement on the intellectual property rights of others;

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factors affecting our common stock as a “penny stock”;

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extreme price fluctuations in our common stock;

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price decreases due to future sales of our common stock;

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future shareholder dilution; and

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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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Section 27A(b)(1)(C) of the Securities Act of 1933, as amended and Section 21E(b)(1)(C) of the Securities Exchange Act of 1934, as amended state that the safe harbor for forward-looking statements does not apply to statements made by companies that issue penny stock.  Because our common stock is “penny stock,” the safe harbor for forward-looking statements does not apply to us.

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, 2010. 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 global and national economies and the 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.  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, Hitachi and Microsoft. 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.

On July 31, 2009, we entered into a $10.1 million, three-year contract with a Fortune 10 financial institution customer to provide technology and digital signage services to approximately 2,100 of the customer’s more than 6,000 retail and administrative locations throughout North America.  The customer is expanding its network to additional retail and administrative locations.  In addition, the customer selected us to be its vendor for certain additional audio visual services during this year.  A factor in securing this contract was the benefits of the CodecSys technology delivering our services to be utilized in our services.  

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 Equity Financing described below, each of the investors converted their purchase to the terms contained in the Equity Financing.  This resulted in the issuance of an additional 956,659 shares of common stock and the cancellation of 2,295,075 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 “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:

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

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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 an exercise price of $1.00 per share.

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 will be 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 was 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, is a senior, unsecured note that matures in three years from the closing and bears 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 is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment.  The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us.  The Amended and Restated Note also contains 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 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 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 as consideration to extend the term of the note.

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Results of Operations for the Six Months ended June 30, 2011 and June 30, 2010

Revenues

We generated $4,044,442 in revenue during the six months ended June 30, 2011.  During the same six-month period in 2010, we generated revenue of $3,474,307.  The increase in revenue of $570,135 or 16% was due primarily to increase of additional locations and increased service revenue for our major customer and its digital signage contract. Our major customer accounted for approximately 91% and 89% of our revenues for the six months ending June 30, 2011and 2010, respectively. Revenues from our other customers were basically unchanged.  The addition of our new digital signage customer has materially affected our results of operations, financial condition and liquidity.

Cost of Revenues

Cost of revenues increased by approximately $306,330 to $2,896,092 for the six months ended June 30, 2011 from $2,589,762 for the six months ended June 30, 2010. The gross margin from operations increased $263,784 from a gross margin of $884,545 in the six months ended June 30, 2010 to a gross margin of $1,148,329 for the six months ended June 30, 2011. The increase was due primarily to the increase in business primarily related expansion of the digital signage contract, which accounted for almost all of the increase of $306,330 in the direct costs related to installations and an increase in the general operations department costs of $47,092, due to the increase in installation activity.  These increases in costs were partially offset by a decrease of $61,695 in satellite distribution costs, which reflected the change by a client from satellite distribution to internet streaming distribution of its content.

Expenses

General and administrative expenses for the six months ended June 30, 2011 were $3,844,700 compared to $2,379,061 for the six months ended June 30, 2010. The increase of approximately $1,465,639 resulted from increases totaling $1,162,755 in granted option and warrant expenses primarily related to grant of restricted stock options for officers and directors, an increase of $279,302 in employee and temporary help expenses related to increases in installation and operational activity, an increase of $122,945 in travel and related expenses, as well as other general operating expenses such as legal fees incurred for filing of our registration statement.  The total increase in administrative expenses was partially offset by a decrease of $168,975 in consulting expenses and a decrease of $60,000 in finance fees expense.  Research and development in process decreased by $278,666 for the six months ended June 30, 2011 to $1,223,399 from $1,502,065 for the six months ended June 30, 2010. The decrease resulted primarily from a decrease of $306,273 in employee related expenses when compared to such expenses incurred in 2010. 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.  Sales and marketing expenses increased $280,676 to $422,945 for the six months ending June 30, 2011 from $142,269 for the six months ending June 30, 2010.  The increase reflects an increased employee related expense of $148,937 and an increase in conventions and related travel expenses of $94,571.

Interest Expense

For the six months ended June 30, 2011, we incurred interest expense of $569,878 compared to interest expense for the six months ended June 30, 2010 of $3,848,704.  The decrease of $3,278,826 resulted primarily from the Company restructuring and reducing the amount of indebtedness related to our senior convertible note from approximately $17,500,000 to $5,500,000.

Net Loss

We realized a net loss for the six months ended June 30, 2011 of $304,641 compared with a net loss for the six months ended June 30, 2010 of $6,124,691. During the same six month period, gross margin increased by $263,784 even though operating expenses increased by $1,430,798 as explained above, which resulted in an increased loss from operating activities of $1,167,074. The increased loss from operating activities was offset by an increase of $5,121,107 related to our derivative valuation gain calculation and the decrease in interest expense of $3,278,826, as explained above.

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Results of Operations for the Three Months ended June 30, 2011 and June 30, 2010

Revenues

The Company generated $2,357,157 in revenue during the three months ended June 30, 2011.  During the same three-month period in 2010, the Company generated revenue of $1,687,240.  The increase in revenue of $669,917 or approximately 40% was due primarily to revenues recognized from network installation activities for our largest customer.  The revenue generated for this customer aggregated $2,201,952 in this year and $1,480,665 for the three months ended June 30, 2010.  The increase of revenues from this customer was partially offset by a decrease of $70,906 in revenues from transponder fees for one client that changed from a satellite distribution platform to an Internet delivery platform.

Our largest customer accounted for approximately 93% of our revenues for the three months ended June 30, 2011 compared to 84% of our revenues for the three months ended June 30, 2010.  Any material reduction in revenues generated from our largest customer could harm the Company’s results of operations, financial condition and liquidity.

Cost of Revenues

Costs of revenues increased by $303,836 to $1,620,555 for the three months ended June 30, 2011, from $1,316,719 for the three months ended June 30, 2010.  The increase was primarily due to continued installation of equipment and operations of our largest customer’s digital signage network.  In addition, the cost of the operations department increased by $46,227, which was primarily the result of our increased activity for our digital signage customer.

Expenses

General and administrative expenses for the three months ended June 30, 2011 were $1,236,328 compared to $1,168,087 for the three months ended June 30, 2010.  The increase of $68,241 resulted primarily from an increase in employee and temporary help expenses of $175,135 and an increase of $59,324 in travel and related expenses, partially offset by a decrease of $161,801 in consulting expenses and a decrease of $34,929 in bad debt expenses.  Research and development in process decreased by $140,302 for the three months ended June 30, 2011 to $625,628 from $765,930 for the three months ended June 30, 2010, which resulted primarily from a decrease of $125,304 in employee related costs and a decrease of $86,601 in consulting fees partially offset by an increase of $74,717 in expenses for tradeshows and related travel.  Sales and marketing expenses increased by $203,190, which increase was composed mainly of increases of $111,270 in employee related expenses and $50,782 in tradeshow and related travel expenses.

Interest Expense

For the three months ended June 30, 2011, the Company incurred interest expense of $188,689 compared to interest expense for the three months ended June 30, 2010 of $2,133,679.  The decrease of $1,944,990 resulted primarily from the restructuring of our senior convertible note and the reduction of our indebtedness from approximately $17,500,000 to $5,500,000.

Net Income

The Company realized net income for the three months ending June 30, 2011 of $442,324 compared with a net loss for the three months ended June 30, 2010 of $3,223,960. The decrease in net loss of $3,666,284 was primarily the result of the difference in the calculation of our derivative valuation of $1,419,807, the decrease in interest expense of $1,944,990 and the decrease in our loss from operations of $259,959 as explained above.

Liquidity and Capital Resources

At June 30, 2011, we had cash of $2,174,689, total current assets of $3,500,533, total current liabilities of $12,371,894 and total stockholders' deficit of $12,838,201.  Included in current liabilities is $9,207,200 relating to the value of the embedded derivatives for our senior convertible note and our unsecured convertible note.

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We experienced negative cash flow used in operations during the six months ended June 30, 2011 of $2,879,361 compared to negative cash flow used in operations for the six months June 30, 2010 of $1,019,861. Of the $2,879,361 of cash used for operations in the six months ended June 30, 2011, only $693,206, or $231,069 per month, was used in the three months ended June 30, 2011.  The negative cash flow was sustained by cash reserves from the equity offering completed in December, 2010.  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.

On December 24, 2010, we also closed on the 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 a 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, is a senior, unsecured note that matures in three years from the closing and bears 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 is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment.  The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us.  The Amended and Restated Note also contains 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, including the right to include 2,500,000 of its shares in the registration statement filed.  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 registration statement was declared effective June 16, 2011 and therefor all of the registration deadlines were 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 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.

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 Equity Financing and 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 an exercise price of $1.00 per share.

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 our senior debt, brought our accounts payable current and the remainder will be used for working capital.

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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 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 filed, and was declared effective on June 16, 2011.  During March 2010 through October 2010, we raised approximately $2,485,000 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 previously 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 any time for a period of three years.

Upon completion of the Equity Financing, each of the investors in these sales elected to treat their purchases according to the terms contained in the 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 $675,000. 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 $175,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which 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 $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 have 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 restructured as described herein.  During 2010, we capitalized interest of $1,491,161 related to the senior secured convertible note.

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The Loan Restructuring Agreement contains, among other things, covenants that may restrict our ability to obtain additional capital, to declare or pay a dividend or to engage in other business activities.  A breach of any of these covenants could result in a default under our senior secured convertible note, in which event the holder of the note could elect to declare all amounts outstanding to be immediately due and payable, which would require us to secure additional debt or equity financing to repay the indebtedness or to seek bankruptcy protection or liquidation.  The Loan Restructuring Agreement provides that we cannot do any of the following without the prior written consent of the holder:

·

directly or indirectly, redeem, or declare or pay any cash dividend or distribution on, our common stock;

·

incur or guarantee any indebtedness other than indebtedness evidenced by the Amended and Restated Note and other permitted indebtedness as defined in the Amended and Restated Note;

·

repay any indebtedness which is junior to the Amended and Restated Note;

·

issue any additional notes or issue any other securities that would cause a breach or default under the Amended and Restated Note;

·

issue or sell any rights, warrants or options to subscribe for or purchase common stock or directly or indirectly convertible into or exchangeable or exercisable for common stock at a price which varies or may vary with the market price of the common stock, including by way of one or more reset(s) to any fixed price unless the conversion, exchange or exercise price of any such security cannot be less than the then applicable conversion price with respect to the common stock into which any note is convertible or the then applicable exercise price with respect to the common stock into which any warrant is exercisable;

·

enter into or effect any dilutive issuance (as defined in the Amended and Restated Note) if the effect of such dilutive issuance is to cause us to be required to issue upon conversion of any note or exercise of any warrant any shares of common stock in excess of that number of shares of common stock which we may issue upon conversion of the note and exercise of the warrants without breaching our obligations under the rules or regulations of the principal market or any applicable eligible market;

·

liquidate, wind up or dissolve (or suffer any liquidation or dissolution);

·

convey, sell, lease, license, assign, transfer or otherwise dispose of all or any substantial portion of our properties or assets, other than transactions in the ordinary course of business consistent with past practices, and transactions by non-material subsidiaries, if any and;

·

cause, permit or suffer, directly or indirectly, any change in control transaction as defined in the Amended and Restated Note.

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 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.   

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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 Company’s recent equity raise in December 2010. 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 for future market development.

Our monthly operating expenses, including our CodecSys technology research and development expenses, exceeded our monthly net sales by approximately $350,000 per month during the six months ended June 30, 2011, although the operating expenses only exceeded our monthly net sales by approximately $231,000 per month in the three months ended June 30, 2011.  The net proceeds from the Equity Financing after the payment of debt to the senior note holder, commissions, expenses of the offering, and payment of past due accounts payable is approximately $5,500,000.  At our current rate of expenditures, including debt service, over expected revenues, we would have sufficient capital to maintain operations at their current level through the end of 2011.  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 IBM, HP, Hitachi  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, if needed, 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.  We have no arrangements for any such additional external financings, whether debt or equity, and are not certain whether any new external financing would be available on acceptable terms or at all. Any new debt financing would require the cooperation and agreement of existing note holders, of which there is no assurance.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

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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, 2011, 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, 2011, 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, 2011.  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 noted significant deficiencies related to the timely recording and issuance of 100,000 stock options to a vendor. We also noted that a copy of the draft minutes of the Board of Directors meeting held on May 11, 2011 were not provided to the auditors before the first quarter 10Q was filed on May 13, 2011 . As a result, the issuance of options and restricted stock units to employees under our approved equity incentive plans was not included in the Subsequent Events footnote of our Form 10Q for the period ending March 31, 2011. With the exception of the aforementioned items above, a s of June 30, 2011, 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

To remedy the aforementioned deficiencies, the Company implemented a restricted-access virtual data room that includes an equity issuance tracking system as well as a listing of all Board and Committee agendas and minutes.  Access has been provided to the appropriate employees, Directors and the outside auditors.

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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.

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, 2011.

Part II – Other Information

Item 1.

  Legal Proceedings

The Company is a defendant in one lawsuit, the total amount in dispute is approximately $105,000. 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, 2010.

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds

In February, 2011, we granted options to acquire up to 100,000 shares of our common stock to a consultant in consideration of consulting services to be rendered by the consultant over a one year period pursuant to a written consulting agreement.  The options are exercisable at $1.15 per share and have a three year life.  The consultant is an accredited investor and was fully informed regarding his investment.  In the transaction, we relied on the exemptions from registration under the Securities Act set forth in Section 4(2) and Section 4(6) thereof.

In May, 2011, we granted 100,000 Restricted Stock Units to a new member of the Board of Directors as part of the director’s initial compensation package. The Restricted Stock Units are settled at the time the director ceases to be a director by the issuance of 100,000 shares of common stock.  The director is 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) and Section 4(6) thereof.

During April and May, 2011, pursuant to our 2008 Equity Incentive Plan we granted options to purchase 426,700 shares of our common stock to 31 of our employees.  The options are exercisable at weighted average price of $.99 per share, have a 10 year life, and vest ratably over a three year period. In the transaction, we relied on the exemption from registration under the Securities Act set forth in Section 4(2) thereof.

In June, 2011, pursuant to our 2008 Equity Incentive Plan we granted options to purchase 8,700 shares of our common stock to 15 of our third party service providers.  The options are exercisable at $.95 per share and have a 3 year life. In the transaction, we relied on the exemption from registration under the Securities Act set forth in Section 4(2) thereof.

In May, 2011, we issued a total of 971 shares of our common stock to one individual in exchange for 14,571 shares of the common stock of our controlled subsidiary, Interactive Devices, Inc.  There were no proceeds from the transaction.  In the transaction, we relied on the exemption from registration under the Securities Act set forth in Section 4(2).

Item 3.  Defaults Upon Senior Securities

None.

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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

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* Management contract or compensatory plan or arrangement.

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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 11, 2011

/s/ Rodney M. Tiede

By:  Rodney M. Tiede

Its:  President and Chief Executive Officer (Principal Executive Officer)

Date: August 11, 2011

/s/ James E. Solomon

By:  James E. Solomon

Its: Chief Financial Officer (Principal Financial and Accounting Officer)

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