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

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Form 10-Q for BROADCAST INTERNATIONAL INC


14-Nov-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 :

Our inability to consummate the proposed merger with AllDigital Holdings, Inc.

loss of customers that historically provided more than 90% of our revenues;

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 were not successful in deploying our CodecSys technology with customers sufficient to achieve a breakeven and found 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) increased the percentage of our outstanding common stock AllDigital's shareholders would receive in the merger from 54% to 58%, (i) modified a number of the closing conditions of the merger, including the working capital and net cash flow require, (iii) added 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) extended 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) eliminated 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) changed 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 and on August 29, 2013, we filed Amendment No. 1 to such Registration Statement as well as an additional Registration Statement on Form S-4 (File No. 333-190898) relating to exchange offers required by the Merger Agreement. On August 26, 2013, we and AllDigital entered into a third amendment to the merger agreement which (i) amended the closing condition that Broadcast have post-merger financing commitments in place for the purchase of no less than $1.5 million, nor more than $3.5 million to provide that the minimum commitments will instead be the difference between $1.5 million and the principal amount of the combined convertible notes, (ii) excluded shares issuable upon conversion of the combined convertible notes from the calculation of fully diluted capital stock for both Broadcast and AllDigital for purposes of determining relative ownership upon closing of the merger, (iii) added a condition that no one but Broadcast shall have any ownership interest in any intellectual property or intellectual property rights at any time owned or supplied by Broadcast, as determined by AllDigital in its reasonable discretion, and (iv) eliminated the ability of either party to terminate the merger agreement without cause on three days advance written notice and with no further liability to the other party.


The merger was not consummated by October 31, 2013, and on November 4, 2013, we notified AllDigital that we were terminating the Merger Agreement as a result. AllDigital responded by asserting that we were not entitled to terminate the Merger Agreement for that reason because it alleged that our failure to perform our obligations under the Merger Agreement caused the Merger not to be consummated by the October 31, 2013 deadline. In addition, AllDigital notified us that it was terminating the Merger Agreement for cause as a result of our alleged violation of the non-solicitation provisions of the Merger Agreement, which AllDigital believes triggers a termination fee of $100,000 and 4% of our equity on a non-diluted basis, and for various other alleged misrepresentations and breaches. We dispute AllDigital's allegations and assertions, deny that AllDigital is entitled to any termination fee and reserve the right to pursue damages from AllDigital arising from AllDigital's actions in relation to the Merger Agreement. In connection with the termination of the Merger Agreement, we filed requests to withdraw our Registration Statements on Form S-4 (File Nos. 333-189869 and 333-190898) with the Securities and Exchange Commission on November 6, 2013.

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, 2012, we realized approximately $7,540,025 in revenue from this contract, which contributed approximately 89% of our revenues for the year. For the nine months ended September 30, 2013, we realized approximately $2,491,015 in revenue compared to $4,894,935 for the nine months ended September 30, 2012, which constituted 85% and 84% of our 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 September 30, 2013 decreased by approximately $1,584,969 to $460,308 compared to revenues for the three month period ended September 30, 2012 of $2,045,273. With the large decrease in our revenues, our gross margin decreased $416,295 compared to our gross margin for the three months ended September 30, 2012 and 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 Nine Months ended September 30, 2013 and September 30, 2012

Revenues

We generated $2,915,535 in revenue during the nine months ended September 30, 2013. During the same nine-month period in 2012, we generated revenue of $5,790,363. The decrease in revenue of $2,874,828 or 50% was due primarily to the loss of our largest customer. Revenues from this customer decreased by $2,403,920, which accounted for 84% of the total decrease in revenues. In addition, web hosting and streaming revenues from one other customer of $205,370 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 85% of total revenues for the nine months ended September 30, 2013 and approximately 85% for the nine months ended September 30, 2012. We will no longer be servicing this customer in the future, which makes finding new customers and restructuring of our costs imperative if we are to survive as a stand-alone entity.

Cost of Revenues

Cost of revenues decreased by approximately $2,186,230 to $1,671,452 for the nine months ended September 30, 2013 from $3,857,682 for the nine months ended September 30, 2012. The gross margin from operations decreased $688,598 from a gross margin of $1,932,681 in the nine months ended September 30, 2012 to a gross margin of $1,244,083 for the nine months ended September 30, 2013. The decrease in cost of revenues was due primarily to the loss of our largest customer, which allowed us to decrease the cost of our operations department and third party costs for installation and service of that account. Although the total revenues and costs of revenues decreased, the gross margin from operations decreased as a percentage even more primarily due to the loss of revenue being greater that our cost reduction measures could offset.


Expenses

General and administrative expenses for the nine months ended September 30, 2013 were $2,277,063 compared to $3,589,602 for the nine months ended September 30, 2012. The decrease of approximately $1,312,539 resulted from decreases totaling $709,838 in employee related expenses due to a reduction in the number of employees and a reduction in salaries for some executives, $295,110 in consulting fees, $301,071 in temporary help, $238,630 in trade show and convention and travel related expenses, and $144,986 in granted option and warrant expenses. These reductions were the result of the less 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 $262,099 in legal and other profession services related primarily to the proposed merger with AllDigital. Research and development in process decreased by $873,346 for the nine months ended September 30, 2013 to $473,194 from $1,346,540 for the nine months ended September 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 $326,970 in employee related expenses reflecting a decrease in the number of employees, a decrease of $191,193 in tradeshow and convention related expenses, and a decrease of $136,447 in consulting fees. Sales and marketing expenses decreased $1,330,144 to $227,591 for the nine months ending September 30, 2013 from $1,557,735 for the nine months ending September 30, 2012. The decrease was primarily a result of decreased employee related expenses of $720,188 and a decrease in conventions and related travel expenses of $388,608, 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 $3,099,043 from an operating loss of $5,015,205 for the nine months ended September 30, 2012 to an operating loss of $1,916,162 for the nine months ended September 30, 2013.

Interest Expense

For the nine months ended September 30, 2013, we incurred interest expense of $1,327,356 compared to interest expense for the nine months ended September 30, 2012 of $1,066,599. The increase of $260,757 resulted primarily from increased interest expense of approximately $416,574 related to the interest on our senior secured convertible notes, offset by a decrease of approximately $128,401 related to satisfaction of leasing obligations and interest payable to vendors.

Net Income

We realized a net loss for the nine months ended September 30, 2013 of $2,492,038 compared with a net loss for the nine months ended September 30, 2012 of $49,357 resulting in an increase in our net loss of $2,442,681. The increase in net loss resulted primarily from a reduction of $5,300,296 in income related to our derivative valuation gain calculation. In addition, the gain from the extinguishment of debt and liabilities decreased by $1,107,231. These elements that increased the net loss were partially offset by a decrease in our operating loss of $3,099,043 as explained above due to our cost reduction efforts and a decrease of $1,095,309 incurred for costs related to the issuance of warrants for the nine months ended September 30, 2012 that were not repeated in 2013.

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

Revenues

We generated $460,309 in revenue during the three months ended September 30, 2013. During the same three-month period in 2012, we generated revenue of $2,045,278. The decrease in revenue of $1,584,969 or approximately 77% 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 $340,177 for the three months ended September 30, 2013 compared to $1,680,927 for the three months ended September 30, 2012. The decrease of $1,340,750 in revenues from this customer was due to the expiration of our service contract with the customer. Of the $340,177 of revenues from our customer, $300,000 related to a one time sale of our music on hold service software to our customer. In addition, web hosting and streaming revenues from one other customer of $74,620 in 2012 were not repeated in 2013. Going forward we would expect to have revenues of only approximately $100,000 per quarter until we secure additional customers.

Our largest customer accounted for approximately 74% of our revenues for the three months ended September 30, 2013 compared to 82% of our revenues for the three months ended September 30, 2012. We will no longer being servicing this customer in the future, which makes restructuring and reducing of our costs imperative if we are to secure new customers to replace the lost revenues and remain as a viable stand-alone entity.


Cost of Revenues

Costs of revenues decreased by $1,168,674 to $97,550 for the three months ended September 30, 2013, from $1,266,224 for the three months ended September 30, 2012. The decrease was primarily due to a reduction of $888,229 in costs related to a reduction in services primarily for our largest customer, a reduction of $255,300 in costs of our production department of which $187,235 was due to a reduction of staff, and a reduction of $94,817 in depreciation expense due to the fact that our equipment providing services to our largest customer was fully depreciated.

Expenses

General and administrative expenses for the nine months ended September 30, 2013 were $648,738 compared to $1,001,001 for the three months ended September 30, 2012. The net decrease of $352,263 resulted primarily from a reduction in employee and related costs of $277,736 reflecting a reduction in staff, a decrease in temporary help expenses of $95,811, a decrease of $77,581 in consulting expenses, all of which was partially offset by an increase in legal expenses of $143,513 related to the proposed merger with AllDigital. Research and development in process decreased by $246,245 for the three months ended September 30, 2013 to $78,881 from $325,126 for the three months ended September 30, 2012, which resulted primarily from a decrease of $129,321 in employee and related expenses and a decrease of $32,721 in expenses for temporary help and a general decrease in almost all categories of expenses reflecting the wind down of development activities. Sales and marketing expenses decreased by $399,912, which decrease was composed mainly of decreases of $224,527 in employee related expenses, $83,178 in tradeshow and related travel expenses and $60,669 in consulting expenses. All of these reductions reflect the discontinuation of active marketing expenses in expectation of the consummation of the proposed merger with AllDigital.

Even with the reduced revenue, due to a reduction of operating expenses, our operating loss decreased $676,942 from an operating loss of $1,116,902 for the three months ended September 30, 2012 to an operating loss of $439,960 for the three months ended September 30, 2013.

Interest Expense

For the three months ended September 30, 2013, we incurred interest expense of $202,173 compared to interest expense for the three months ended September 30, 2012 of $460,388. The decrease of $258,215 resulted primarily from a reduction of interest of approximately $250,543 because the senior secured convertible notes were fully accreted.

Net Income

The Company realized a net loss for the three months ending September 30, 2013 of $147,266 compared with a net loss for the three months ended September 30, 2012 of $711,072. The aggregate decrease in net loss of $563,806 was primarily the result of a decrease in our operating loss of $676,942 and decreased interest expense of $258,215 all as explained above and an increase of $150,860 in gain on the extinguishment of debt and liabilities all partially offset by a decrease in our derivative valuation gain of $686,210.

Liquidity and Capital Resources

At September 30, 2013, we had cash of $75,360, total current assets of $520,860, total current liabilities of $7,686,972 and total stockholders' deficit of $6,870,378. Included in current liabilities is $914,495 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 nine months ended September 30, 2013 was $1,532,386 compared to cash used in operations for the nine months ended September 30, 2012 of $3,286,344. Although the net cash used in operations decreased it was primarily due to a decrease in accounts receivable of $512,629 and a decrease in accounts payable and accrued liabilities of $15,883. 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 was treated as debt in our financial statements and has been converted to senior secured convertible debt. We expect to continue to experience negative operating cash flow until we secure additional customers that replace the revenue no longer realize from our former largest customer or cease operations.

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. For the nine months ended September 30, 2013 we reduced our accounts payable by $838,250 and recorded a $481,590 gain on extinguishment of liabilities resulting from the issuance of 2,240,852 shares of our common stock valued at $153,860 and cash payments totaling $202,800 to 21 of our accounts payable vendors. As of September 30, 2013 we owe 7 of these vendors an additional aggregate amount of $58,817. Additionally we reduced our accounts payable by $335,701 by returning equipment to two vendors who accepted the returns for full credit against our payable.

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 converted the $750,000 principal balance of 2013 Accounts Receivable Purchase Agreement into our 2012 Convertible Debt Offering through the issuance of short term debt. No warrants were issued with respect to this transaction.

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 Holdings, 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. On June 30, 2013, we entered into a second amendment to the Merger Agreement which (i) increased the percentage of our outstanding common stock AllDigital's shareholders would receive in the merger from 54% to 58%, (i) modified a number of the closing conditions of the merger, including the working capital and net cash flow require, (iii) added 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) extended the "end date" (a date upon which either party may terminate the Merger Agreement if the merger has not been consummated) from July . . .

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