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 risk factors discussed in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2007, as follows:

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dependence on commercialization of our CodecSys technology;

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our need and ability to raise sufficient additional capital;

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our continued losses;

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restrictions contained in our outstanding convertible notes;

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general economic and market conditions;

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ineffective internal operational and financial control systems;

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rapid technological change;

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intense competitive factors;

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our ability to hire and retain specialized and key personnel;

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dependence on the sales efforts of others;

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dependence on significant customers;

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uncertainty of intellectual property protection;

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potential infringement on the intellectual property rights of others;

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factors affecting our common stock as a "penny stock;"

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extreme price fluctuations in our common stock;

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price decreases due to future sales of our common stock;

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future shareholder dilution; and

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absence of dividends.

Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed or implied in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statement. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

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, 2007. Except for the critical accounting policy set forth below entitled "Valuation of Investments," there have been no other significant changes in our critical accounting policies or estimates since those reported in our Annual Report.

Valuation of Investments

As discussed in Note 7 to the unaudited condensed consolidated financial statements, we adopted the provisions of SFAS 157 effective January 1, 2008. In valuing our investments, we predominantly use market data or data derived from market sources. When market data is not available, such as when the investment is illiquid, we utilize a discounted cash flow analysis to arrive at the recorded fair value. This process involves incorporating our assumptions about the anticipated term and the yield that a market participant would require to purchase the security in the marketplace. We utilized unobservable (Level 3) inputs in determining the fair value of our auction rate preferred securities, which totaled $2,554,597 at September 30, 2008.

Our auction rate preferred securities are classified as available-for-sale securities and reflected at fair value. In prior periods, due to the auction process which took place every 7-30 days for most securities, quoted market prices were readily available, which would qualify as Level 1 under SFAS
157. However, due to events in credit markets during 2008, the auction events for most of these instruments failed, and, therefore, we have determined the estimated fair values of these securities utilizing a discounted cash flow analysis as of September 30, 2008. This analysis considers, among other items, the collateralization of the underlying securities, the expected future cash flows and the expectation of the next time the security is expected to have a successful auction. These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by us. Due to these events, we reclassified these instruments as Level 3 during first quarter 2008 and recorded a temporary unrealized decline in fair value of $560,187, with an offsetting entry to accumulated other comprehensive loss at March 31, 2008. During the quarter ended June 30, 2008, we liquidated at par approximately 80% of our auction rate securities held at March 31, 2008 resulting in the temporary unrealized decline in fair value being adjusted to $194,326 at June 30, 2008, which we have increased by $51,077 to $245,403 at September 30, 2008 to further reflect current market conditions. We currently believe that this temporary decline in fair value is due entirely to liquidity issues and not credit issues, because they are in AAA closed-end bond mutual funds that are over-collateralized by at least 200% and are backed by the underlying marketable securities. We believe we have sufficient cash and cash equivalents available at September 30, 2008 to allow us sufficient time for the securities to return to full value. We will re-evaluate each of these factors as market conditions change in subsequent periods.

Executive Overview

The current economic downturn and uncertainty in the financial markets in the U.S. and internationally may adversely affect our business, financial results and our liquidity. If economies remain unstable or weaken, or if businesses or consumers perceive that these economic conditions may continue or weaken, we may experience declines in the sales or renewals as customers delay or defer buying or reduce their level of spending activity. Moreover, these economic conditions and uncertain financial markets have caused companies across many of the industries we serve, particularly in the financial services and retail sectors, to experience downturns in their businesses, which may cause our customers in these industries to reduce the level of services they purchase from us. Additionally, we may experience increased difficulty in obtaining financing in the future, which could negatively impact our ability to pursue our business and development of CodecSys products. As a result, we cannot predict what impact the current economic downturn and uncertainty of the financial markets will have on our business, but

expect that such events may have an adverse effect on our business, financial results and liquidity in the current quarter and future periods, including 2009.

On November 15, 2007, we entered into a two-year license agreement with IBM pursuant to which we will license our patented CodecSys technology for use by IBM in video encoders that IBM intends to manufacture and sell. The IBM video encoder is not completed in a commercially deployable form. The IBM agreement is our first significant license of the CodecSys technology for use in a commercial application. We believe this agreement may hold substantial revenue opportunities for our business. Although IBM has commenced marketing and sales activities with respect to products incorporating our CodecSys technology, no sales of products have been made, and we have not derived any material revenue from our CodecSys technology to date.

During the quarter ended September 30, 2008, our revenues decreased by 14% compared to the same quarter in 2007. For the nine months ended September 30, 2008, our revenues decreased by 10% compared to the same period in 2007. These decreases resulted primarily from customer contracts that were either not renewed or were completed, as discussed below. Net cash used for operations in the nine months ended September 30, 2008 increased compared to the nine months ended September 30, 2007 by 243%. Until cash from operations is sufficient to cover all corporate expenses, we will continue to deplete our available cash and increase our need for future equity and debt financing.

Results of Operations for the Nine Months ended September 30, 2008 and September 30, 2007

Revenues

We generated $2,759,767 in revenue during the nine months ended September 30, 2008. During the same nine-month period in 2007, we generated revenue of $3,197,170. The decrease in revenue of $437,403 was due primarily to: (i) a $414,661 decrease in satellite fees charged, due to the expiration of a customer contract that was not renewed, resulting in a decrease in satellite revenue of $441,600 from that customer and, (ii) the Company completing installation services for two customers in 2007 that were not repeated in 2008, which was offset by increased services provided to other customers, resulting in a decrease in installation related revenues of $94,430. (iii) studio and production fees decreased by $96,739 due mainly to a decrease of production jobs, (iv) increased web and development fees of $98,280 from increased activity primarily for a single customer, and (v) increased license fees of $70,146 from the addition of a new customer, as well as increased installation and satellite usage revenues from other new and existing customers.

Sales revenues from our three largest customers accounted for approximately 49% and 62% of total revenues for the nine months ended September 30, 2008 and 2007, respectively. Any material reduction in revenues generated from any one of our largest customers could harm our results of operations, financial condition and liquidity. The three largest customers in 2008 are not the same three largest customers in 2007. One of our three largest customers in 2008, accounting for $328,811 in revenues for the nine months ended September 30, 2008, will not generate significant revenues for us in the future and will need to be replaced by new business or we will suffer a further reduction in revenues.

Cost of Revenues

Cost of revenues decreased by approximately $196,832 to $3,018,600 for the nine months ended September 30, 2008 from $3,215,431 for the nine months ended September 30, 2007. The decrease was due primarily to decreased satellite distribution costs of $217,113, which resulted from the expiration of a customer contract referenced above. In addition, costs of installation services decreased by $149,367 due to decreased activity in installation of equipment primarily for one customer. These decreases were partially offset by an increase in depreciation and amortization of approximately $190,005, which resulted from large equipment purchases and improvements related primarily to our development activities.

Expenses

General and administrative expenses for the nine months ended September 30, 2008 were $4,744,585 compared to $4,291,635 for the nine months ended September 30, 2007. The increase in general and administrative expenses of approximately $452,950 resulted primarily from an increase in employee salary and related expenses of $205,711, an increase of $171,263 in bad debt expense and an increase in legal services expenses of $98,470.

Research and development in process increased by $2,424,174 for the nine months ended September 30, 2008 to $3,239,094 from $814,920 for the nine months ended September 30, 2007, not including a one-time expense for impairment of license rights of $1,142,400 recorded in 2007. The increase resulted primarily from an increase of $1,294,931 in employee related expenses, an increase of $365,249 in professional services, an increase of $108,278 in developmental services incurred by IDI, an increase of $117,839 in option and warrant expense, an increase of $27,345 in patent related expenses, an increase in general operating expenses of $264,704 related to the increased number of employees and an increase of $157,210 in materials and supplies expense also related to increased developmental activities. In addition, we recorded an expense of $76,047 for the purchase of a portion of the minority interests of IDI, our development subsidiary..

Sales and marketing expenses increased $549,835 to $962,405 for the nine months ending September 30, 2008 from $412,570 for the nine months ending September 30, 2007. The increase reflects an increase in consulting and other professional services of $259,881, an increase in advertising and promotion expenses of $118,557, and $93,990 for additional sales personnel hired to begin marketing of our CodecSys products and related overhead expenses.

Interest Expense

For the nine months ended September 30, 2008, we incurred interest expense of $4,487,362 compared to interest expense for the nine months ended September 30, 2007 of $1,492,193. The increase of $2,995,168 resulted primarily from the Company recording more non cash interest expense related to the accretion of note liability on our 6.25% senior secured convertible note and related amortization of debt offering costs, which was not outstanding in 2007 and on our unsecured convertible note. In addition, interest expense paid or accrued on the 6.25% senior secured convertible note is likewise greater due to the increased principal balance outstanding.

Net Loss

We realized a net loss for the nine months ended September 30, 2008 of $12,432,597 compared with a net loss for the nine months ended September 30, 2007 of $12,515,563. The decrease in the net loss of $82,966 is primarily due to the difference of $5,285,633 between a loss of $4,350,910 recorded in 2007 related to our derivative valuation calculation and the gain of $934,723 recorded as of September 30, 2008 relative to the derivative valuation calculation, which was offset by (i) the increase of $2,995,168 in interest expense, (ii) an increase in operating expenses of $2,284,559 as explained above, and (iii) a $240,572 decrease in gross margin as a result of decreased revenues.

Results of Operations for the Three Months ended September 30, 2008 and September 30, 2007

Revenues

The Company generated $761,572 in revenue during the three months ended September 30, 2008. During the same three-month period in 2007, the Company generated revenue of $834,320. The decrease in revenue of $72,748 was due primarily to a decrease of $242,306 in satellite fees resulting from the expiration of a customer contract, partially offset by the Company realizing an increase of $175,014 from installation and service work in the three months ended September 30, 2008.

The Company's three largest customers' sales revenues accounted for approximately 58% and 60% of total revenues for the quarters ended September 30, 2008 and 2007, respectively. The three customers with the greatest revenues in 2007 were not the same three customers in 2008. Any material reduction in revenues generated from any one of its largest customers could harm the Company's results of operations, financial condition and liquidity unless we could replace the lost revenues with new customers.

Cost of Revenues

Costs of revenues increased by approximately $93,474 to $913,295 for the three months ended September 30, 2008, from $819,821 for the three months ended September 30, 2007. The increase was due primarily to increased depreciation of $100,752 due to purchases of equipment and upgrades of our internal network primarily for our development activities and increased activity in installation of equipment, which resulted in an increase in the costs related to such installation services for all the Company's customers of $90,183 and an increase in

salaries and attendant expense in the operations department. The increases were partially offset by a decrease in satellite distribution costs of $159,035 due to the loss of a satellite customer.

Expenses

General and administrative expenses for the three months ended September 30, 2008 were $1,755,844 compared to $1,542,058 for the three months ended September 30, 2007. The increase of approximately $213,786 resulted primarily from increases in expenses incurred for bad debt expense of $88,111, outside director fees of $70,000 and payroll and related expenses of $38,994. Consulting fees for the quarter ended September 30, 2008 increased by $339,716, but were offset by a decrease in option and warrant expense of $348,978.

Research and development in process increased by $1,109,092 for the three months ended September 30, 2008 to $1,410,308 from $301,216 for the three months ended September 30, 2007. This increase resulted primarily from increased employee and related costs of $620,890, increased consulting and other professional services of $305,821 and increased expenses in IDI of $141,421, all of which expenses were increased as a result of increasing our development activity.

Sales and marketing expenses increased $256,769 for the three months ended September 30, 2008 to $359,904 from $103,135 for the three months September 30, 2007. The increase was due primarily to increased consulting and other professional fees of $132,826, increased payroll and related expenses of $57,257 resulting from hiring of additional personnel devoted to sales, and an increase of $50,008 in advertising and promotion expenses.

Interest Expense

For the three months ended September 30, 2008, the Company incurred interest expense of $1,492,785 compared to interest expense for the three months ended September 30, 2007 of $365,355. The increase of $1,127,430 resulted primarily from the Company recording interest expense related to note accretion and accrual of interest payable related to our 6.25% senior secured convertible note, which was not outstanding during the third quarter of 2007, partially offset by note accretion of our 6.0% senior secured convertible notes in 2007, which have since been converted and are no longer outstanding. The $1,492,785 interest expense recorded primarily consisted of $1,131,159 recorded to account for the accretion of note liability on our balance sheet, interest payable on all notes of $246,876 and amortization of debt offering costs of $114,750.

Net Loss

We realized a net loss for the three months ended September 30, 2008 of $9,034,660 compared with a net loss for the three months ended September 30, 2007 of $6,981,166. The increase in net loss of $2,053,494 was primarily the result of the increase of $1,127,430 in interest expense, the increase of operating expenses of $1,579,647 as described above, and a decrease in gross margin of $166,222. These factors which increased net loss were offset by a decrease in derivative valuation loss of $749,900, which resulted primarily from the valuation of our 6.25% senior secured convertible note.

Liquidity and Capital Resources

At September 30, 2008, we had cash of $ 6,714,626, total current assets of $8,082,693, total current liabilities of $13,231,576 and total stockholders' deficit of $5,735,190. Included in current liabilities is $11,871,400, which relates to the value of the embedded derivatives for the 6.25% senior secured convertible note and related warrants and the unsecured convertible note and warrants. Our current liabilities, without considering the derivative liability, were $1,360,176.

As of September 30, 2008, we held approximately $2,800,000 of auction rate preferred securities, valued at $2,554,597 and classified as long-term investments. Beginning in February 2008, many of these auction rate preferred securities became illiquid because their scheduled auctions failed to settle. During the second quarter 2008, $8,800,000 of the $11,600,000 auction rate preferred securities held at March 31, 2008 were liquidated at par, with the Company not sustaining any losses. However, we may have limited or no opportunities to liquidate the remaining auction rate investments and fully recover their stated value in the near term. An auction failure occurs when the parties wishing to sell securities at auction cannot effect a sale. When an auction fails, the affected securities begin to pay interest under their default interest rate terms. As a result of this illiquidity caused by the lack of an active market, these investments were classified as non-current. Although approximately 80% of

our investments have been redeemed by the issuers, none of the issuers of the auction rate preferred securities still held by us have announced a definitive plan for redemption of the remainder of the securities in the near term. A temporary unrealized loss of $560,187 was recorded in the first quarter of 2008, which was decreased to $194,326 at June 30, 2008 to reflect the redemptions which occurred in the second quarter, but was increased to $245,403 in the third quarter to reflect changed market conditions. We utilized a discounted cash flow analysis in determining the fair value of these securities, which used significant unobservable inputs at September 30, 2008.

We believe the impairment of these securities is temporary because they are backed by more than 200% collateral and approximately 80% have already been redeemed. All of our remaining auction rate preferred securities are currently rated AAA, the highest rating by a rating agency. We believe we will ultimately be able to liquidate these investments without significant loss through successful auctions or redemptions of securities by the issuers. However, it could take a long period of time to realize the investments' full value for a portion of the investments. Based on our expected operating cash flows, and our other sources of cash, we do not anticipate that the current illiquidity of $2,800,000 of these investments will adversely affect our operations.

We experienced negative cash flow used in operations during the nine months ended September 30, 2008 of $6,464,723 compared to negative cash flow used in operations for the nine months ended September 30, 2007 of $1,882,905. The negative cash flow was met by cash reserves. We expect to continue to experience negative operating cash flow as long as we continue our technology development program or until we begin to receive licensing revenue from licenses of our CodecSys technology or increase sales in our network division to new or existing customers.

On December 24, 2007, we entered into a securities purchase agreement in which we raised $15,000,000 (less $937,000 of prepaid interest and $1,377,000 of related costs including commissions). We are using the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. The senior secured convertible note is due December 21, 2010 and bears interest at 6.25% per annum. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 are due quarterly and commence in April 2009. Interest payments may be made through issuance of common stock in certain circumstances. The note is 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 have 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 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. The warrants are exercisable any time for a five-year period beginning on the date of grant. 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 is being amortized over the term of the note. See note 6 of our consensed consolidated financial statements included elsewhere in this report.

The $5.45 conversion price of the senior secured convertible note and the $5.00 exercise price of the warrants are subject to adjustment pursuant to standard anti-dilution rights. These rights include (i) equitable adjustments in the event we effect a stock split, dividend, combination, reclassification or similar transaction; (ii) "weighted average" price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than the then current market price of our common stock; and (iii) "full ratchet" price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than $5.45 per share.

The senior secured convertible note contains a prepayment provision allowing us to prepay, in certain limited circumstances, all or a portion of the note. The portion of the note subject to prepayment must be purchased at a price equal to the greater of (i) 135% of the amount to be purchased and (ii) the company option redemption price, as defined in the note. Even if we elect to prepay the note, the note holder may still convert any portion of the note being prepaid pursuant to the conversion feature thereof.

We also entered into a registration rights agreement with the holder of the senior secured convertible note pursuant to which we agreed to provide certain registration rights with respect to the shares of common stock, the shares of common stock issuable upon conversion of the note, the shares of common stock issuable as interest

shares under the note and shares of common stock issuable upon exercise of the warrant under the Securities Act of 1933, as amended (the "Securities Act").
The holder is entitled to demand registration of the above-mentioned shares of common stock after six months from the closing of the securities purchase agreement in certain circumstances.

The securities purchase agreement under which the senior secured convertible note and related securities were issued contains, among other things, covenants that may restrict our ability to obtain additional capital, to declare or pay a dividend or to engage in other business activities. A breach of any of these covenants could result in a default under our senior secured convertible note, in which event the holder of the note could elect to declare all amounts outstanding to be immediately due and payable, which would require us to secure additional debt or equity financing to repay the indebtedness or to seek . . .