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

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Form 10-Q for BROADCAST INTERNATIONAL INC


14-Aug-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 set forth more fully in Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2012 and in our Registration Statement on Form S-4 (File No, 333-189869)., including without limitation :

dependence on consummating the proposed merger with AllDigital Holdings, Inc.

dependence on commercialization of our CodecSys technology;

our need and ability to raise sufficient additional capital;

uncertainty about our ability to repay our outstanding convertible notes;

our continued losses;

delays in adoption of our CodecSys technology;

concerns of OEMs and customers relating to our financial uncertainty;

restrictions contained in our outstanding convertible notes;

general economic and market conditions;

ineffective internal operational and financial control systems;

rapid technological change;

intense competitive factors;

our ability to hire and retain specialized and key personnel;

dependence on the sales efforts of others;

dependence on significant customers;

uncertainty of intellectual property protection;

potential infringement on the intellectual property rights of others;

extreme price fluctuations in our common stock;

price decreases due to future sales of our common stock;

future shareholder dilution; and

absence of dividends.

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


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.

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 itself. Accordingly, we sought a merger partner that has compatible video broadcasting products and services, with which it could integrate the CodecSys encoding system. In January 2013, we entered into the Merger Agreement with AllDigital Holdings, Inc. ("AllDigital"). On February 8, 2013, AllDigital notified us that we were in breach of certain covenants regarding unencumbered ownership or potential claims against our technology, and 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 and later to May 8, 2013 for the remainder of the alleged defects to be cured or waived. On April 10, 2013, we entered into an amendment to the Merger Agreement which (i) provides that either party may terminate the Merger Agreement upon 3 days notice, with or without cause, without liability, (ii) eliminates the cure period date requirement and (iii) removes the "No Shop" provision preventing us from contacting other potential purchasers or merger partners. On June 30, 2013, we entered into a second amendment to the Merger Agreement which (i) increases the percentage of our outstanding common stock AllDigital's shareholders would receive in the merger from 54% to 58%, (i) modifies a number of the closing conditions of the merger, including the working capital and net cash flow require, (iii) adds a new closing condition that we have post-merger financing commitments in place for the purchase of no less than $1.5 million, nor more than $3.5 million, of our common stock, (iv) extends the "end date" (a date upon which either party may terminate the Merger Agreement if the merger has not been consummated) from July 31, 2013 to October 31, 2013, (v) eliminates one of our existing directors from the post-closing board of directors such that the post-closing directors are expected to be Donald A. Harris, Paul Summers, David Williams and up to two additional directors mutually approved by us and AllDigital prior to the closing of the merger and (vi) changes the reverse stock split ratio from a 10 to 1 reverse stock split to a 15 to 1 reverse stock split. On July 9, 2013, we filed a Registration Statement on Form S-4 (File No. 333-189869) with the SEC in connection with the anticipated merger.

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 our 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, before termination of the relationship with Fujitsu, adopted CodecSys as its compression technology for use in its NuVolo cloud initiative. Until the beginning of 2013, we continued to make sales presentations and respond to requests for proposals at other large telecoms, cable companies and broadcasting companies. These presentations were made with our technology partners which are suppliers of hardware and software for video transmission applications in media room environments such as IBM, HP and Microsoft. In October 2011, we completed our first sale of CodecSys to a small cable operator in Mexico as part of our OTT product offering operating on Fujitsu hardware. The sale demonstrates that the CodecSys product offering does operate to its operating specifications in a working environment, which we believe will help in 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 six months ended June 30, 2013, we realized approximately $2,148,313 in revenue compared to $3,212,332 for the six months ended June 30, 2012, which constituted 87% and 86% of its total revenues respectively. The contract with our largest customer expired in May 2013, and we expect our revenues will be substantially less going forward unless we can secure contracts which can replace the revenue lost from this customer.

Our revenues for the three months ended June 30, 2013 decreased by approximately $1,025,331 compared to the three month period ended June 30, 2012. Even with the large decrease in our revenues, our gross margin decreased only $475,698 compared to our gross margin for the three months ended June 30, 2012 due primarily to cost cutting efforts, but we continue to deplete our available cash and need future equity and debt financing because we continue to spend more money that we generate from operations. To fund operations, we have engaged in the transactions described below under the heading "Liquidity and Capital Resources."

Results of Operations for the Six Months ended June 30, 2013 and June 30, 2012

Revenues

We generated $2,455,226 in revenue during the six months ended June 30, 2013. During the same six-month period in 2012, we generated revenue of $3,745,085. The decrease in revenue of $1,289,859 or 34% was due primarily to the loss of our largest customer. Revenues from this customer decreased by $1,061,550, which accounted for 82% of the total decrease in revenues. In addition, web hosting and streaming revenues from one other customer of $132,000 in 2012 were not repeated in 2013.

Sales revenues from our largest customer, which we will no longer service in the future, accounted for approximately 87% of total revenues for the six months ended June 30, 2013 and approximately 86% for the six months ended June 30, 2012. We will no longer be servicing this customer in the future, which makes restructuring of our costs imperative until we merge with AllDigital or secure new customers to replace the lost revenues.

Cost of Revenues

Cost of revenues decreased by approximately $1,017,556 to $1,573,902 for the six months ended June 30, 2013 from $2,591,458 for the six months ended June 30, 2012. The gross margin from operations decreased $272,303 from a gross margin of $1,153,627 in the six months ended June 30, 2012 to a gross margin of $881,324 for the six months ended June 30, 2013. The decrease in cost of revenues was due primarily to less installation activity for our largest customer's digital signage network and other smaller customers, which accounted for approximately $432,500 of the total decrease in cost of revenues and a decrease in the general operations department costs of $189,704, due to cost savings measures including reducing the number of our employees. Although the total revenues and costs of revenues decreased, the gross margin from operations increased primarily due to the cost reduction measures implemented.

Expenses

General and administrative expenses for the six months ended June 30, 2013 were $1,628,325 compared to $2,588,601 for the six months ended June 30, 2012. The decrease of approximately $960,276 resulted from decreases totaling $432,101 in employee related expenses due to a reduction in the number of employees and a reduction in salaries for some executives, $217,528 in consulting fees, $205,260 in temporary help, $190,979 in trade show and convention related expenses, $119,956 in granted option and warrant expenses and a reduction of $76,000 in director fees. Most of these reductions were the result of the reduction in activity due to the loss of our largest customer for which we ceased performing any material services at the end of May. The total reductions were partially offset by an increase of $170,412 in legal and other profession services related primarily to the proposed merger with AllDigital. Research and development in process decreased by $627,100 for the six months ended June 30, 2013 to $394,313 from $1,021,414 for the six months ended June 30, 2012. The development expenditures have been significantly curtailed in view of the proposed merger and cessation of sales efforts of the CodecSys products. The decrease resulted primarily from a decrease of $197,649 in employee related expenses reflecting a decrease in the number of employees, a decrease of $179,034 in tradeshow and convention related expenses, and a decrease of $124,447 in consulting fees. Sales and marketing expenses decreased $930,232 to $1,573,225 for the six months ending June 30, 2013 from $1,115,240 for the six months ending June 30, 2012. The decrease was primarily a result of decreased employee related expenses of $495,661 and a decrease in conventions and related travel expenses of $281,184, which were the result of reducing staff and sales efforts of the CodecSys products and services.


Even with the reduced revenue, due to a reduction of operating expenses as explained above, our operating loss decreased $2,422,101 from an operating loss of $3,898,303 for the six months ended June 30, 2012 to an operating loss of $1,476,202 for the six months ended June 30, 2013.

Interest Expense

For the six months ended June 30, 2013, we incurred interest expense of $1,125,183 compared to interest expense for the six months ended June 30, 2012 of $606,211. The increase of $518,972 resulted primarily from interest expense of approximately $202,825 related to the interest on our senior secured convertible notes, most of which were outstanding for the first six months of 2013 and note accretion of $832,799 on our senior secured convertible notes and our unsecured convertible note. Interest expense for the six months ended June 30, 2013 is $252,269 greater than interest expense for the six months ended June 30, 2012 because the senior secured convertible notes were outstanding for the entire period in 2013 and the note accretion for those notes and the unsecured note were reflected for the entire period.

Net Income

We realized a net loss for the six months ended June 30, 2013 of $2,344,772 compared with a net income for the six months ended June 30, 2012 of $661,715 resulting in an aggregate reduction of $3,006,487. The resulting increase in net loss resulted primarily from a reduction of $4,614,086 income related to our derivative valuation gain calculation. In addition, the gain from the extinguishment of debt decreased by $1,258,091. These elements that increased the net loss were partially offset by a decrease in our operating loss of $2,422,101 as explained above due to our cost reduction efforts and the expense of $1,095,309 incurred for costs related to the issuance of warrants for the six months ended June 30, 2012 that were not repeated in 2013.

Results of Operations for the Three Months ended June 30, 2013 and June 30, 2012

Revenues

We generated $974,656 in revenue during the three months ended June 30, 2013. During the same three-month period in 2012, we generated revenue of $1,999,987. The decrease in revenue of $1,025,331 or approximately 51% was due primarily to the expiration of the contract with our largest customer and the general reduction of services provided for that customer after the expiration of the contract on May 31, 2013. The revenue generated for this customer aggregated $800,893 for the three months ended June 30, 2013 compared to $1,692,029 for the three months ended June 30, 2012. The decrease of $891,135 in revenues from this customer was due to the expiration of our service contract with the customer. In addition, web hosting and streaming revenues from one other customer of $132,000 in 2012 were not repeated in 2013.

Our largest customer accounted for approximately 82% of our revenues for the three months ended June 30, 2013 compared to 85% of our revenues for the three months ended June 30, 2012. We will no longer being servicing this customer in the future, which makes restructuring and reducing of our costs imperative until we merge with AllDigital or secure new customers to replace the lost revenues.

Cost of Revenues

Costs of revenues decreased by $549,633 to $796,333 for the three months ended June 30, 2013, from $1,345,966 for the three months ended June 30, 2012. The decrease was primarily due to a reduction of $218,706 in costs related to a reduction in services for our largest customer, a reduction of $132,712 in costs of our production department of which $100,420 was due to a reduction of staff and a reduction of $198,215 in depreciation expense due to the fact that our equipment providing services to our largest customer was fully depreciated for the entire quarter.


Expenses

General and administrative expenses for the three months ended June 30, 2013 were $642,116 compared to $1,259,320 for the three months ended June 30, 2012. The net decrease of $617,204 resulted primarily from a reduction in employee and related costs of $233,500 reflecting a reduction in staff, a decrease in temporary help expenses of $176,077, a decrease of $105,899 in tradeshow and convention expenses, a decrease of $13,346 in legal expenses and smaller decreases in a number of expenses all reflecting the reduction of business activity in the quarter. Research and development in process decreased by $295,907 for the three months ended June 30, 2013 to $168,940 from $464,847 for the three months ended June 30, 2012, which resulted primarily from a decrease of $147,628 in employee and related expenses and a decrease of $82,688 in expenses for tradeshows and related travel. Sales and marketing expenses decreased by $551,302, which decrease was composed mainly of decreases of $289,847 in employee related expenses, $153,582 in tradeshow and related travel expenses and $66,504 in consulting expenses. All of these reductions reflect the discontinuation of active marketing expenses pending the consummation of the proposed merger with AllDigital.

Even with the reduced revenue, due to a reduction of operating expenses, our operating loss decreased $1,098,743 from an operating loss of $1,833,028 for the three months ended June 30, 2012 to an operating loss of $734,286 for the three months ended June 30, 2013.

Interest Expense

For the three months ended June 30, 2013, we incurred interest expense of $591,398 compared to interest expense for the three months ended June 30, 2012 of $263,483. The increase of $327,915 resulted primarily from interest of $103,964 related to our senior secured convertible notes, and a net increase of $266,380 related the accretion of our convertible note discounts, which was partially offset by a decrease of $32,049 in interest incurred for equipment financing for our largest digital signage network customer and a decrease of $13,442 in amortization of debt offering costs.

Net Income

The Company realized a net loss for the three months ending June 30, 2013 of $457,209 compared with net income for the three months ended June 30, 2012 of $847,192. The aggregate decrease in net income of $1,304,401 was primarily the result of the decrease in our derivative valuation of $2,249,646, and a loss of $184,822 in the disposition of assets partially offset by the reduction in our operating loss of $1,523,841, as explained above, and a gain on the extinguishment of debt of $345,398.

Liquidity and Capital Resources

At June 30, 2013, we had cash of $686,347, total current assets of $877,438, total current liabilities of $7,968,941 and total stockholders' deficit of $6,736,801. Included in current liabilities is $1,275,275 related to the value of the embedded derivatives for our senior secured convertible notes, our unsecured convertible note, and warrants issued in connection with our 2012 Equity Financing and notes. All of our notes mature within the next six months and must either be refinanced or otherwise retired. We do not have the liquidity to do so nor do we have the ability to raise additional equity to retire the notes.

Cash used in operations during the six months ended June 30, 2013 was $1,052,472 compared to cash used in operations for the six months June 30, 2012 of $1,773,339. Although the net cash used in operations decreased it was primarily due to a decrease in accounts receivable of $763,461 and a decrease in accounts payable of $246,738. The negative cash flow was sustained by cash reserves from the issuance of our senior secured convertible notes and the sales of our accounts receivable to a related party, which has been treated as debt in our financial statements. We expect to continue to experience negative operating cash flow until we consummate the merger with AllDigital or until we secure additional customers that replace the revenue no longer realized from our former largest customer.


We initiated discussions with various of our accounts payable vendors to settle some of our accounts payable for less than face value in exchange for a payment in cash and/or issuance of common stock. During the three months ended June 30, 2013 we entered into agreements to discount our payables by approximately $962,630 through the payment of cash and/or issuance of stock and return of equipment to a vendor. We paid cash of $66,646, issued 2,240,852 shares of our common stock valued at $153,860 from which we recognized a $414,484 gain from the reduction of these company obligations. At June 30, 2013 our accounts payable included $76,409 which we owed to vendors as part of these settlements. Additionally, we returned equipment to a vendor for which we had been invoiced $327,640.

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 August 8, 2013, we entered into a consent to convert accounts receivable agreement with this director whereby he agreed to accept a convertible promissory note in a principal amount of $750,000 in full satisfaction of our obligations under the accounts receivable purchase agreement. The note bears interest of 12% per annum, is due October 31, 2013 and is convertible into shares of our common stock at a rate of $0.25 per share at the option of the holder.

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. In January 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 third 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 and later to May 8, 2013 for the remainder of the alleged defects to be cured or waived. 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.

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 June 30, 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. 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 . . .

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