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BCST > SEC Filings for BCST > Form 10-Q on 14-May-2013All Recent SEC Filings

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Form 10-Q for BROADCAST INTERNATIONAL INC


14-May-2013

Quarterly Report


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, 2012:

consummation of pending merger agreement with AllDigital.

dependence on commercialization of our CodecSys technology;

our need and ability to raise sufficient additional capital;

uncertainty about our ability to repay our outstanding notes;

our continued losses;

delays in adoption of our CodecSys technology;

concerns of OEMs and customers relating to our financial uncertainty;

restrictions contained in our outstanding convertible notes;

general economic and market conditions;

ineffective internal operational and financial control systems;

rapid technological change;

intense competitive factors;

our ability to hire and retain specialized and key personnel;

dependence on the sales efforts of others;

dependence on significant customers;

uncertainty of intellectual property protection;

potential infringement on the intellectual property rights of others;

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.

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, 2012. 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 it.

Because we have not been successful in deploying our CodecSys technology with customers sufficient to achieve a breakeven and are finding it difficult to raise additional investment capital, we determined that we should seek an alternative to continuing to commercialize CodecSys by ourselves. Accordingly we sought a merger partner that has compatible video broadcasting products and services, with which we could integrate our CodecSys encoding system. On January 7, 2013, we entered into a Merger Agreement with AllDigital, Inc., a Nevada corporation. The merger is subject among other things to normal due diligence, approval of the shareholders of both companies, and the filing and effectiveness of a registration statement. The registration statement requires year-end financial statements be included with the proxy statements furnished to the shareholders and will not be effective until at least the second quarter of 2013. On February 8, 2013, AllDigital notified us that we were in breach of certain covenants regarding unencumbered ownership or potential claims against our technology, which gave us 30 days to cure the alleged defects before the merger agreement could be terminated. On March 8, 2013 AllDigital notified us that sufficient progress had been made that the cure period was extended to April 8, 2013 for the remainder of the alleged defects to be cured or waived, which extension was further extended to May 8, 2013 . On April 10, 2013, the parties entered into an amendment to the Merger Agreement which provides that either party may (i) terminate the Merger Agreement upon 3 days notice, with or without cause, without liability, (ii) eliminates the cure period date requirement and (iii) that the "No Shop" provision preventing us from contacting other potential purchasers or merger partners was removed.

During 2009, we decreased certain of our development activities and expenses notwithstanding the need to refocus and develop our CodecSys technology on a different platform using a newly announced Intel operating chip. Even with decreased engineering staff and certain related development employees, we were able to complete our video encoding system utilizing the Intel chip, prepare its CodecSys technology for installation on both the IBM and HP equipment platforms, and become certified by Microsoft as an approved software video encoding system for use by IPTV providers using Microsoft operating platforms. On July 1, 2010, we released CodecSys 2.0, which has been installed in various large telecoms and labs for evaluation by potential customers. In 2011 we continued development of additional sales channel partners by integrating CodecSys on hardware manufactured and sold by Fujitsu, which has adopted CodecSys as its compression technology for use in its NuVolo cloud initiative and has commenced sales and marketing efforts including CodecSys as an integral part of the products. We continue to make sales presentations and respond to requests for proposals at other large telecoms, cable companies and broadcasting companies. These presentations have been made with our technology partners which are suppliers of hardware and software for video transmission applications in media room environments such as IBM, HP Fujitsu and Microsoft. In October 2011, we completed our first sale of CodecSys to a small cable operator in Mexico as part of its OTT product offering operating on Fujitsu hardware. It is currently in operation and demonstrates that the CodecSys product offering does operate to its operating specifications in a working environment, which we believe will help in its sales and marketing efforts.


On July 31, 2009, we entered into a $10.1 million, three-year contract with Bank of America, a Fortune 10 financial institution, to provide technology and digital signage services to approximately 2,100 of its more than 6,000 retail and administrative locations throughout North America. For the year ended December 31, 2012, we realized approximately $6,386,903 from this contract, which constituted approximately 85% of our revenues for the period. For the year ended December 31, 2011, we realized approximately $7,540,025 in revenue from this contract, which contributed approximately 89% of our revenues for the year. For the quarter ended March 31, 2013, we realized approximately $1,346,644 in revenue compared to $1,518,654 for the quarter ended March 31, 2012, which constituted 91% and 87% of our total revenues respectively. Because the customer has not selected us as its vendor after the contract expires in May 2013, our revenues will be substantially less after the contract terminates unless we can secure contracts which can replace the revenue lost from its largest customer.

Our revenues for the year ended December 31, 2012 decreased by approximately $922,458 compared to the year ended December 31, 2011. Even with the decrease in our revenues, we realized an increase of approximately $126,519 in our gross margin for the year ended December 31, 2012 compared to the same period in 2011, but we continued to deplete our available cash and increased our need for future equity and debt financing because we continue to spend more money than we generate from operations.

To fund operations, we engaged our investment banker to raise funds through the issuance of convertible promissory notes. We anticipate issuing promissory notes with a principal amount of up to $5,000,000 ("2012 Convertible Debt Offering") due and payable on or before July 13, 2013. As of March 31, 2013, we had issued notes with an aggregate principal value of $3,475,000 as explained below. The notes bear interest at 12% per annum and may be convertible to common stock at a $0.25 per share conversion price. We also granted holders of the notes warrants with a five year life to acquire up to 200,000 shares of our common stock for each $100,000 of principal amount of the convertible notes. The notes are secured by all of our assets with the exception of the equipment and receivables secured by the equipment lessor for equipment used in providing services for our largest customer's digital signage network. On July 13, 2012, we entered into a note and warrant purchase and security agreement with individual investors and broke escrow on the initial funding under the 2012 Convertible Debt Offering, the principal amount of which was $1,900,000, which included the conversion of $900,000 of previously issued short term debt (see Bridge Loan described below) to the 2012 Convertible Debt Offering, which extinguished the Bridge Loan. We realized $923,175 of cash in the initial closing, issued warrants to acquire 3,800,000 shares of our common stock and paid $76,825 in investment banking fees and costs of the offering. We have continued sales of convertible debt under the 2012 Convertible Debt Offering and as of January 31, 2013 have issued additional short term debt with a principal amount of $1,225,000, from which we realized cash of $1,176,624 after payment of investment banking fees of $48,376. We have, however, paid no investment banking fees on sales of our 2012 Convertible Debt Offering since August 2012 and do not anticipate paying additional investment banking fees for the 2012 Convertible Debt Offering. We have issued warrants to acquire a total of 6,950,000 shares of our common stock pursuant to the 2012 Convertible Debt Offering.

In April 2013 we entered into an accounts receivable purchase agreement with one of our directors under the terms of which he agreed to purchase $750,000 of our accounts receivable generated over the next succeeding three months. The $750,000 was discounted by $45,000 and we received net proceeds from the accounts receivable factoring of $705,000.

On March 16, 2012, we closed on an equity financing (the "2012 Equity Financing") as well as a restructuring of our outstanding senior convertible indebtedness (the "2012 Debt Restructuring") resulting in complete satisfaction our senior indebtedness.

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


Pursuant to the Engagement Agreement, we entered into a Securities Purchase Agreement ("SPA") dated March 13, 2012 with select institutional and other accredited investors for the private placement of 27,800,000 units of our securities. The SPA included a purchase price of $0.25 per unit, with each unit consisting of one share of common stock and two forms of Warrant: (1) The "A" Warrant grants the investors the right to purchase an additional share of common stock for each two shares of common stock purchased, for a term of six years and at an exercise price of $.35 per share; and (2) The "B" Warrant, which has now been extinguished as described below, would not have been exercisable unless and until the occurrence of a future issuance of stock at less than $0.25 per share, but, in the event of such issuance, granted the investors the right to acquire additional shares at a price of $0.05 to reduce the impact of the dilution caused by such issuance, but in no event were the number of shares to be issued under the B Warrant to cause us to exceed the number of authorized shares of our common stock. A majority of the holders of the B Warrants agreed in December 2012 to amend the terms of the B Warrant to reduce the amount of subsequent financing required to extinguish the B Warrants.

Proceeds from the 2012 Equity Financing, before deducting the commissions and the legal, printing and other costs and expenses related to the financing, were approximately $6,950,000. Coincident to the closing of the 2012 Equity Financing, we also closed on the 2012 Debt Restructuring. In connection therewith, we paid $2.75 million to Castlerigg Master Investment Ltd. ("Castlerigg"), and issued to Castlerigg 2,000,000 shares of common stock valued at $760,000 in full and complete satisfaction of the $5.5 million senior convertible note and all accrued interest then owing. In accepting the cash and stock tendered, Castlerigg forgave $2,670,712, which included $680,816 in accrued but unpaid interest. In consideration of negotiating the 2012 Debt Restructuring, we paid to one of our placement agents compensation equal to 10% of the savings realized through the 2012 Debt Restructuring, which consisted of paying cash of $275,041 and issuing 586,164 shares of Broadcast common stock valued at $222,742. As a result of the forgoing we recognized a gain on settlement of debt of $2,173,032.

In December 2011, we entered into a loan with 7 accredited individuals and entities under the terms of which we borrowed $1,300,000 to be used as working capital ("Bridge Loan"). The Bridge Loan bears an interest rate of 18% per annum and had a maturity date of February 28, 2012, which was subsequently extended to the earlier of the date nine months from the original maturity date or the date we closed on an additional sale of its securities that resulted in gross proceeds to us of $12 million. In consideration of the Bridge Loan, we granted to lenders of the Bridge Loan warrants with a five year term to purchase 357,500 shares of our common stock at an exercise price of $0.65 per share. In consideration of the extension of the maturity date of the Bridge Loan, we granted the lenders Bridge Loan warrants with a six year term to purchase 247,500 shares of our common stock at an exercise price of $.35 per share.

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

In connection with the 2012 Equity Financing and under the terms of the SPA, we agreed to prepare and file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying certain warrants. We filed as required and the registration statement was declared effective within 120 days following the date of the filing of the registration statement, with the result that we were not obligated to pay any penalties in connection with the registration statement.

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


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

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

Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of its 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 2010 Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million. We used a portion of the net proceeds of the 2010 Equity Financing to pay down debt and the remainder was used for working capital.

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

In connection with the 2010 Equity Financing and under the terms of the Subscription Agreements, we 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 certain of the warrants. The registration statement continues to be effective.

On December 24, 2010, we also closed on the 2010 Debt Restructuring. In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the "Amended and Restated Note") to Castlerigg Master Investment Ltd. ("Castlerigg"), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents were issued (the "Loan Restructuring Agreement"), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.
The Amended and Restated Note, dated December 23, 2010, was a senior, unsecured note that matured in three years from the closing and bore interest at an annual rate of 6.25%, payable semi-annually. Broadcast paid the first year's interest of approximately $344,000 at the closing.

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


Results of Operations for the Three Months ended March 31, 2013 and March 31, 2012

Revenues

The Company generated $1,480,569 in revenue during the three months ended March 31, 2013. During the same three-month period in 2012, the Company generated revenue of $1,745,097. The decrease in revenue of $264,528 was due primarily to a decrease of $223,414 of system sales and installation fees, approximately 65% of which was related to work performed on the digital signage network of our largest customer due to decreased installations and onsite service as we transition away from serving that customer. The revenue generated by our largest customer aggregated $1,346,644, which was $172,010 less than in the same quarter of 2012. In the same period our studio and production fees decreased by approximately $43,343 which represents a decision to perform less of such services in the future.

The Company's largest customer's sales revenues accounted for approximately 91% of total revenues for the quarter ended March 31, 2013 and 87% for the quarter ended March 31, 2012. Any material reduction in revenues generated from our largest customer will harm the Company's results of operations, financial condition and liquidity and since we will no longer be servicing this customer after May of this year we expect that our gross revenues will be substantially less than in the past.

Cost of Revenues

Costs of Revenues decreased by $467,923 to $777,569 for the three months ended March 31, 2013, from $1,245,492 for the three months ended March 31, 2012. The decrease was primarily due to a decrease of $213,796 in our cost of equipment sales due to reduced activity for our largest customer, a decrease of $197,138 in depreciation and amortization expenses because assets used in servicing our largest client have been fully depreciated, and a decrease of $56,992 in our operations department expenses due primarily to a reduction of personnel in anticipation of losing our largest customer. With the cost containment measures we implemented in view of our decreasing revenues in coming quarters, the gross margin from our operating activities, increased by $203,395 to $703,000 for the quarter.

Expenses

General and Administrative expenses for the three months ended March 31, 2013 were $986,209 compared to $1,329,281 for the three months ended March 31, 2012. The decrease of $343,072 resulted primarily from a decrease in employee and related costs of $198,601 due to a reduction in staff and salary deductions, a reduction of $176,963 in consulting expenses, a reduction of $78,258 in travel related expenses and a decrease of expenses incurred for the issuance of options and warrants of $56,305. The overall decrease was partially offset by an increase of $131,932 in legal expenses related primarily to the proposed merger with Alldigital and $86,670 in consulting expenses also related primarily to the pending merger. Research and development in process decreased by $331,193 for the three months ended March 31, 2013 to $225,374 from $556,567 for the three months ended March 31, 2012, primarily due to a reduction in tradeshow, conventions and travel related expense of $99,965 demonstrating reduced activity before the pending merger, a reduction of $88,731 in consulting fees due to decreased development activities, a reduction of $50,021 in employee and related expenses due to reductions of development personnel and a reduction of $49, 086 in temporary help resulting from decreased development work being done. Sale and marketing expenses decreased by $378,930 primarily due to a reduction of employee and related costs of $205,814 and a reduction of $146,799 in tradeshow and related travel expenses reflecting the general reduction in staff and emphasis in anticipation of the pending merger.

Interest Expense

For the three months ended March 31, 2013, the Company incurred interest expense . . .

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