BROADCAST INTERNATIONAL INC - FORM 10-Q

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EX-31.2 - EXHIBIT 31.2 - BROADCAST INTERNATIONAL INC	ex31_2.htm
EX-31.1 - EXHIBIT 31.1 - BROADCAST INTERNATIONAL INC	ex31_1.htm
EX-32.1 - EXHIBIT 32.1 - BROADCAST INTERNATIONAL INC	ex32_1.htm
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EX-32.2 - EXHIBIT 32.1 - BROADCAST INTERNATIONAL INC	ex32_2.htm

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 September 30, 2011

£ 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 October 31, 2011
Common Stock, $.05 par value	75,975,656 shares

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	22
Item 3. Quantitative and Qualitative Disclosures about Market Risk	31
Item 4. Controls and Procedures	31
PART II -OTHER INFORMATION
Item 1. Legal Proceedings	32
Item 1A. Risk Factors	32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	32
Item 3. Defaults Upon Senior Securities	33
Item 4. [REMOVED AND RESERVED]	33
Item 5. Other Information “Not Applicable”	33
Item 6. Exhibits	33
Signatures	35

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

	December 31, 2010			September 30, 2011
				(Unaudited)
ASSETS:
Current Assets
Cash and cash equivalents	$	6,129,632		$	414,472
Trade accounts receivable, net		1,125,055			1,192,248
Inventory		52,175			106,574
Prepaid expenses		190,877			238,043
Total current assets		7,497,739			1,951,337
Property and equipment, net		2,419,891			1,732,177
Other Assets, non current
Patents, net		167,410			159,797
Deposits and other assets		624,598			476,156
Total other assets, non current		792,008			635,953

Total assets	$	10,709,638		$	4,319,467

LIABILITIES AND STOCKHOLDERS DEFICIT:

Current Liabilities
Accounts payable	$	1,552,006		$	1,073,967
Payroll and related expenses		341,255			433,169
Other accrued expenses		381,015			78,526
Unearned revenue		139,437			35,808
Current notes payable		775,000			171,875
Other current obligations		1,426,834			1,443,044
Derivative valuation		14,759,300			3,095,900
Total current liabilities		19,374,847			6,332,289
Long-term Liabilities
Long-term portion of notes payable (net of discount of $992,832 and $742,830, respectively		6,187,984			6,266,111
Other long-term obligations		1,067,649			--
Total long-term liabilities		7,255,633			6,266,111
Total liabilities		26,630,480			12,598,400
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; 74,078,153 and 75,949,016 shares issued as of December 31, 2010 and September 30, 2011, respectively		3,703,908			3,797,451
Additional paid-in capital		92,867,561			96,686,414
Accumulated deficit		(112,492,311	)		(108,762,798	)
Total stockholders’ deficit		(15,920,842	)		(8,278,933	)

Total liabilities and stockholders’ deficit	$	10,709,638		$	4,319,467

See accompanying notes to condensed consolidated financial statements.

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the three months ended						For the nine months ended
	September 30,						September 30,
	2010			2011			2010			2011

Net sales	$	1,885,600		$	2,277,074		$	5,359,907		$	6,321,495
Cost of sales		1,257,954			1,518,310			3,847,716			4,414,402
Gross profit		627,646			758,764			1,512,191			1,907,093

Operating expenses:
Administrative and general		801,351			1,280,183			3,180,412			5,124,883
Selling and marketing		55,007			401,826			197,276			824,771
Research and development		588,147			570,197			2,090,212			1,793,596
Depreciation and amortization		190,846			169,592			575,856			517,751
Total operating expenses		1,635,351			2,421,798			6,043,756			8,261,001
Total operating loss		(1,007,705	)		(1,663,034	)		(4,531,565	)		(6,353,908	)

Other income (expense):
Interest income		--			338			3,295			2,324
Interest expense		(3,531,090	)		(176,047	)		(7,379,794	)		(745,925	)
Gain (loss) on derivative valuation		(1,044,993	)		5,851,300			240,100			12,257,500
Equity issuance costs related to warrants		--			--			--			(476,234	)
Loss on extinguishment of debt		--			16,000			--			(954,033	)
Loss on sale of securities		--			--			(49,264	)		--
Loss on sale of assets		--			--			--			(362	)
Other income (expense), net		59,121			5,597			67,870			151
Total other income (expense)		(4,516,962	)		5,697,188			(7,117,793	)		10,083,421

Profit (loss) before income taxes		(5,524,667	)		4,034,154			(11,649,358	)		3,729,513
Provision for income taxes		--			--			--			--
Net profit (loss)	$	(5,524,667	)	$	4,034,154		$	(11,649,358	)	$	3,729,513

Net profit (loss) per share – basic	$	(0.13	)	$	0.05		$	(0.28	)	$	0.05
Net profit (loss) per share – diluted	$	(0.13	)	$	0.05		$	(0.28	)	$	0.05

Weighted average shares – basic		43,098,800			75,229,254			41,402,000			75,240,313
Weighted average shares –diluted		43,098,800			78,414,453			41,402,000			77,970,216

See accompanying notes to condensed consolidated financial statements.

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine Months Ended
	September 30,
	2010			2011
Cash flows from operating activities:
Net income (loss)	$	(11,649,358	)	$	3,729,513
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization		1,179,380			1,117,703
Common stock issued for services		399,466			--
Common stock issued for interest		--			19,634
Common stock issued for research and development		4,024			903
Non-cash interest upon conversion of convertible notes		802,190			--
Accretion of discount on convertible notes payable		3,251,360			250,002
Capitalized interest on convertible note		1,131,836			--
Stock based compensation		879,570			2,072,993
Loss on sale of assets		--			362
Loss on extinguishment of Debt		--			954,033
Gain on derivative liability valuation		(240,100	)		(12,257,500	)
Loss on sale of securities available for sale		49,264			--
Warrants issued for interest		--			157,400
Warrants issued for debt extinguishment costs		--			404,000
Allowance for doubtful accounts		(38,904	)		1,414
Changes in assets and liabilities:
Decrease (increase) in accounts receivable		279,020			(68,607	)
Decrease (increase) in inventories		42,295			(54,399	)
Decrease in debt offering costs		1,648,620			--
Decrease in prepaid and other assets		20,393			126,704
Increase (decrease) in accounts payable and accrued expenses		259,419			(485,735	)
Decrease in deferred revenues		(10,909	)		(103,629	)

Net cash used in operating activities		(1,992,434	)		(4,135,209	)

Cash flows from investing activities:
Purchase of equipment		(190,173	)		(422,978	)
Proceeds from the sale of auction rate preferred securities		225,000			--
Proceeds from the sale of assets		--			240

Net cash provided by investing activities		34,827			(422,738	)

Cash flows from financing activities:
Proceeds from the sale of common stock		1,335,000			--
Proceeds from the exercise of options and warrants		--			18,304
Principal payments on debt		(1,304,658	)		(1,151,439	)
Equity issuance costs		--			(24,078	)
Proceeds from notes payable		1,975,000			--

Net cash provided (used) by financing activities		2,005,342			(1,157,213	)

Net increase (decrease) in cash and cash equivalents		47,735			(5,715,160	)
Cash and cash equivalents, beginning of period		263,492			6,129,632

Cash and cash equivalents, end of period	$	311,227		$	414,472

Supplemental disclosure of cash flow information:
Interest paid	$	369,591		$	244,966
Income taxes paid	$	--		$	--

See accompanying notes to condensed consolidated financial statements.

BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

September 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 September 30, 2011 and the results of operations for the three and nine months ended September 30, 2010 and 2011, respectively, with the cash flows for each of the nine month periods ended September 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 nine months ended September 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

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 computation of diluted earnings per share does not assume conversion or exercise of securities that would have an anti-dilutive effect on earnings.

The following table sets forth the computation of basic and diluted earnings per common share for the three and nine month periods ended September 30, 2011 and 2010:

	For the three months ended					For the nine months ended
	September 30,					September 30,
	2010			2011		2010			2011
Numerator
Net income (loss)	$	(5,524,667	)	$	4,034,154	$	(11,649,358	)	$	3,729,513
Denominator
Basic weighted average shares outstanding		43,098,800			75,844,526		41,402,000			75,240,313
Effect of dilutive securities:
Stock options and warrants		--			19,927		--			179,903
Restricted stock units		--			2,550,000		--			2,550,000
Diluted weighted average shares outstanding		43,098,800			78,414,453		41,402,000			77,970,216

Net income (loss) per common share
Basic	$	(0.13	)	$	0.05	$	(0.28	)	$	0.05
Diluted	$	(0.13	)	$	0.05	$	(0.28	)	$	0.05

Potentially dilutive securities representing 25,193,934 and 24,723,934 shares of common stock were excluded from the computation of diluted earnings per common share for the three and nine months ended September 30, 2011, respectively, because their effect would have been 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 September 30, 2011 was 2,024,400.

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 1,165,000 at September 30, 2011.

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 nine months ended September 30, 2011 and 2010 were estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Nine Months Ended September 30, 2011		Nine Months Ended September 30, 2010
Risk free interest rate		1.96%		3.14%
Expected life (in years)		6.28		7.5
Expected volatility		81.03%		80.71%
Expected dividend yield		0.00%		0.00%

The weighted average fair value of options granted during the nine months ended September 30, 2011 and 2010 was $0.63 and $0.80, 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 nine months ended September 30, 2011 and 2010 estimated at the date of issuance using the Black-Scholes option-pricing model with the following weighted average assumptions:

	Nine Months Ended September 30, 2011		Nine Months Ended September 30, 2010
Risk free interest rate		2.04%		1.34%
Expected life (in years)		5.00		2.98
Expected volatility		85.82%		88.65%
Expected dividend yield		0.00%		0.00%

The weighted average fair value of warrants issued during the nine months ended September 30, 2011 and 2010 was $0.79 and $0.53, respectively.

Results of operations for the nine months ended September 30, 2011 and 2010 includes $2,072,993 and $879,570, 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 $2,072,993 non-cash stock-based compensation expense for the nine months ended September 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) $124,000 for 200,000 restricted stock units issued to one employee, (iii) $263,572 for 600,000 options issued to one individual and one corporation for consulting services, (iv) $51,207 for 874,200 options granted to 38 employees, (v) $4,263 for 8,700 options granted to 15 of our non-employee installation technicians and (vi) $85,951 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2011.

Included in the $879,571 non-cash stock-based compensation expense for the nine months ended September 30, 2010 is (i) $80,000 for 100,000 options granted to one member of the board of directors, (ii) $93,000 for 150,000 warrants issued to three new members of our advisory board, (iii) $44,450 for 460,000 warrants issued to five individuals and two corporations for consulting services, (iv) $568,121 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2010 and (v) $94,000 for 100,000 restricted stock units issued to a member of the board of directors. Additionally, we issued (i) 183,824 warrants to a former member of the board of directors in exchange for the return and cancellation of 125,000 shares of our common stock, (ii) 2,295,075 warrants to investors of our Private Placement Memorandum Offering and (iii) 3,333,333 warrants with the July 2010 amendment to our 6.25% senior secured convertible note.

The impact on our results of operations for recording stock-based compensation for the three and nine months ended September 30, 2011 and 2010 is as follows:

	For the three months ended September 30,				For the nine months ended September 30,
	2010		2011		2010		2011
General and administrative	$	96,973	$	234,185	$	616,001	$	1,915,969
Research and development		87,593		51,934		263,570		157,024

Total	$	184,566	$	286,119	$	879,571	$	2,072,993

Due to unexercised options and warrants outstanding at September 30, 2011, we will recognize an additional aggregate total of $692,344 of compensation expense over the next four years based upon option and warrant award vesting parameters as shown below:

2011	$	174,037
2012		257,857
2013		178,090
2014		82,360
Total	$	692,344

The following unaudited tables summarize option and warrant activity during the nine months ended September 30, 2011.

	Options and Warrants Outstanding			Weighted Average Exercise Price

Outstanding at December 31, 2010		20,442,170		$	1.13
Options granted		1,482,900			0.93
Warrants issued		1,275,334			0.68
Expired		(201,254	)		3.47
Forfeited		(2,319,981	)		1.25
Exercised		(455,098	)		0.08

Outstanding at September 30, 2011		20,224,071		$	1.10

The following table summarizes information about stock options and warrants outstanding at September 30, 2011.

	Outstanding						Exercisable
			Weighted Average Remaining		Weighted Average				Weighted Average
Range of Exercise Prices	Number Outstanding		Contractual Life (years)		Exercise Price		Number Exercisable		Exercise Price
$0.05-0.95		1,901,336		5.12	$	0.78		1,273,836	$	0.71
1.06-6.25		18,321,135		4.25		1.13		17,916,991		1.13
9.50-11.50		1,600		0.42		10.50		1,600		10.50
$0.05-11.50		20,224,071		4.33	$	1.10		19,192,427	$	1.10

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 nine months ended September 30, 2011 and 2010, 1,600,000 and 100,000 restricted stock units were awarded, respectively. During the nine months ended September 30, 2010, 35,000 restricted stock units were settled by two individuals through the issuance of 35,000 shares of our common stock.

The following is a summary of restricted stock unit activity for the nine months ended September 30, 2011.

	Restricted Stock Units		Weighted Average Grant Date Fair Value

Outstanding at December 31, 2010		950,000	$	1.63
Awarded at fair value		1,600,000		1.04
Canceled/Forfeited		--		--
Settled by issuance of stock		--		--
Outstanding at September 30, 2011		2,550,000	$	1.25
Vested at September 30, 2011		2,550,000	$	1.25

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 September 30, 2011 and December 31, 2010, we had bank balances of $104,367 and $5,879,632, 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 $1,192,248 and $1,125,055 net accounts receivable for the nine months ended September 30, 2011 and the year ended December 31, 2010, respectively, were (i) $1,150,276 and $1,031,795 for billed trade receivables, respectively; (ii) $86,716 and $143,542 of unbilled trade receivables (iii) $56 and $208 for employee travel advances and other receivables, respectively; less (iv) ($44,800) and ($50,490) 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.

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 September 30, 2011, 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 $7,613 for the three and nine months ended September 30, 2011, respectively. Amortization expense recognized on all patents totaled $2,591 and $7,466 for the three and nine months and ended September 30, 2010, respectively.

Estimated amortization expense, if all patents were issued at the beginning of 2011, for each of the next five years is as follows:

Year ending December 31:
2011	$	12,231
2012		11,763
2013		11,763
2014		11,763
2015		11,763

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.

Research and Development

Research and development costs are expensed when incurred. We expensed $570,197 and $1,793,596 of research and development costs for the three and nine months ended September 30, 2011, respectively. We expensed $588,147 and $2,090,212 of research and development costs for the three and nine months ended September 30, 2010, 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 nine months ended September 30, 2011 and 2010, we had one customer that individually constituted 91% and 87%, respectively of our total revenues.

Note 6 – Notes Payable

The recorded value of our notes payable (net of debt discount) for the nine months ended September 30, 2011 and year ended December 31, 2010 was as follows:

	December 31, 2010			September 30, 2011

Amended and Restated Senior 6.25% Convertible Note	$	6,180,816		$	6,180,816
Unsecured Convertible Note		7,168			257,170
Pledged A/R Note Payable		675,000			--
Short Term Note Payable		100,000			--
Total		6,962,984			6,437,986
Less Current Portion		(775,000	)		(171,875	)
Total Long-term	$	6,187,984		$	6,266,111

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 (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. Pursuant to the financing, we issued a senior secured convertible note in the principal amount of $15,000,000. The senior secured convertible note bore interest at 6.25% per annum if paid in cash. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 were due quarterly and commenced in April 2009. The original principal of the note was convertible into 2,752,294 shares of our common stock at a conversion price of $5.45 per share, convertible any time during the term of the note. We granted a first priority security interest in all of our property and assets and of our subsidiaries to secure our obligations under the note and related transaction agreements.

In connection with the 2007 financing, the senior secured convertible note holder received warrants to acquire 1,875,000 shares of our common stock exercisable at $5.00 per share. We also issued to the convertible note holder 1,000,000 shares of our common stock valued at $3,750,000 and incurred an additional $1,377,000 for commissions, finders fees and other transaction expenses, including the grant of a three-year warrant to purchase 112,500 shares of our common stock to a third party at an exercise price of $3.75 per share, valued at $252,000. A total of $1,377,000 was included in debt offering costs and was amortized over the term of the note.

From March 26, 2010 through October 29, 2010, we entered into a series of amendments to the senior secured convertible note under which we issued to the holder of the senior secured convertible note an additional 3,000,000 shares of our common stock, increased the number of warrants by 3,333,333 shares, and reduced the warrant exercise price to $1.80 per share for all warrants, all as consideration for the amendments.

On December 24, 2010, we closed on the Debt Restructuring (as defined below). 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 a 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 Debt Restructuring was considered a troubled-debt restructuring and a gain on debt restructuring of $3,062,457 was recorded during the year ended December 31, 2010, which was the difference between the adjusted carrying value of the original note and the carrying value of the Amended and Restated Note.

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 $350,434 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. 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.

As of September 30, 2011 and 2010, we recorded an aggregate derivative liability of $203,700 and $1,000,500 respectively, 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 $2,403,700 and loss of $235,200 was recorded during the nine months ended September 30, 2011 and 2010, to reflect the change in value of the aggregate derivative liability since December 31, 2010 and 2009, respectively. The aggregate derivative liability of $203,700 for the Amended and Restated Note conversion feature was calculated at September 30, 2011 using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate of 0.25%, (ii) expected life (in years) of 2.2; (iii) expected volatility of 68.80% for the conversion feature, (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

During the nine months ended September 30, 2010, the principal value of the 6.25% senior secured convertible note was increased by $1,131,836 to $17,528,086 (convertible into 9,737,826 common shares), for interest capitalized rather than making a payment in cash.

The original principal value of the note was being accreted over the term of the obligation, for which $1,047,825 and $3,143,475 was included in interest expense for the three and nine months ended September 30, 2010. The note now bears a 6.25% annual interest rate payable quarterly and for the nine months ended September 30, 2010, $27,388 was accrued and included as interest expense. For the nine months ended September 30, 2010, $1,106,217 ($1,131,836 offset by $25,619 note interest accrued in 2009) was included in interest expense for capitalized interest.

The $6,180,816 value of the note at September 30, 2011 consists of $5,500,000 for the principal due of the note plus $1,031,250 for aggregate future interest less $350,434 for interest withheld at closing for interest due from the initial date of the debt restructuring transaction until December 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 a 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, (i) 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 September 29, 2006; (ii) the convertible note bore an annual interest rate of 5%, payable semi-annually in cash or shares of our common stock; (iii) the convertible note was convertible into shares of our common stock at a conversion price of $1.50 per share subject to full-ratchet anti-dilution price protection provisions ; and (iv) we issued to the convertible note holder four classes of warrants (A Warrants, B Warrants, C Warrants and D Warrants), which give the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock as described below. The A and B Warrants originally expired one year after the effective date of a registration statement filed under the Securities Act of 1933, as amended (the “Securities Act”), to register the subsequent sale of shares received from exercise of the A and B Warrants. The C Warrants and D Warrants originally expired eighteen months and twenty four months, respectively, after the effective date of a registration statement to be filed under the Securities Act. The A Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.60 per share, the B Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.75 per share, the C Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $2.10 per share, and the D Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $3.00 per share.

During the year ended December 31, 2007, the convertible note holder exercised 454,000 A Warrants. We entered into an exchange agreement dated October 31, 2007 in which the convertible note holder received 650,000 shares of our common stock in exchange for cancellation of the C and the D Warrants. The expiration date of the A Warrants and the B Warrants was extended from January 11, 2008 to December 3, 2008. During the year ended December 31, 2008, the convertible note holder exercised 64,400 A Warrants. On December 3, 2008, the remaining 231,600 A Warrants and 750,000 B Warrants expired.

On December 23, 2009 we entered into an amendment with the holder of this unsecured convertible note, which (i) extended the note maturity date to December 22, 2010 and (ii) increased the annual rate of interest from 5% to 8% commencing October 16, 2009. All other terms and conditions of the note remained unchanged.

On December 24, 2010 we closed on a Debt Restructuring as mentioned above. In connection with that 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 issued 150,000 shares to the holder of this note as consideration to extend the term of the note.

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 nine months ended September 30, 2011, the $157,400 value of the warrant was included in interest expense.

At September 30, 2011 and 2010 we recorded an aggregate derivative liability of $256,700 and $2,800, respectively, related to the conversion feature of the note. A derivative valuation gain of $1,145,200 and $197,200, respectively, was recorded to reflect the change in value of the aggregate derivative liability since December 31, 2010 and December 31, 2009, respectively. The aggregate derivative liability of $256,700 for the conversion feature of the note was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.25%, (ii) expected life (in years) of 2.3; (iii) expected volatility of 73.43%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

In connection with the amendment mentioned above, the principal value of the note will be accreted due to the difference in the value of the conversion feature before and after the amendment. The accretion for the three and nine months ended September 30, 2011, was $83,334 and $250,002, respectively and was included in interest expense. The note currently bears an 8% annual interest rate payable semi-annually, and for each of the three and nine month periods ended September 30, 2011 and 2010, $20,000 and $60,000, 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 $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 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 ended March 31, 2011 we converted the remaining $675,000 of principal along with $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.

At September 30, 2011 we recorded an aggregate derivative liability of $135,500 related to the warrant reset provision. A derivative valuation gain of $314,600 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 $135,500 for the reset provision of the warrants was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 0.83%, (ii) expected life (in years) of 4.5; (iii) expected volatility of 81.42%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

Short Term Note Payable

During the three months ended March 31, 2011 we remitted $100,000 of the principal balance and accrued interest of $8,360 to a company pursuant to a short term note. The note had originated in June 2010 and bore an annual interest rate of 12%. Of the $8,360 of interest paid, $2,327 was related to and included in interest expense for the nine months ended September 30, 2011.

Note 7 – 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.

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 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 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.

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.

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 nine months ended September 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 to the holder of this note as consideration to extend the term of the note.

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.

At September 30, 2011, we recorded an aggregate derivative liability of $2,500,000 related to these warrants and valuation gain of $8,250,000 for the nine months ended September 30, 2011 to reflect the change in value of the aggregate derivative from December 31, 2010. The aggregate derivative liability of $2,500,000 was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate of 0.83%, (ii) expected life (in years) of 4.2; (iii) expected volatility of 81.51%, (iv) expected dividend yield of 0.00%; and (v) stock trading price of $0.45.

Note 8 – 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.

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 September 30, 2011:

					Significant
			Quoted Prices in		Other		Significant
			Active Markets for		Observable		Unobservable
			Identical Assets		Inputs		Inputs
	Total		(Level 1)		(Level 2)		(Level 3)
Assets
Treasury cash reserves	$	414,472	$	414,472	$	--	$	--
Total assets measured at fair value	$	414,472	$	414,472	$	--	$	--

Liabilities
Derivative valuation (1)	$	3,095,900	$	--	$	--	$	3,095,900
Total liabilities measured at fair value	$	3,095,900	$	--	$	--	$	3,095,900

(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 September 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.

	Derivative
	Valuation
	Liability
Balance at December 31, 2010	$	(14,759,300	)
Total gains or losses (realized and unrealized)
Included in net loss		12,257,500
Valuation adjustment		--
Purchases, issuances, and settlements, net		(594,100	)
Transfers to Level 3		--
Balance at September 30, 2011	$	(3,095,900	)

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 its 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.

During the three and nine months ended September 30, 2011, we made lease payments totaling approximately $422,096 and $1,266,287 of which $361,966 and $1,048,491 was applied toward the outstanding lease with $60,130 and $217,796, respectively, included in interest expense.

During the three and nine months ended September 30, 2010, we made lease payments totaling approximately $422,096 and $1,266,287 of which $314,080 and $909,781 was applied toward the outstanding lease with $108,016 and $356,506, respectively, included in interest expense.

Additionally, we recognized amortization of the lease acquisition fee of $12,567 and $37,701 which was included in interest expense for the three and nine months ended September 30, 2011 and 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 nine months ended September 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 September 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 September 30, 2011 we have advanced an aggregate amount of $3,057,605 pursuant to a promissory note that is secured by assets and technology of IDI.

Note 11 – Recent Accounting Pronouncements

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. The Company will evaluate whether or not it will utilize the qualitative assessment option prior to performing the first goodwill impairment test in 2012 and will also determine if it wants to adopt the Update early and utilize the option for its goodwill impairment test.

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 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 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.

The following update was issued in 2010 and became effective on or after January 1, 2011. 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.

Note 12 – Supplemental Cash Flow Information

2011

During the nine months ended September 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 nine months ended September 30, 2011, $263,572 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 had a 5 - year life from the date of grant, contained full-ratchet anti-dilution price protection provisions and were valued $404,000 using a Black Scholes pricing model on the date of grant. During the three and nine months ended September 30, 2011 the warrant holder exercised these warrants using a cashless provision resulting in the company issuing 372,272 shares of our common stock.

For the nine months ended September 30, 2011 an aggregate non-cash expense of $250,002 was recorded for the accretion of the unsecured convertible note.

For the nine months ended September 30, 2011, we recognized $1,117,703 in depreciation and amortization expense from the following: (i) $599,952 related to cost of sales for equipment used directly by or for customers, (ii) $510,138 related to other property and equipment, and (iii) $7,613 for patent amortization.

2010

During the nine months ended September 30, 2010, we issued 406,927 shares of our common stock valued in aggregate at $399,466 to three companies and three individuals for consulting services rendered, the expense of which is included in our general and administrative expense.

During the nine months ended September 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 will amortize it as part of cost of sales.

During the nine months ended September 30, 2010, we issued 3,000,000 shares our common stock valued at $3,290,000 to our senior secured 6.25% convertible note holder as part of amendment and extension agreements. 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 nine months ended September 30, 2010, an aggregate non-cash expense of $3,251,360 was recorded for the accretion of our convertible notes as follows, (i) $3,143,475 for the senior secured 6.25% convertible note and (ii) $107,885 for our unsecured 3% convertible notes.

For the nine months ended September 30, 2010, we recognized $1,179,380 in depreciation and amortization expense from the following: (i) $603,524 related to cost of sales for equipment used directly by or for customers, (ii) $568,390 related to other property and equipment, and (iii) $7,466 for patent amortization.

During the nine months ended September 30, 2010, the conversion to common stock of all of our unsecured 3% convertible notes and the conversion of $50,000 to common stock of our unsecured short term notes resulted in an $802,190 extinguishment of debt primarily due to unrealized note discounts and accrued interest.

Note 13 – Subsequent Events

During October 2011 we issued 26,640 shares of our common stock to one individual in exchange for 399,601 Interact Device Inc. (IDI) share equivalents.

During October 2011 we issued an aggregate of 77,500 options to one member of our Advisory Board and two employees.

During October and November 2011 we entered into an Equipment Sales Agreement under the terms of which a company purchased installation services and equipment to be installed, used and sold to our customers. The company granted us ninety (90) day terms, which should allow us time to install the equipment, bill our customers, and receive payment to satisfy the outstanding payable to the financing company. This accommodation will increase the cost of our equipment by approximately 10% if it is paid on time. The total amount of equipment funding aggregated to $700,000.

We evaluated subsequent events pursuant to ASC Topic 855 and have determined that there are no additional events that need to be reported.

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:

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 technoloty;

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;

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

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.

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 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 over 30 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, Fujitsu and Microsoft. In September 2011, we entered into a sales agreement with a small cable company in Mexico for the installation of our CodecSys software running on a Fujitsu hardware platform. The sale included a three year license of CodecSys with license fees payable monthly. The initial installation includes 20 standard definition channels with potential for expansion. The installation has been made and will be on line in November 2011. This represents the first of our installations of CodecSys in an operating environment. 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. 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.

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.

Results of Operations for the Nine Months ended September 30, 2011 and September 30, 2010

Revenues

We generated $6,321,495 in revenue during the nine months ended September 30, 2011. During the same nine-month period in 2010, we generated revenue of $5,359,907. The increase in revenue of $961,588 was due primarily to continued increases in revenue from our digital signage contract with our largest customer, a financial services company, which accounted for approximately 91% of our revenues for the nine months ending September 30, 2011. License fees decreased by $354,571, but system sales and installation revenues increased by $1,417,355 in the nine months ended September 30, 2011, almost all of which increase was due to our major digital signage customer. Satellite transmission fees decreased by $114,621, which resulted primarily from changing the delivery platform of one customer from a satellite delivered service to delivering its content via the Internet.

Sales revenues from our largest customer accounted for approximately 91% and 87% of total revenues for the nine months ended September 30, 2011 and 2010, respectively. Revenues from all of our customers, except our largest customer, decreased by $156,030 in the nine months ended September 30, 2011 compared to the nine months ended September 30, 2010.

Cost of Revenues

Cost of revenues increased by approximately $566,686 to $4,414,402 for the nine months ended September 30, 2011 from $3,847,716 for the nine months ended September 30, 2010. Costs of equipment and installation services increased by $579,761 primarily due to the installation of new equipment used in the continued expansion of our largest customer’s digital signage network. Installation services for all other customers combined increased by approximately $35,266. In addition, depreciation decreased by $58,105 due to certain equipment being fully depreciated.

Expenses

General and administrative expenses for the nine months ended September 30, 2011 were $5,124,883 compared to $3,180,412 for the nine months ended September 30, 2010. The increase of $1,944,471 resulted primarily from an increase of approximately $1,299,967 in the amount charged for the issuance of options and warrants. In addition, employee and related costs increased by $239,635, temporary help increased by $215,895, and travel, lodging and meals expense increased by $177,752. These and other miscellaneous increases in costs were partially offset by a decrease of $161,880 in consulting fees and a decrease of $60,000 in finance fees.

Research and development in process decreased by $296,616 for the nine months ended September 30, 2011 to $1,793,596 from $2,090,212 for the nine months ended September 30, 2010. The decrease resulted primarily from a decrease of $463,133 in employee related expenses and a decrease of $106,545 in option related expenses, which were partially offset by an increase of $207,569 in temporary help expense.

Sales and marketing expenses increased $627,495 to $824,771 for the nine months ending September 30, 2011 from $197,276 for the nine months ended September 30, 2010. The increase reflects an increase in employee and related costs of $336,051, an increase of $214,021 in general operating costs including travel and tradeshow expenses and an increase in other professional services and consulting fees of $ 57,148. The increases in sales and marketing expenses primarily reflects increased staff and activity in marketing the CodecSys technology subsequent to its readiness for implementation.

Interest Expense

For the nine months ended September 30, 2011, we incurred interest expense of $745,925 compared to interest expense for the nine months ended September 30, 2010 of $7,379,794. The decrease of $6,633,869 resulted primarily from the negotiation and execution of the Loan Restructuring Agreement with Castlerigg Master Investments, Ltd. paying, extending and reducing the principal of our 6.25% senior convertible note in December, 2010. The principal balance of the 6.25% senior convertible note was reduced from approximately $17,500,000 to $5,500,000, which resulted in the decrease in interest expense. Of the total interest expense recorded for the nine months ended September 30, 2011, $467,402 was the amount incurred on the $1,000,000 of principal outstanding on our 8.0% unsecured convertible note, $217,796 was incurred on our equipment lease financing and $60,727 on all of our other indebtedness. The amount of interest on our 6.25% senior convertible note was accounted for as accretion to the principal amount of the note resulting from the restructuring of that note.

Net Income

We realized net income for the nine months ended September 30, 2011 of $3,729,513 compared with a net loss for the nine months ended September 30, 2010 of $11,649,358. The change from a net loss to net income of $15,378,871 is primarily due to an increased gain related to our derivative valuation calculation of warrants and convertible notes of $12,017,400 and the decrease in interest expense of $6,633,869 discussed above. The increase was partially offset by an unrealized loss on securities of $1,381,003 resulting from the restructuring of our 6.25% senior convertible note.

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

Revenues

We generated $2,277,074 in revenue during the three months ended September 30, 2011. During the same three-month period in 2010, we generated revenue of $1,885,600. The increase in revenue of $391,474 was due primarily to an increase of $450,873 in system sales and installation and service work primarily completed for the digital signage network of our largest customer. The increase was partially offset by a decrease in satellite fees of $28,263 reflecting the change of one of our customers from a satellite delivered platform to an Internet delivered platform.

Our largest customer’s sales revenues accounted for approximately 92% and 83% of total revenues for the quarters ended September 30, 2011 and 2010, respectively. Any material reduction in revenues generated from our largest customer could cause a substantial deterioration in our results of operations, financial condition and liquidity.

Cost of Revenues

Costs of revenues increased by approximately $260,356 to $1,518,310 for the three months ended September 30, 2011 from $1,257,954 for the three months ended September 30, 2010. The increase was due primarily to an increase of $260,698 in cost of equipment sales and services because our largest customer’s digital signage network continued to expand and we perform additional services for it.

Expenses

General and administrative expenses for the three months ended September 30, 2011 were $1,280,183 compared to $801,351 for the three months ended September 30, 2010. The increase of approximately $478,832 resulted primarily from an increase of $137,212 in option and warrant expenses, and increase in temporary help of $103,520, an increase of $72,707 in employee and related costs and an increase of $50,211 in bad debt expenses.

Research and development in process decreased by $17,950 for the three months ended September 30, 2011 to $570,197 from $588,147 for the three months ended September 30, 2010. This decrease resulted primarily from decreased employee and related costs of $156,860, partially offset by an increase of $79,151 in temporary help and increased consulting and professional services of $77,335.

Sales and marketing expenses increased $346,819 for the three months ended September 30, 2011 to $401,826 from $55,007 for the three months September 30, 2010. The increase was due primarily to increased employee and related expenses of $187,113 and increased travel and tradeshow expenses, including lodging and food of $108,187 reflecting increased marketing and sales activity in selling the CodecSys encoding system.

Interest Expense

For the three months ended September 30, 2011, we incurred interest expense of $176,047 compared to interest expense for the three months ended September 30, 2010 of $3,531,090. The decrease of $3,355,043 resulted primarily from a decrease in interest expense due to the restructuring and payment of approximately $12,000,000 of our 6.25% senior convertible note in December, 2010. The $176,047 of interest expense recorded consisted of $103,334 recorded to account for the accretion of note liability on our balance sheet and accrued interest on our 8.0% unsecured convertible note and $60,130 of interest related to equipment financing for our largest customer.

Net Income

We realized net income for the three months ended September 30, 2011 of $4,034,154 compared to a net loss of $5,524,667 for the three months ended September 30, 2010. The difference between our net income in 2011 compared to our net loss in 2010 of $9,558,821 was primarily the result of recording a gain related to our derivative valuation of warrants and convertible notes for the three months ended September 30, 2011 of $6,896,293 and decreased interest expense recorded of $3,355,043 as explained above. The increase in our total income was partially offset by an increase in loss from operations of $655,329 resulting from increased operating expenses as explained above.

Liquidity and Capital Resources

At September 30, 2011, we had cash of $414,472, total current assets of $1,951,337, total current liabilities of $6,332,289 and total stockholders' deficit of $8,278,933. Included in current liabilities is $3,095,900, which relates to the value of the embedded derivatives for the 6.25% senior convertible note and related warrants and the 8.0% unsecured convertible note and $1,443,044 related to the current portion of debt obligations for equipment financing.

We experienced negative cash flow used in operations during the nine months ending September 30, 2011 of $4,135,209 compared to negative cash flow used in operations for the nine months ended September 30, 2010 of $1,992,434. The negative cash flow was met by cash reserves from the completion of our Equity Financing in December of 2010. We expect to continue to experience negative operating cash flow as long as we continue our current expenditures related primarily to bringing our CodecSys products to market, continue our development of CodecSys or until we begin to receive licensing revenue from sales of our CodecSys proprietary software or increase sales in our network division by adding new customers.

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 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 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 therefore 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 shares of common stock 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.

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 is being used for working capital.

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. If the Company had failed to file the registration statement within 60 days or to have the registration statement declared effective within 120 days following the date of the filing of the registration statement, the Company would have been obligated to issue additional warrants to the investors to purchase an additional 1,250,000 shares for each 30-day period after the deadlines. However, since the registration statement was declared effective on June 16, 2011, all deadlines were satisfied.

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 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 plus applicable sales taxes.

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.

The Loan Restructuring Agreement we entered into as part of the Debt Restructuring 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 Amended and Restated 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 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.

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 $400,000 per month during the nine months ended September 30, 2011. At our current rate of expenditures, including debt service, over expected revenues, we do not have sufficient capital to maintain operations at their current level. It will be necessary to raise additional equity or debt capital to enable us to maintain our operations at the current level or we will be required to curtail operations which may affect our relationships with our customers and affect are ability to market our products and services. 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, Fujitsu 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.

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. 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 September 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 September 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 September 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 believe that, as of September 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

There were no changes in our internal control over financial reporting for the quarter ended September 30, 2011 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.

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 September 30, 2011.

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 $125,000.

Item 1A. Risk Factors

Except as indicated below, 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 August, 2011, we granted options pursuant to our 2004 Equity Incentive Plan to purchase up to 100,000 shares of our common stock to one consultant in consideration of consulting services to be rendered by the consultants over a one year period pursuant to written consulting agreements. The options are exercisable at $1.15 per share and have a ten year life. The consultants are accredited investors and were fully informed regarding their 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 July, August and September, 2011, we granted options pursuant to our 2004 Equity Incentive Plan to purchase 447,500 shares of our common stock to 7 of our employees. The options are exercisable at prices of $0.54 to $.0.68 per share and 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 August, 2011, the holder of our 6.25% convertible note exercised a warrant to acquire shares of our stock and we issued 372,272 shares to the holder. The warrant was for 400,000 shares, but was exercised pursuant to cashless exercise provisions and we received no cash in exchange for the exercise. In the transaction, we relied on the exemption from registration under the Securities Act set forth in Sections 4(2) and 4(6) thereof.

In August we awarded 200,000 Restricted Stock Units (“RSU”) pursuant to our 2008 Equity Incentive Plan to one of our employees. The RSUs are to be settled by the issuance of 200,000 shares of common stock at the time that the employee ceases to be employed by us. In the transaction, we relied on the exemption from registration under the Securities Act set forth in Section 4(2) thereof.

In October, 2011, we issued a total of 26,640 shares of our common stock to one individual in exchange for 399,600 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.

Item 4. Submission of Matters to Vote of Security Holders.

None.

Item 5. Other Information

(a) None.

(b) None.

Item 6. Exhibits Not Updated

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.)

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*	Employment Agreement of James E Solomon dated September 19, 2008. (Incorporated by reference to Exhibit No. 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on Mach 31, 2010.)

10.3*	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.)

10.4*	Broadcast International 2008 Long-Term Incentive Plan. (Incorporated by reference to the Company’s definitive Proxy Statement on Schedule 14A filed with the SEC on April 17, 2009)

10.5	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.)

10.6	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.)

10.7	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.)

10.8	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.)

10.9	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.)

10.10	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.)

10.11	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.)

10.12	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.)

10.13	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.)

10.14	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.)

10.15	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.)

10.16	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.)

10.17	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.)

10.18	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.)

10.19	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.)

101.INS**	XBRL Instance Document

101.SCH**	XBRL Taxonomy Extension Schema Document

101.CAL**	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB**	XBRL Taxonomy Extension Label Linkbase Document

101.PRE**	XBRL Taxonomy Extension Presentation Linkbase Document

* Management contract or compensatory plan or arrangement.

** Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Act of 1934 and otherwise are not subject to liability.

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: November 14, 2011	/s/ Rodney M. Tiede
	By: Rodney M. Tiede
	Its: President and Chief Executive Officer (Principal Executive Officer)


Date: November 14, 2011	/s/ James E. Solomon
	By: James E. Solomon
	Its: Chief Financial Officer (Principal Financial and Accounting Officer)

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