ITEM 1. BUSINESS
Broadcast International, Inc. is a communications services and technology company headquartered in Salt Lake City, Utah. The Company operates two divisions - BI Networks and CodecSys.
Overview of BI Networks
Through BI Networks, we install, manage and support private communication networks for large organizations that have widely-dispersed locations or operations. Our enterprise clients use these networks to deliver digital signage solutions, training programs, product announcements, entertainment and other communications to their employees and customers. We use a variety of delivery technologies, including satellite, Internet streaming and WIFI, depending on the industry standard products and equipment sold by other companies.
In July 2009, we entered into a $10.1 million, three-year contract with a Fortune 10 financial company to provide technology and digital signage services to approximately 2,100 of its more than 6,000 retail and administrative locations throughout North America. Our customer is in process of expanding its network to additional retail and administrative locations. In addition, the customer has selected us to be its vendor for certain additional audio visual services and to perform additional network management services for it during 2011. A factor in securing them as a customer was our CodecSys® technology utilized in delivering our services.
Bi Networks Products and Services
Following are some of the ways in which businesses utilize our products and services.
Internal Business Applications
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Deliver briefings from the CEO or other management
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Launch new products or services
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Present new marketing campaigns
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Train employees
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Announce significant changes or implement new policies and procedures
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Respond to crisis situations
External Business Applications
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Display advertising in public areas utilizing digital signage
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Make promotional presentations to prospective customers or recruits
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Provide product/service training to customers
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Train and communicate with sales agents, dealers, VARs, franchisees, association members, etc.
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Sponsor satellite media tours
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Provide video/audio news releases
Network-Based Services
We utilize satellite technology for various business training and communication applications. The list that follows describes the comprehensive offering of products and services that attracts companies in need of a satellite solution.
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Network design and engineering
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Equipment and installation
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Network management
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24/7 help desk services
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On-site maintenance and service
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Full-time or occasional satellite transponder purchases (broadcast time)
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Uplink facilities or remote SNG uplink trucks
Streamed Video Hosting Services
With the advancement of streaming technologies and the increase of bandwidth, the Internet provides an effective platform for video-based business training and communications. Our management believes that the Internet will become an increasing means of broadband business video delivery. Consequently, we have invested in the infrastructure and personnel needed to be a recognized provider of Internet-based services. Following are the services we currently provide:
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Dedicated server space
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High-speed, redundant Internet connection
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Secure access
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Seamless links from client's website
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Customized link pages and media viewers
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Testing or self-checks
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Interactive discussion threads
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Participation/performance reports for managers/administrators
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Notification of participants via email
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Pay-per-view or other e-commerce applications
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Live events
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24/7 technical support
Production and Content Development Services
To support both satellite and Internet-based delivery platforms, we employ professional production and content development teams and operate full service video and audio production studios. A list of support services follows:
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In-studio or on-location video/audio production
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Editing/post-production
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Instructional design
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Video/audio encoding for Internet delivery
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Conversion of text or PowerPoint to HTML
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Alternative language conversion
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Access to “off-the-shelf” video training content
Service Revenue
We generate revenue by charging fees for the services we provide, and/or by selling equipment and satellite time. A typical satellite network generates revenues from the sale and installation of satellite or Internet receivers and antennas and additional monthly revenues from network management services. On-site maintenance/service, production fees, and occasional satellite time are charged as they are used.
For Internet-based services, we charge customers monthly fees for hosting content, account management, quality assurance and technical support, if requested. Encoding, production and content creation or customization are billed as these services are performed. We have also entered into content development partnerships with professional organizations that have access to subject matter experts. In these cases, we produce web-based training presentations and sell them on a pay-per-view basis, sharing revenues with the respective partner.
In the process of creating integrated technology solutions, we have developed proprietary software systems such as our content delivery system, incorporating site, user, media and template controls to provide a powerful mechanism to administer content delivery across multiple platforms and to integrate into any web-based system. We use our content delivery system to manage networks of thousands of video receiving locations for enterprise clients.
The percentages of revenues derived from our different services fluctuate depending on the customer contracts entered into and the level of activity required by such contracts in any given period.
Of our net sales in 2010 and 2009 approximately 95% were derived from network management related services and approximately 5% were derived from product and content development and all other services.
Our network management and support services are generally provided to customers by our operations personnel located at our corporate headquarters. Our production and content development services are generally provided by our personnel from our production studio. We generally contract with independent service technicians to perform our installation and maintenance services at customer locations throughout the United States.
Overview of CodecSys
We own proprietary video compression technology that we have trademarked “CodecSys.” Video compression is the process by which video content is converted into a digital data stream for transmission over satellite, cable, Internet or wireless networks. Initially, we developed this technology for delivering video content for our network customers. However, this proprietary technology has expanded into a much wider application.
Video compression is generally accomplished by using a single technique or computer formula to create a particular data stream. Our patented CodecSys technology is a software-based video operating system that uses multiple techniques or computer formulas to create a particular data stream. With CodecSys, video content may be transmitted over substantially decreased bandwidth while maintaining media quality. We believe our CodecSys technology offers significant efficiencies and cost savings over traditional hardware solutions associated with video content transmission and storage.
We have developed a video encoding software product based upon our CodecSys technology that operates on multiple hardware platforms and is easily upgradable. In September 2009, our CodecSys video encoding technology was certified by Microsoft as an approved software encoding system for use by IPTV providers that use Microsoft operating platforms. Our CodecSys technology is the only software video encoding system certified by Microsoft. Microsoft is a leading provider of network control software to the IPTV market.
In July 2010, we released CodecSys version 2.0, which has been installed in various large telecoms and labs for evaluation by potential customers. We continue to make sales presentations and respond to requests for proposals at other large telecoms, cable companies and broadcasting companies. These presentations have been made with our technology partners, including IBM, HP and Microsoft, which are suppliers of hardware and software for video transmission applications in Microsoft’s Media Room environment. Because CodecSys is software-based, it is also ideal for cloud-based initiatives.
CodecSys Technology
We own proprietary video compression technology that we trademarked as “CodecSys” and are developing commercial applications for the technology. Video compression is the process by which video content is converted into a digital data stream for transmission over satellite, cable, Internet or wireless networks. Today, video compression is generally accomplished by using a single technique or mathematical algorithm to create a particular data stream. Our CodecSys technology uses multiple techniques or mathematical algorithms to create a particular data stream. With CodecSys, video content may be transmitted over decreased bandwidth while maintaining media quality.
In today's market, any video content to be distributed via satellite, cable, the Internet and other methods must be encoded into a digital stream using any one of numerous codecs. The most commonly used codecs are now MPEG2, MPEG4, and H.264. When new codecs are developed that perform functions better than the current standards, all of the video content previously encoded in the old format must be re-encoded to take advantage of the new codec. Our CodecSys technology eliminates obsolescence in the video compression marketplace by integrating new codecs into its library. Using a
CodecSys switching system to utilize the particular advantages of each codec, we may utilize any new codec as it becomes available by including it in the application library. Codec switching can happen on a scene-by-scene or even a frame-by-frame basis.
We believe the CodecSys technology represents an unprecedented shift from currently used technologies for two important reasons. First, CodecSys allows a change from using only a single codec to compress video content to using multiple codecs and algorithms in the compression and transmission of content. The CodecSys system selects dynamically the most suitable codecs available from the various codecs stored in its library to compress a single video stream. As a video frame, or a number of similar frames (a scene), is compressed, CodecSys applies the optimized codec from the library that best compresses that content. CodecSys repeats the selection throughout the video encoding process, resulting in the use of numerous codecs on a best performance basis. The resulting file is typically substantially smaller than when a single codec compression method is used.
The second important distinction is that CodecSys is a software encoding system that can be upgraded and improved without changing the hardware on which it is resident much as a personal computer can have its application software upgraded and changed without replacing the equipment. In addition, CodecSys software can run equally efficiently on different manufacturers’ equipment. For example, using the Intel chip currently employed by us, our CodecSys encoding system can run equally as well on IBM equipment and HP equipment, which expands our potential market of customers and opens the possibility of different sales channels as our software can be sold by IBM sales people as well as HP sales people. In addition, currently, most video encoders utilize an application specific integrated circuit (ASIC) chip as the encoding engine and when new developments are made, the customer must purchase new hardware to take advantage of the changes. Having a software based encoding system new changes in technology and encoding algorithms can be downloaded remotely to upgrade the encoding system on the customers already resident hardware. We believe that having a software based encoding product will slow hardware obsolescence for the customer and be a competitive advantage for us.
CodecSys Products and Services
In November 2007, we entered into a two-year license agreement with IBM pursuant to which we licensed our patented CodecSys technology for use by IBM in selling video encoding solutions using IBM’s Cell-BE processing chip. The IBM agreement was our first significant license of the CodecSys technology for use in a commercial application. In connection with this license, we increased our engineering staff, acquired additional equipment to facilitate the development process, purchased additional codecs for use in our encoding system and engaged outside engineering firms to perform development services. These development initiatives resulted in substantially increased research and development expenditures for 2008. The initial version of a video encoder running on the IBM platform was completed in a commercially deployable form for sales in 2009, although additional development work was required.
After we had completed substantially all of our development work on the IBM Cell-BE processor chip in the first half of 2009, IBM sales efforts using the Cell-BE processor chip were redirected to products not employing the Cell-BE processor chip. Intel then released a newly developed operating chip on which we decided to redirect our development efforts. The Intel chip has the processing power necessary to perform the multiple functions required by our CodecSys technology. This chip is based on x86 architecture, which is the standard in the industry acceptable to almost all users, and it is easier to program applications to this architecture. Although our license agreement with IBM has expired, IBM is making hardware sales presentations utilizing our CodecSys technology based upon the Intel chip. The initial version of the CodecSys video encoding system utilizing the Intel chip was first ready for sales presentations and testing in the fourth quarter of 2009, but the CodecSys version 2.0, the first commercial version of the software hardened for sales and deployment was not ready for sales installation until July 1, 2010. All sales anticipated in the future will be made using the Intel chip. Notwithstanding the expiration of our license with IBM, we continue to market our CodecSys video encoding software with IBM for use on IBM hardware to prospective customers.
As described above, we continue to make sales presentations with IBM to IBM customers as our software based encoding system is a part of the IBM media room product offering. The IBM media room products consist of servers and control and management software used by broadcasters and other distributors of video content over a variety of delivery platforms. Using CodecSys as an integral part of the product offering gives IBM and other hardware providers an additional product that is sold in the same process as its media room offering. Currently, IBM has installed our CodecSys based software in “proof of concept” systems at customer locations for the customers to test and evaluate the quality, speed, and bandwidth requirements of our software encoding solution. IBM marketing and sales activities with respect to an encoder utilizing the Intel chip and incorporating our CodecSys technology are continuing, and we are increasing the number of our “proof of concept” units at IBM potential customers.
Because we now have our CodecSys technology resident on the Intel chip, we are able to market with other manufacturers of computer equipment such as HP. We have made sales presentations to HP customers in conjunction with HP, which has also selected our video encoding solution as a solution that it will present to its customers. We have installed our CodecSys based software in “proof of concept” systems at HP customer locations. This has occurred primarily because CodecSys is the only software based encoding system available that will operate on HP hardware platforms and is the only solution that will operate in a cloud computing environment.
In September 2009, our CodecSys encoding system was certified by Microsoft as an approved software encoding system for use by IPTV providers, which use Microsoft Media Room software in their delivery and management of their IPTV systems. It is the only software video encoding system certified by Microsoft that can be used on a variety of hardware platforms. The certification has been a source of sales and marketing leads from Microsoft customers desiring encoding solutions for their projects.
Despite the developments described above, we have not derived any material revenue from our CodecSys technology to date.
We continue to develop the CodecSys technology for a variety of applications, including Internet streaming, cable and satellite broadcasting, IPTV and transmitting video content to cellular phones and other hand-held electronic devices. Commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $2.0 million annually. This estimate may increase or decrease depending on specific opportunities and available funding.
Research and Development
We have spent substantial amounts in connection with our research and development efforts. These efforts have been dedicated to the development and commercialization of the CodecSys technology. Our research and development expenditures were approximately $2,711,933 in 2010 and $3,584,019 in 2009. Because of our current liquidity position and capital budgeting plans and the fact that we still expend approximately $300,000 per month more than we receive from operating activities, our cash resources may not be sufficient to support future research and development activities unless we raise additional capital or succeed in generating revenues from sales of CodecSys encoders. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources”.
Intellectual Property Protection
Because much of our future success and value depends on the CodecSys technology, our patent and intellectual property strategy is of critical importance. Two provisional patents describing the technology were filed on September 30, 2001 in the United States and subsequently in various foreign countries. Our initial U.S. patent related to the CodecSys technology was granted by the U.S. Patent and Trademark Office, or PTO, in August 2007. Four additional patents have since been issued by the PTO. As of February 1, 2011, we also had eleven patents issued in foreign countries and 20 pending patent applications, including U.S. and foreign counterpart applications.
We have identified additional applications of the technology, which represent potential patents that further define specific applications of the processes that are covered by the original patents. We intend to continue building our intellectual property portfolio as development continues and resources are available.
We have registered the “CodecSys” trademark with the PTO, and seek to protect our know-how, trade secrets and other intellectual property through a variety of means, including confidentiality agreements with our employees, customers, vendors, and others.
Major Customers
A small number of customers account for a large percentage of our revenue. Sales revenues from our largest customer accounted for approximately 87% and 72% of total revenues for the twelve months ended December 31, 2010 and 2009, respectively. No other customer accounted for more than 5% of our total revenues in either year.
In September 2009, we accelerated the extent of the services we were performing for our new Fortune 10 financial customer by commencing a retrofit program for approximately 2,100 of its retail locations throughout the country. Despite performing on that contract for only four months, this customer was our largest customer in 2009and this customer accounted for 87% of our total revenues in 2010. Any material reduction in revenues generated from this customer could harm our results of operations, financial condition and liquidity. Our largest customer may not continue to purchase our services and may decrease its level of purchases. To the extent that our largest customer no longer uses our services, revenues will decline substantially, which would harm our business unless we can replace that customer with another similarly large customer.
Competition
The communications industry is extremely competitive. In the private satellite network market, there are many firms that provide some or all of the services we provide. Many of these competitors are larger than us and have significantly greater financial resources. In the bidding process for potential customers, many of our competitors have a competitive advantage in the satellite delivery of content because many own satellite transponders or otherwise have unused capacity that gives them the ability to submit lower bids than we are able to make. In the satellite network and services segment, we compete with Convergent Media Systems, Globecast, IBM, Cisco, TeleSat Canada and others.
There are several additional major market sectors in which we plan to compete with our CodecSys technology, all with active competitors. These sectors include the basic codec technology market, the corporate enterprise and small business streaming media market, and the video conferencing market. These are sectors where we may compete by providing direct services. Competition in these new market areas will also be characterized by intense competition with much larger and more powerful companies, such as Microsoft and Yahoo, which are already in the video compression and transmission business. Many of these competitors already have an established customer base with industry standard technology, which we must overcome to be successful.
The video encoders to be sold by IBM and HP will compete directly against video encoders manufactured and sold by a number of competitors, including Tandberg, Harmonic, Cisco, Motorola, and Thomson. Neither IBM nor HP has ever produced a video encoder to compete in this market. To the extent our marketing partners are unsuccessful in entering this new market, we will not derive the amount of licensing revenue currently anticipated by management.
On a technology basis, CodecSys competition varies by market sector, with codecs and codec suppliers like Microsoft Windows Media Player, Real Networks' Real Player, Apple, QuickTime, MPEG2, MPEG4, On2, DivX and many others. There are several companies, including Akamai, Inktomi, Activate and Loudeye, that utilize different codec systems. These companies specialize in encoding, hosting and
streaming content services primarily for news/entertainment clients with large consumer audiences. All are larger and have greater financial resources than we have.
Employees
We currently employ 41 full-time personnel at our executive offices and studio facilities in Salt Lake City, Utah, and 4 employees outside Utah. In January 2009, we reduced our employee count by terminating 12 individuals, most of whom worked in technical positions. We engage independent contractors and employ the services of independent sales representatives as well as voice and production talent on an “as needed” basis at our recording studios.
Government Regulation
We have seven licenses issued by the Federal Communications Commission for satellite uplinks, Ethernet, radio connections and other video links between our facilities and third-party uplinks. Notwithstanding these licenses, all of our activities could be performed outside these licenses with third-party vendors. All material business activities are subject to general governmental regulations with the exception of actual transmission of video signals via satellite.
ITEM 1A.
ITEM 1A. RISK FACTORS
You should carefully consider the following risk factors and all other information contained in this report. Our business and our securities involve a high degree of risk.
If we do not successfully commercialize our CodecSys technology, we may never achieve profitability, retire our convertible debt or be able to raise future capital.
It is imperative that we successfully commercialize our CodecSys technology. We continue to develop this technology for a variety of applications. We have never been involved in a development project of the size and breadth that is involved with CodecSys and none of our management has ever been involved with a software development project. Management may lack the expertise and we may not have the financial resources needed for successful development of this technology. Furthermore, commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $2.0 million annually for the foreseeable future, although we have spent considerably more than that in past years. This estimate will increase or decrease depending on specific opportunities and available funding. If we are unsuccessful in our CodecSys development and commercialization efforts, it is highly doubtful we will achieve profitable operations, retire our existing convertible indebtedness or be able to raise additional funding in the future.
We may need additional capital. If additional capital is required but is not available, we may have to curtail or cease operations.
We completed an equity funding in December 2010, which should provide us with working capital for the next 18 months. During this time, we anticipate that we will be able to generate net sales in excess of operating expenses. If, however, we are unable to do so, we will need to obtain additional financing to continue operations. We believe external funding may be difficult to obtain, particularly given the prevailing financial market conditions. If sufficient capital is not available to us, we will be required to pursue one or a combination of the following remedies: significantly reduce development, commercialization or other operating expenses; sell part or all of our assets; or terminate operations.
The existing turbulence and illiquidity in the credit and financial markets are continuing challenges that have generally made potential funding sources more difficult to access, less reliable and more expensive. These market conditions have made the management of our own liquidity significantly more challenging. A further deterioration in the credit and financial markets or a prolonged period without improvement could adversely affect our ability to raise additional capital.
We may not be able to repay our outstanding convertible notes when they become due.
The maturity date of our $5.5 million senior unsecured convertible note is December 23, 2013. Our $1.0 million unsecured convertible note is due on December 31, 2013. In order to repay our outstanding convertible notes, we believe we will need to secure additional debt or equity financing. If we are unable to repay our unsecured convertible notes when due, we may face possible foreclosure on our assets by the note holders, bankruptcy protection or liquidation.
We have sustained and may continue to sustain substantial losses.
We have sustained operating losses in each of the last seven years. Through December 31, 2010, our accumulated deficit was $112,492,311. Although we have significantly reduced our use of cash for operations due to our new digital signage contracts, we continue to sustain losses on a quarterly and annual basis.
Our success depends on adoption of our CodecSys technology by OEMs and end-users.
The success of our CodecSys technology depends on the adoption of this technology by original equipment manufacturers, or OEMs, like IBM and HP, as well as end-users. The OEM qualification and adoption process is complex, time-consuming and unpredictable. Furthermore, OEMs may elect to maintain their relationships with incumbent technology providers, even when presented with technology that may be superior to the incumbent technology. Significant delays in the development or OEM adoption of CodecSys will adversely affect our results of operations, financial condition and prospects.
Our continued losses may impact our relationships with OEMs and customers.
Our continued losses may impact our relationships with existing and potential OEMs and customers. OEMs may be reluctant to partner with us or present our technology in conjunction with their product offerings if they believe our financial condition is marginal or in jeopardy. OEMs and prospective customers may delay adoption of our CodecSys technology and other products if they believe we are not financially sound enough to support our technology or other product offerings.
Covenant restrictions contained in our outstanding convertible notes may limit our ability to obtain additional capital and to operate our business.
Our $5.5 million senior convertible note and our $1.0 million unsecured convertible note contain, among other things, covenants that may restrict our ability to obtain additional capital or to operate our business. For example, (i) the senior convertible note prohibits us from paying any dividends unless we obtain the prior written consent of the holder of such note; (ii) the senior convertible note prohibits us from incurring any indebtedness; (iii) the senior convertible note prohibits us from repaying any indebtedness which is junior to the senior convertible note; and (iv) the senior convertible note and the unsecured convertible note contain anti-dilution provisions. Even if we are able to obtain additional capital, such covenants could result in substantial dilution to our existing shareholders. Furthermore, a breach of any of the covenants contained in the convertible notes could result in a default under the notes, in which event the note holders could elect to declare all amounts outstanding to be immediately due and payable, which would require us to secure additional debt or equity financing to repay the indebtedness or to seek bankruptcy protection or liquidation.
Adverse economic or other market conditions could reduce the purchase of our services by existing and prospective customers, which would harm our business.
Our business is impacted from time to time by changes in general economic, business and international conditions and other similar factors. Adverse economic or other market conditions negatively affect the business spending of existing and prospective customers. In adverse market times, our network and other services may not be deemed critical for these customers. Therefore, our services
are often viewed as discretionary and may be deferred or eliminated in times of limited business spending, thereby harming our business.
The recent recession and market turmoil present considerable risks and challenges. These risks and challenges have reached unprecedented levels and have significantly diminished overall confidence in the national economy, upon which we are dependent. Such factors could have an adverse impact on our business and prospects in ways that are not predictable or that we may fail to anticipate.
Our systems of internal operational and financial controls may not be effective.
We establish and maintain systems of internal operational and financial controls that provide us with critical information. These systems are not foolproof, and are subject to various inherent limitations, including cost, judgments used in decision-making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of internal controls or procedures may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management. We have previously experienced significant deficiencies in our required disclosure controls and procedures regarding the updating of certain accounting pronouncements and the reporting of current information required to be filed with the SEC. We have also experienced a significant deficiency and a material weakness in our required disclosure controls and procedures regarding our accounting entries and financial statements, which resulted in the restatement of one accounting period. Any future deficiency, weakness, malfunction or inadequacy related to internal operational or financial control systems or procedures could produce inaccurate and unreliable information that may harm our business.
We may be unable to respond adequately to rapid changes in technology.
The markets for private communication networks and video encoder systems are characterized by rapidly changing technology, evolving industry standards and frequent new product introductions. The introduction of new technology and products and the emergence of new industry standards not only impacts our ability to compete, but could also render our products, services and CodecSys technology uncompetitive or obsolete. If we are unable to adequately respond to changes in technology and standards, we will not be able to serve our clients effectively. Moreover, the cost to modify our services, products or infrastructure in order to adapt to these changes could be substantial and we may not have the financial resources to fund these expenses.
We face intense competition that could harm our business.
The communications industry is extremely competitive. We compete with numerous competitors who are much larger than us and have greater financial and other resources. In the satellite network and services segment, we compete with Convergent Media Systems, Globecast, IBM, Cisco, TeleSat Canada and others. Our competitors have established distribution channels and significant marketing and sales resources. Competition results in reduced operating margins for our business and may cause us to lose clients and/or prevent us from gaining new clients critical for our success.
There are several additional major market sectors in which we plan to compete with our CodecSys technology, all with active competitors. These sectors include the basic codec technology market, the corporate enterprise network market and small business streaming media market. These are sectors where we may compete by providing direct services. Competition in these new market areas will also be characterized by intense competition with much larger and more powerful companies, such as Microsoft and Yahoo, which are already in the video compression and transmission business. Many of these competitors already have an established customer base with industry standard technology, which we must overcome to be successful.
On a technology basis, CodecSys competition varies by market sector, with codecs and codec suppliers like Microsoft Windows Media Player, Real Networks' Real Player, Apple QuickTime, MPEG2, MPEG4, On2, DivX and many others. There are several companies, including Akamai, Inktomi, Activate and Loudeye, which utilize different codec systems. These companies specialize in encoding, hosting and streaming content services primarily for news/entertainment clients with large consumer audiences. All are larger and have greater financial resources than we have.
If we fail to hire additional specialized personnel or retain our key personnel in the future, we will not have the ability to successfully commercialize our technology or manage our business.
We still need to hire additional specialized personnel to successfully commercialize our CodecSys technology. If we are unable to hire or retain qualified software engineers and project managers, our ability to complete further development and commercialization efforts will be significantly impaired. Our success is also dependent upon the efforts and abilities of our management team. If we lose the services of certain of our current management team members, we may not be able to find qualified replacements which would harm the continuation and management of our business.
Our revenue is dependent upon the sales efforts of others.
We are dependent upon the sales and marketing efforts of IBM, HP, Microsoft and other third-party businesses in order to derive licensing revenue from our CodecSys technology. Such businesses may not continue their sales efforts which would adversely affect our potential licensing fees. We are not able to control the sales and marketing efforts of these third parties. Limited revenues from our historical sources make us even more dependent upon the sales efforts of others. Given the current recession and market developments, third-party businesses may scale back on sales efforts which could significantly harm our business and prospects.
We rely heavily on a few significant customers and if we lose any of these significant customers, our business may be harmed.
A small number of customers account for a large percentage of our revenue. Our business model relies upon generating new sales to existing and new customers. Sales revenues from our largest customer accounted for approximately 87% of total revenues for the twelve months ended December 31 2010 and 72% of total revenues for the twelve months ended December 31, 2009. In September 2009 we secured a contract with a large national organization, which has become our largest customer. To the extent that our largest customer reduces its reliance on us or terminates its relationship with us, revenues would decline substantially, which would harm our business, unless we can replace that customer with another similarly large customer.
There is significant uncertainty regarding our patent and proprietary technology protection.
Our success is dependent upon our CodecSys technology and other intellectual property rights. If we are unable to protect and enforce these intellectual property rights, competitors will have the ability to introduce competing products that are similar to ours. If this were to occur, our revenues, market share and operating results would suffer. To date, we have relied primarily on a combination of patent, copyright, trade secret, and trademark laws, and nondisclosure and other contractual restrictions on copying and distribution to protect our proprietary technology. Our initial U.S. patent related to our CodecSys technology was granted by the PTO in August 2007 and four additional patents related to applications of the technology were subsequently issued by the PTO. As of February 1, 2011, eleven foreign countries had issued our initial patent. In addition, we have 20 pending U.S. and foreign patent applications. If we fail to deter misappropriation of our proprietary information or if we are unable to detect unauthorized use of our proprietary information, then our revenues, market share and operating results will suffer. The laws of some countries may not protect our intellectual property rights to the same extent as do the laws of the United States. Furthermore, litigation may be necessary to enforce our intellectual property rights, to protect trade secrets, to determine the validity and scope of the proprietary
rights of others, or to defend against claims of infringement or invalidity. This litigation could result in substantial costs and diversion of resources that would harm our business.
Our products could infringe on the intellectual property rights of others, which may subject us to future litigation and cause financial harm to our business.
To date, we have not been notified that our services, products and technology infringe the proprietary rights of third parties, but there is the risk that third parties may claim infringement by us with respect to current or future operations. We expect software developers will increasingly be subject to infringement claims as the number of products and competitors in the industry segment grows and the functionality of products in different industry segments overlaps. Any of these claims, with or without merit, could be time-consuming to defend, result in costly litigation, divert management’s attention and resources, cause product shipment delays, or require us to enter into royalty or licensing agreements. These royalty or licensing agreements, if required, may not be available on terms acceptable to us. A successful claim against us of infringement and failure or inability to license the infringed or similar technology on favorable terms would harm our business.
Our common stock is considered “penny stock” which may make selling the common stock difficult.
Our common stock is considered to be a “penny stock” under the definitions in Rules 15g-2 through 15g-6 promulgated under Section 15(g) of the Securities Exchange Act of 1934, as amended. Under the rules, stock is considered “penny stock” if: (i) the stock trades at a price less than $5.00 per share; (ii) it is not traded on a “recognized” national exchange; (iii) it is not quoted on the Nasdaq Stock Market, or even if quoted, has a price less than $5.00 per share; or (iv) is issued by a company with net tangible assets less than $2.0 million, if in business more than a continuous three years, or with average revenues at less than $6.0 million for the past three years. The principal result or effect of being designated a “penny stock” is that securities broker-dealers cannot recommend our stock but must trade it on an unsolicited basis.
Section 15(g) of the Exchange Act and Rule 15g-2 promulgated thereunder by the SEC require broker-dealers dealing in penny stocks to provide potential investors with a document disclosing the risks of penny stocks and to obtain a manually signed and dated written receipt of the document before effecting any transaction in a penny stock for the investor’s account. Potential investors in our common stock are urged to obtain and read such disclosure carefully before purchasing any shares that are deemed to be “penny stocks.” Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the account of any investor for transactions in such stocks before selling any penny stock to that investor. This procedure requires the broker-dealer to (i) obtain from the investor information concerning his or her financial situation, investment experience and investment objectives; (ii) reasonably determine, based on that information, that transactions in penny stocks are suitable for the investor and that the investor has sufficient knowledge and experience as to be reasonably capable of evaluating the risks of penny stock transactions; (iii) provide the investor with a written statement setting forth the basis on which the broker-dealer made the determination in (ii) above; and (iv) receive a signed and dated copy of such statement from the investor, confirming that it accurately reflects the investor’s financial situation, investment experience and investment objectives. Compliance with these requirements may make it more difficult for holders of our common stock to resell their shares to third parties or to otherwise dispose of them in the market or otherwise.
Trading in our securities could be subject to extreme price fluctuations that could cause the value of your investment to decrease.
Our stock price has fluctuated significantly in the past and could continue to do so in the future. Our stock is thinly-traded, which means investors will have limited opportunities to sell their shares of common stock in the open market. Limited trading of our common stock also contributes to more volatile price fluctuations. The market price of our common stock is also subject to extreme fluctuations because of the nature of the CodecSys technology and the potential for large-scale acceptance or rejection of our
technology in the marketplace. Given these fluctuations, an investment in our stock could lose value. A significant drop in our stock price could expose us to the risk of securities class action lawsuits. Defending against such lawsuits could result in substantial costs and divert management’s attention and resources, thereby causing an investment in our stock to lose additional value.
Future sales of our common stock could cause our stock price to decrease.
Substantial sales of our common stock in the public market, or the perception by the market that such sales could occur, could lower our stock price. As of December 31, 2010, we had 74,078,153 shares of common stock outstanding. As of December 31, 2010, stock options, including options granted to our employees, and warrants to purchase an aggregate of 20,442,170 shares of our common stock were issued and outstanding, a substantial portion of which were fully exercisable. As of December 31, 2010, notes convertible into 5,740,741 shares of our common stock were issued and outstanding. As of December 31, 2010, we had granted restricted stock units to members of our Board of Directors and others, which may be settled at various time in the future by the issuance of 950,000 shares of common stock. Future sales of our common stock, or the availability of our common stock for sale, may cause the market price of our common stock to decline.
Any stock ownership interest may be substantially diluted by future issuances of securities.
We may issue shares of our common stock to holders of outstanding convertible notes, stock options and warrants. The conversion of the convertible notes and the exercise of options and warrants into shares of our common stock will be dilutive to shareholders. We also have offered and expect to continue to offer stock options to our employees and others, and have approximately 1,936,065 shares of common stock available for future issuance under our 2004 long-term incentive stock option plan and 2,765,000 shares of common stock available for future issuance under our 2008 equity incentive plan. To the extent that future stock options are granted and ultimately exercised, there will be further dilution to shareholders.
In connection with the Equity Financing (as defined below) completed in December, 2010, the Company agreed to prepare and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants. If the Company fails to have the registration statement declared effective within 120 days following the date of the filing of the registration statement, the Company will be obligated to issue additional warrants to the investors to purchase an additional 1,250,000 shares for each 30-day period after the deadlines, until either the registration statement is filed or declared effective, as the case may be which could result in further dilution to the shareholders.
We have never paid dividends and do not anticipate paying any dividends on our common stock in the future, so any return on an investment in our common stock will depend on the market price of the stock.
We currently intend to retain any future earnings to finance our operations. The terms and conditions of our convertible notes restrict and limit payments or distributions in respect of our common stock. The return on any investment in our common stock will depend on the future market price of our common stock and not on any potential dividends.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our executive offices are located at 7050 Union Park Ave., Suite 600, Salt Lake City, Utah 84047. We occupy the space at the executive offices under a 12 month lease, the term of which ends October 31, 2011. The lease covers approximately 13,880 square feet of office space leased at a rate of $26,316 per month. Our production studio is located at 6952 South 185 West, Unit C, Salt Lake City, Utah 84047, and consists of approximately 15,200 square feet of space leased under a month to month contract at a rate of $11,551 per month. We have no other properties.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is a defendant in one lawsuits, the total amount in dispute in which is approximately $105,000. To the knowledge of management, no other litigation has been filed or threatened.
ITEM 4.
ITEM 4. REMOVED AND RESERVED
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Price Range
Our common stock is currently traded on the OTC Bulletin Board under the symbol “BCST.” The following table sets forth, for the periods indicated, the high and low bid quotations, as adjusted for stock splits of our common stock, as reported by the OTC Bulletin Board, and represents prices between dealers, does not include retail markups, markdowns or commissions, and may not represent actual transactions:
Holders
As of March 17, 2011, we had 74,213,522 shares of our common stock issued and outstanding, and there were approximately 1,400 shareholders of record.
Dividends
We have never paid or declared any cash dividends. Future payment of dividends, if any, will be at the discretion of our board of directors and will depend, among other criteria, upon our earnings, capital requirements, and financial condition as well as other relative factors. Management intends to retain any and all earnings to finance the development of our business, at least in the foreseeable future. Such a policy is likely to be maintained as long as necessary to provide working capital for our operations.
Moreover, our outstanding convertible notes contain restrictive covenants that prohibit us to declare or pay dividends.
Sales of Unregistered Securities
During December 2010 and March, 2011, we issued a total of 293,517 shares of common stock to the holder of our unsecured convertible note in satisfaction of $176,110 of accrued interest on the unsecured convertible note. Also, in March 2011, in connection with the satisfaction of the accrued interest we granted to the holder a warrant to acquire up to 221,758 additional shares of our common stock at an exercise price of $.90 per share. The warrant is exercisable at any time for a five year period.
The holder of the unsecured convertible note is an accredited investor and was fully informed regarding his investment. In the transactions, we relied on the exemptions from registration under the Securities Act set forth in Section 4(2) and Section 4(6) thereof.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
We had no purchases of equity securities by the issuer or affiliated purchasers during the fourth quarter of 2010.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and related notes that are included elsewhere in this report. This discussion may contain forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under the caption “Risk Factors” or in other parts of this report. See “Cautionary Note Regarding Forward-Looking Statements.”
Critical Accounting Policies
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
We consider all cash on hand and in banks, and highly liquid investments with maturities of three months or less, to be cash equivalents. At December 31, 2010 and 2009, we had bank balances in the excess of amounts insured by the Federal Deposit Insurance Corporation. We have not experienced any losses in such accounts, and believe we are not exposed to any significant credit risk on cash and cash equivalents.
Current financial market conditions have had the effect of restricting liquidity of cash management investments and have increased the risk of even the most liquid investments and the viability of some
financial institutions. We do not believe, however, that these conditions will materially affect our business or our ability to meet our obligations or pursue our business plans.
Accounts Receivable
Trade accounts receivable are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 90 days. After the receivable becomes past due, it is on non-accrual status and accrual of interest is suspended.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the property, generally from three to five years. Repairs and maintenance costs are expensed as incurred except when such repairs significantly add to the useful life or productive capacity of the asset, in which case the repairs are capitalized.
Auction Rate Preferred Securities
As of December 31, 2009, we had investments in auction rate preferred securities, or ARPS, in the amount of $300,000 which were classified as long-term investments on our consolidated balance sheet and reflected at fair value. These ARPS were all that remained of investments that originally totaled $11,600,000 and which all but the $300,000 were redeemed at par. The ARPS secured a loan made by the brokerage company from which we purchased the ARPS in the original amount of $1,400,000, of which $162,500 remained outstanding at December 31, 2009. During the year ended December 31, 2010, we redeemed the remaining balance of $300,000 (par value) of our ARPS and recognized a $49,264 loss on sale of available for sale securities and retired the loan.
Patents and Intangibles
Patents represent initial legal costs incurred to apply for United States and international patents on the CodecSys technology, and are amortized on a straight-line basis over their useful life of approximately 20 years. We have filed patent applications in the United States and foreign countries. As of December 31, 2010, the U.S. Patent and Trademark Office or PTO had approved five patents. Additionally, eleven foreign countries had issued patents and we had 20 pending patent applications, including U.S. and foreign counterpart applications. While we are unsure whether we can develop the technology in order to obtain the full benefits, the patents themselves hold value and could be sold to companies with more resources to complete the development. On-going legal expenses incurred for patent follow-up have been expensed from July 2005 forward.
Long-Lived Assets
We review our long-lived assets, including patents, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset to future un-discounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, then the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Fair value is determined by using cash flow analyses and other market valuations.
After our review at December 31, 2010, it was determined that no adjustment was required.
Stock-based Compensation
Stock-based compensation cost is estimated at the grant date, based on the estimated fair value of the awards, and recognized as expense ratably over the requisite service period of the award for awards expected to vest.
Income Taxes
We account for income taxes in accordance with the asset and liability method of accounting for income taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in the years in which those temporary differences are expected to be recovered or settled.
Revenue Recognition
We recognize revenue when evidence exists that there is an arrangement between us and our customers, delivery of equipment sold or service has occurred, the selling price to our customers is fixed and determinable with required documentation, and collectability is reasonably assured. We recognize as deferred revenue, payments made in advance by customers for services not yet provided.
When we enter into a multi-year contract with a customer to provide installation, network management, satellite transponder and help desk, or combination of these services, we recognize this revenue as services are performed and as equipment is sold. These agreements typically provide for additional fees, as needed, to be charged if on-site visits are required by the customer in order to ensure that each customer location is able to receive network communication. As these on-site visits are performed the associated revenue and cost are recognized in the period the work is completed. If we install, for an additional fee, new or replacement equipment to an immaterial number of new customer locations, and the equipment immediately becomes the property of the customer, the associated revenue and cost are recorded in the period in which the work is completed.
In instances where we have entered into license agreements with a third parties to use our technology within their product offering, we recognize any base or prepaid revenues over the term of the agreement and any per occurrence or periodic usage revenues in the period they are earned.
Research and Development
Research and development costs are expensed when incurred. We expensed $2,711,933 in 2010 and $3,584,019 in 2009 of research and development costs.
Concentration of Credit Risk
Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of trade accounts receivable. In the normal course of business, we provide credit terms to our customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have been within the range of management’s expectations.
In 2010 and 2009, we had one customer that individually constituted 87% and 72%, respectively of our total revenues, with no other single customer representing more than 5% of total revenues. Our largest customer signed a three year contact which we began servicing in the second half of 2009.
Loss per Common Share
The computation of basic loss per common share is based on the weighted average number of shares outstanding during each year.
The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year, plus the dilutive common stock equivalents that would rise from the exercise of stock options, warrants and restricted stock units outstanding during the year, using the treasury stock method and the average market price per share during the year. Options and warrants to purchase 20,442,170 shares of common stock at prices ranging from $.33 to $36.25 per share were outstanding at December 31, 2010. Options and warrants to purchase 13,167,337 shares of common stock at prices ranging from $.04 to $36.25 per share were outstanding at December 31, 2009. There were 950,000 and 975,000 restricted stock units outstanding at December 31, 2010 and 2009, respectively. As we experienced a net loss during the years ended December 31, 2010 and 2009, no common stock equivalents have been included in the diluted earnings per common share calculation as the effect of such common stock equivalents would be anti-dilutive.
Advertising Expenses
We follow the policy of charging the costs of advertising to expense as incurred. Advertising expense for the years ended December 31, 2010 and 2009 were $7,704 and $4,013, respectively.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Executive Overview
The current recession and market conditions have had substantial impacts on the global and national economies and financial markets. These factors, together with soft credit markets, have slowed business growth and generally made potential funding sources more difficult to access. We continue to be affected by prevailing economic and market conditions, which present considerable risks and challenges to us.
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. 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 and Microsoft. Although license revenue from the CodecSys technology has been minimal to date, we believe we have made significant progress and continue to believe that our CodecSys technology holds substantial revenue opportunities for our business.
On July 31, 2009, we entered into a $10.1 million, three-year contract with a Fortune 10 financial institution customer to provide technology and digital signage services to approximately 2,100 of the customer’s more than 6,000 retail and administrative locations throughout North America. The customer is expanding its network to additional retail and administrative locations. In addition, the customer selected us to be its vendor for certain additional audio visual services during the next year. A factor in securing this contract was the benefits of the CodecSys technology delivering our services to be utilized
in our services. For 2010, we realized approximately $6,342,057 in revenue from this new customer contract, which contributed approximately 87% of our revenues for the year.
Our revenues for the twelve months ended December 31, 2010 increased by approximately $3,685,647 or 102% over the twelve months ended December 31, 2009. In order to reduce our operating cash requirements and preserve our cash resources, we reduced our personnel in January 2009 and curtailed other spending and our cash used for operations for the year ended December 31, 2010 decreased by approximately $3,223,549 compared to the twelve months ending December 31, 2009. However, even with the increase in our revenues and an increase of approximately $1,680,152 in our gross profit for the year ending December 31, 2010 compared to the same period in 2009, we continued to deplete our available cash and increased our need for future equity and debt financing.
During 2010 we sold 1,601,666 shares of our common stock to 19 separate investors at a purchase price of $1.00 per share together with a warrant to purchase additional shares of our stock for $1.50 per share. The warrant expires at the end of three years. The net proceeds from the sale of these shares were used for general working capital purposes. Each of the investors was given the right to adjust their purchase in the event we sold additional equity at a price and on terms different from the terms on which their equity was purchased. Upon completion of the Equity Financing described below, each of the investors converted their purchase to the terms contained in the Equity Financing. This resulted in the issuance of an additional 956,659 shares of common stock and the cancellation of 2,295,075 warrants with an exercise price of $1.50 and the issuance of 2,079,222 warrants with an exercise price of $1.00 and an expiration date of five years from the conversion.
On December 24, 2010, we closed on an equity financing (the “Equity Financing”) as well as a restructuring of our outstanding convertible indebtedness (the “Debt Restructuring”). The Equity Financing and the Debt Restructuring are described as follows.
We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000. The Units consisted of two shares of our common stock and one warrant to purchase a share of our common stock. The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering. The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the Equity Financing and the simultaneous Debt Restructuring.
Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities. The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock. The warrants have a term of five years and an exercise price of $1.00 per share.
Net proceeds from the Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million. We used a portion of the net proceeds of the Equity Financing to pay down debt and the remainder will be used for working capital.
On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million. Upon the closing of the Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.
In connection with the Equity Financing and under the terms of the Subscription Agreements, the Company 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 the warrants. If the Company fails to file the registration statement within 60 days or to have the registration statement declared effective within 120 days following the date of the filing of the registration statement, the Company will be obligated to issue additional warrants to the investors to purchase an additional 1,250,000 shares for each 30-day period after the deadlines, until either the registration statement is filed or declared effective, as the case may be.
On December 24, 2010, we also closed on the Debt Restructuring. In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the “Amended and Restated Note”) to Castlerigg Master Investment Ltd. (“Castlerigg”), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents was issued (the “Loan Restructuring Agreement”), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.
The Amended and Restated Note, dated December 23, 2010, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year’s interest of approximately $344,000 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.
The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
In connection with the Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We also issued 150,000 shares to the holder of this note as consideration to extend the term of the note.
Results of Operations for the Years Ended December 31, 2010 and December 31, 2009
Net Sales
We realized net sales of $7,313,218 for the year ended December 31, 2010 compared to net sales of $3,627,571 for the year ended December 31, 2009 which represents an increase of approximately 102% for the year. The net increase in revenues of $3,685,647 was primarily the result of an increase of $3,729,091 in revenues directly related to services provided for our new digital signage network customer, which was offset by a decrease in other income of $43,444 made up of many smaller customers.
Cost of Sales
The cost of sales for the year ended December 31, 2010 aggregated $5,185,779 as compared to the cost of sales of $3,180,284 for the year ended December 31, 2009, which represents an increase in cost of sales of 63%. The increase in cost of sales of $2,005,495 was primarily a result of the increase of $1,208,153 in cost of equipment sales due to increased installation activity for our digital signage customer and an increase of $143,063 in operations department costs, which increase consisted primarily of increased employee costs of $152,549 resulting from hiring additional personnel to handle the increased workload. In addition, an increase in depreciation and amortization of $665,492 added to the overall increase in cost of sales.
Operating Expenses
We incurred total operating expenses of $7,872,266 for the year ended December 31, 2010 compared to total operating expenses of $10,983,139 for the year ended December 31, 2009. The decrease of $3,110,873 was primarily due to a decrease in general and administrative expenses of $1,851,600 and a decrease in our research and development in process expenses of $872,086. In addition, our sales expense decreased by $397,320.
Our general and administrative expenses decreased $1,851,600 from $5,991,317 for the year ended December 31, 2009 to $4,139,717 for the year ended December 31, 2010. The decrease of $753,549 in option expense accounted for the largest single decrease in expense due to fewer options being granted consultants and employees. Legal and other professional services decreased by $366,299 and expenses incurred for temporary help decreased by $213,730. Expenses related to our purchase of minority interest in our IDI subsidiary decreased by $252,242, which also contributed to the decrease in general and administrative expenses. In addition, our director’s fees decreased by $80,304. We experienced decreases of lesser amounts in many accounts, but an increase of $118,097 in employee and related costs offset a portion of such decreases.
Our research and development expenses decreased by $872,086 primarily due to a decrease in employee and related costs of $561,146, a decrease of $297,493 for other professional services, including outside engineering and design costs, and a decrease of $96,984 in equipment and office space rental as we closed our California development office. These decreases were primarily due to a management decision to conserve capital in the past year through restricting discretionary expenditures and the completion of our initial release of CodecSys 2.0 in July of 2010.
Our sales and marketing expenses for the year ended December 31, 2010 were $254,002 compared to sales and marketing expenses of $651,322 for the year ended December 31, 2009. The decrease of $397,320 is due primarily to a decrease of $170,850 in consulting and other professional services, a decrease of $89,482 in employee related expenses, and a decrease of $189,640 in tradeshow and convention related expenses. These decreases also reflect the reduction of staff and cost savings instituted by management at the beginning of the year.
Interest Expense
We recorded an increase in interest expense of $4,748,870 from interest of $6,605,988 in 2009 to $11,354,858 in 2010. Of the total amount of interest expense incurred, $10,321,210 were non cash expenses. Of the total non-cash interest expense, $4,078,631 related to accretion of our 6.25% senior secured convertible note, which was restructured in December, 2010, $3,737,525 of non-cash interest expense was incurred related to the loan restructuring agreement entered into with holder of our debt and $1,465,543 related to the capitalization of interest expense throughout the year. An amount equal to $792,115 was recorded as interest expense related to the conversion of a portion of our senior note that was converted to common stock. In addition, we recorded interest expense paid or accrued during the year of $1,033,648, $453,179 of which related to our equipment leasing transaction entered into to finance the equipment retrofit for our large digital signage customer, $268,338 of which related to the conversion to equity of certain expenses, and $159,666 of which related to payments due on our
unsecured convertible note, which were accrued and not paid during the year and $120,808 related to short term borrowings needed to maintain operations.
Net Loss
We had a net loss of $18,664,117 for the year ended December 31, 2010 compared to a net loss of $13,380,689 for the year ended December 31, 2009. The net loss increased by $5,283,428, which resulted primarily from recording an increase of $10,074,453 in other expenses, which consisted of an increase of $7,059,911 in the derivative valuation gain or loss related to our convertible notes, for which we recorded a gain of $3,579,600 for the year ended December 31, 2009 and recorded a loss of $3,480,311 for the year ended December 31, 2010, and an increase of $4,478,870 in interest expense as discussed above, a loss of $1,102,682 on the equity issuance costs related to warrants issued. The increase in other expenses was offset by a decrease in the loss from operations of $4,791,025, as discussed above, and a gain of $3,062,457 from the restructuring of our senior debt.
Contractual Obligations
The following table summarizes our contractual obligations as of December 31, 2010:
Liquidity and Capital Resources
At December 31, 2010, we had cash of $6,129,632, total current assets of $7,497,739, total current liabilities of $19,374,847 and total stockholders' deficit of $15,920,842. Included in current liabilities is $14,759,300 of liability related to the value of the embedded derivatives for convertible notes and investor warrants and $1,426,834 related to the current portion of debt obligations for equipment financing.
We experienced negative cash flow used in operations during the twelve months ending December 31, 2010 of $3,862,030 compared to negative cash flow used in operations for the twelve months ended December 31, 2009 of $7,085,579. The negative cash flow was met by cash reserves, sales of our common stock, and issuances of short term debt. 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 by adding new customers.
During the year the December 31, 2010, we issued 458,974 shares of our common stock valued in aggregate at $437,501 to three companies and three individuals for consulting services rendered the expense for which is included in our general and administrative expense.
On December 24, 2010, we also closed on the Debt Restructuring. In connection therewith, we (i) issued the Amended and Restated Note in the principal amount of $5.5 million to Castlerigg, (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement with Castlerigg dated December 23, 2010 pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the Loan Restructuring Agreement, and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.
The Amended and Restated Note, dated December 23, 2010, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year’s interest of approximately $344,000 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.
The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg, including the right to include 2,500,000 of its shares in this registration. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
In connection with the Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We also issued 150,000 to the holder of this note as consideration to extend the term of the note.
We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000. The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering. The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the Equity Financing and simultaneous Debt Restructuring.
Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities. The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock. The warrants have a term of five years and an exercise price of $1.00 per share.
Net proceeds from the Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million. We used a portion of the net proceeds of the Equity Financing to pay down our senior debt, brought our accounts payable current and the remainder will be used for working capital.
On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million. Upon the
closing of the Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.
In connection with the Equity Financing and under the terms of the Subscription Agreements, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the Warrants. If the Company fails to file the registration statement within 60 days or to have the registration statement declared effective within 120 days following the date of the filing of the registration statement, the Company will be obligated to issue additional warrants to the investors to purchase an additional 1,250,000 shares for each 30-day period after the deadlines, until either the registration statement is filed or declared effective, as the case may be.
During March 2010 through October 2010, we raised approximately $2.485 million through the sale of common stock and the issuance of convertible notes to purchasers at an investment or conversion price of $1.00 per share. The financing included the sale of 1,535,000 shares of our common stock and the issuance of convertible notes in the aggregate principal amount of $950,000. We also issued to these purchasers warrants to acquire shares of our common stock at an exercise price of $1.50 per share, which are exercisable anytime during a three year period. At the time of these sales, we agreed to certain price protection provisions whereby if we were to sell equity at a price lower than $1.00 per share before December 31, 2010, the purchasers would be able to elect to exchange and receive equity on the same financial terms and conditions as the new investors.
All holders of the convertible notes converted the notes and aggregate accrued interest of $10,075 into 960,075 shares of our common stock at a conversion price of $1.00 per share. In addition, the holders received warrants to acquire up to 960,075 shares our common stock at an exercise price of $1.50 per share. The shares issued upon conversion of the notes, together with the 1,535,000 shares issued to the purchasers of the common stock, total 2,495,075 shares of our common stock. In addition, warrants to purchase an aggregate of 2,495,075 shares at an exercise price of $1.50 were held by the purchasers in this financing. The warrants could be exercised any time for a period of three years.
Upon completion of the Equity Financing, each of the investors in these sales elected to treat their purchases according to the terms contained in the Equity Financing. This resulted in the issuance of an additional 2,083,374 shares of common stock and the cancellation of 2,495,075 warrants with an exercise price of $1.50 and the issuance of 2,079,222 warrants with an exercise price of $1.00 and an expiration date of five years from the conversion.
During 2010, we entered into two Accounts Receivable Purchase Agreements with one individual for an aggregate amount of $675,000. In these agreements, we pledged certain outstanding accounts receivable in exchange for an advance payment and a commitment to remit to the purchaser the amount advanced upon collection from our customer. Terms of the first agreement under which we were advanced $175,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which we were advanced $500,000 include a 10% discount with a 0.5% interest fee for every 30 days the advances remain outstanding.
During 2010, we entered into a $500,000 line of credit for equipment financing to purchase equipment for our largest customer’s digital signage network. The terms of the line of credit include a 3% interest fee for every 30 days the advances on the line of credit remain outstanding. We received total advances on the line of credit of $500,000 and subsequent to the completion of the Equity Financing repaid the line of credit. We used the proceeds to purchase and install the equipment at our customer’s locations.
In August 2009, we entered into a sale and leaseback agreement which financed the purchase and installation of equipment to retrofit our new customer’s approximately 2,100 retail sites with our digital signage product offering. We received approximately $4,100,000 from the sale of the equipment in exchange for making lease payments over a 36 month period of $144,000 per month.
On December 24, 2007, we entered into a securities purchase agreement in connection with our senior secured convertible note financing in which we raised $15,000,000 (less $937,000 of prepaid interest). We have used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. The senior secured convertible note has been restructured as described above. During 2010, we capitalized interest of $1,491,161 related to the senior secured convertible note.
The Loan Restructuring Agreement 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 bankruptcy protection or liquidation. The Loan Restructuring Agreement provides that we cannot do any of the following without the prior written consent of the holder:
·
directly or indirectly, redeem, or declare or pay any cash dividend or distribution on, our common stock;
·
incur or guarantee any indebtedness other than indebtedness evidenced by the Amended and Restated Note and other permitted indebtedness as defined in the Amended and Restated Note;
·
repay any indebtedness which is junior to the Amended and Restated Note;
·
issue any additional notes or issue any other securities that would cause a breach or default under the Amended and Restated Note;
·
issue or sell any rights, warrants or options to subscribe for or purchase common stock or directly or indirectly convertible into or exchangeable or exercisable for common stock at a price which varies or may vary with the market price of the common stock, including by way of one or more reset(s) to any fixed price unless the conversion, exchange or exercise price of any such security cannot be less than the then applicable conversion price with respect to the common stock into which any note is convertible or the then applicable exercise price with respect to the common stock into which any warrant is exercisable;
·
enter into or effect any dilutive issuance (as defined in the note) if the effect of such dilutive issuance is to cause us to be required to issue upon conversion of any note or exercise of any warrant any shares of common stock in excess of that number of shares of common stock which we may issue upon conversion of the note and exercise of the warrants without breaching our obligations under the rules or regulations of the principal market or any applicable eligible market;
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liquidate, wind up or dissolve (or suffer any liquidation or dissolution);
·
convey, sell, lease, license, assign, transfer or otherwise dispose of all or any substantial portion of our properties or assets, other than transactions in the ordinary course of business consistent with past practices, and transactions by non-material subsidiaries, if any and;
·
cause, permit or suffer, directly or indirectly, any change in control transaction as defined in the Amended and Restated Note.
On November 2, 2006, we closed on a convertible note securities agreement dated October 28, 2006 with an individual that provided we issue to the convertible note holder (i) an unsecured convertible
note in the principal amount of $1,000,000 representing the funding received by us from an affiliate of the convertible note holder on September 29, 2006, and (ii) four classes of warrants (A warrants, B warrants, C warrants and D warrants) which gave the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock. The holder of the note no longer has any warrants to purchase any of our stock. The unsecured convertible note was due October 16, 2009 and was extended to December 22, 2010 and the annual interest rate was increased to 8%, payable semi-annually in cash or in shares of our common stock if certain conditions are satisfied The unsecured convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share, convertible any time during the term of the note, and is subject to standard anti-dilution rights. The term of the convertible note has been extended and now is due December 31, 2013. In connection with the extension of the note, we issued to the holder of the note 150,000 shares of common stock to extend the term of the note. In addition, we committed to pay accrued interest due on the convertible note through the issuance of common stock and warrants on the same terms as the Equity Financing.
The conversion feature and the prepayment provision of our $5.5 million Amended and Restated Note and our $1.0 million unsecured convertible note have been accounted for as embedded derivatives and valued on the respective transaction dates using a Black-Scholes pricing model. The warrants related to the $1.0 million unsecured convertible notes have been accounted for as derivatives and were valued on the respective transaction dates using a Black-Scholes pricing model as well. At the end of each quarterly reporting date, the values of the embedded derivatives and the warrants are evaluated and adjusted to current market value. The conversion features of the convertible notes and the warrants may be exercised at any time and, therefore, have been reported as current liabilities. Prepayment provisions contained in the convertible notes limit our ability to prepay the notes in certain circumstances. For all periods since the issuance of the senior secured convertible note and the unsecured convertible note, the derivative values of the respective prepayment provisions have been nominal and have not had any offsetting effect on the valuation of the conversion features of the notes. For a description of the accounting treatment of the senior secured convertible note financing, see Note 7 to the Notes to Condensed Consolidated Financial Statements (Unaudited) included elsewhere herein.
On March 21, 2011, we converted $784,292 of our short-term debt into equity through the issuance of common stock and warrants to two lenders at the same unit pricing as the Company’s recent equity raise in December 2010. In consideration of converting the short- term loans on the basis of $1.20 for two shares of common stock plus one warrant at an exercise price of $1.00, we issued 1,307,153 shares of common stock and warrants to acquire up to 653,576 shares of common stock, which warrants have a five year term and are exercisable at $1.00 per share. Our objective for converting the short-term debt into equity was to conserve cash.
Our monthly operating expenses, including our CodecSys technology research and development expenses, exceeded our monthly net sales by approximately $300,000 per month during the year ended December 31, 2010. The net proceeds from the Equity Financing after the payment of debt to the senior note holder, commissions, expenses of the offering, and payment of past due accounts payable is approximately $6,000,000. At our current rate of expenditures over revenues, we would have sufficient capital for approximately eighteen months. The foregoing estimates, expectations and forward-looking statements are subject to change as we make strategic operating decisions from time to time and as our expenses and sales fluctuate from period to period.
The amount of our operating deficit could decrease or increase significantly depending on strategic and other operating decisions, thereby affecting our need for additional capital. We expect our operating expenses will continue to outpace our net sales until we are able to generate additional revenue. Our business model contemplates that sources of additional revenue include (i) sales from our private communication network services, (ii) sales resulting from new customer contracts, and (iii) sales, licensing fees and/or royalties related to commercial applications of our CodecSys technology, including sales resulting from marketing efforts by companies such as IBM, HP and Microsoft.
Our long-term liquidity is dependent upon execution of our business model and the realization of additional revenue and working capital as described above, and upon capital needed for continued
commercialization and development of the CodecSys technology. Commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $2.0 million annually for the foreseeable future. This estimate will increase or decrease depending on specific opportunities and available funding.
To date, we have met our working capital needs primarily through funds received from sales of our common stock and from convertible debt financings. Until our operations become profitable, we will continue to rely on proceeds received from external funding. We expect additional investment capital, if needed, may come from (i) the exercise of outstanding warrants to purchase our capital stock currently held by existing warrant holders; (ii) additional private placements of our common stock with existing and new investors; and (iii) the private placement of other securities with institutional investors similar to those institutions that have provided funding in the past. We have no arrangements for any such additional external financings, whether debt or equity, and are not certain whether any new external financing would be available on acceptable terms or at all. Any new debt financing would require the cooperation and agreement of existing note holders, of which there is no assurance.
Recent Accounting Pronouncements
In August 2010, the FASB issued ASU No 2010-22, Accounting for Various Topics. Technical Corrections to SEC Paragraphs- An announcement made by the staff of US Securities and Exchange Commission. This Update makes changes to several of the SEC guidance literature within the Codification. Some of the changes relate to (1) Oil and Gas Exchange Offers, (2) Accounting for Divestiture of a Subsidiary or Other Business Operations, (3) Replaces “Push Down” basis accounting references with “New” basis of accounting to be used in the acquired companies financial statements, (4) Fees paid to an investment banker in connection with an acquisition or asset purchase, when the investment banker is also providing interim financing or underwriting services must be allocated between the related service and debt issue costs. The amendments in this Update are effective immediately. The Company doesn’t expect this guidance to have a significant impact on its financials since there are no changes to accounting that were not already being applied by the Company.
In July 2010, the FASB issued ASU No 2010-20, Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This Update requires additional disclosures for financing receivables, excluding short-term trade accounts receivables and or receivables measured at fair value. The new disclosures are designed to allow a user to better evaluate a company’s credit risk in the portfolio of financing receivables, how the risk is analyzed and in allowing for credit losses and the reason for the changes in the allowance for credit losses. Some of the additional disclosures required are to provide a rollforward of allowance for credit losses by portfolio segment basis, credit quality of indicators of financing receivables by class of financing receivables, the aging of financing receivables by class of financing receivable, significant purchases and sales of financing receivables by portfolio segment, amongst other requirements. The amendments in this Update are effective for reporting periods ending on or after December 15, 2010 for disclosures as of the end of the reporting period and disclosures related to activity are effective for reporting periods beginning on or after December 15, 2010 for public entities. For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011. Comparative disclosures for earlier reporting periods are encouraged, but not required. The Company doesn’t expect this guidance to have a significant impact on its financials since it doesn’t have any finance receivables. The receivables are short-term trade receivables.
In February 2010, the FASB issued ASU No 2010-10, Consolidation (Topic 810) - Amendments for Certain Investment Funds. This update provides for the deferral of the consolidation requirements under Topic 810 for a reporting entity’s interest in an entity 1) that has all the attributes of an investment company or 2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The amendments are effective as of the first annual period that begins after November 15, 2009, and for interim periods within that period. The Company will adopt this Update on January 1, 2010 and it didn’t have a significant impact on the financials since the Company has no interest in investment type companies.
In February 2010, the FASB issued ASU No 2010-08, Technical Corrections to Various Topic. This update provides clarifications, eliminates inconsistencies and outdated provisions within the guidance. None of the provisions fundamentally change US GAAP, but certain clarifications regarding hedging and derivatives may cause a change in the application of that Subtopic. The amendments are effective for the first reporting beginning after issuance - March 31, 2010 for the Company. The amendments were reviewed and no items of significance were noted. As such, this update is not expected to have a significant impact on the Company’s financial statements.
In January 2010, the FASB issued ASU No 2010-06, Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements. This update provides amendment to the codification regarding the disclosures required for fair value measurements. The key additions area as follows: 1) Disclose transfer in and out of Level 1 and 2, 2) Activity in Level 3 should show information about purchases, sales, settlements, etc on a gross basis rather than as net basis, and 3) Additional disclosures about inputs and valuation techniques. The new disclosure requirements are effective for interim and annual periods beginning after December 31, 2009, except for the gross disclosures of purchases, etc which is effective for periods beginning after December 15, 2010. The Company will adopt this Update on January 1, 2010 and doesn’t expect it will have a significant impact on the financials since there aren’t many items recorded at fair value, but additional disclosures about inputs and valuation techniques will be made.
In January 2010, the FASB issued ASU No 2010-04, Accounting for Various Topics - Technical Corrections to SEC Paragraphs. This update provides updates/corrections to various topics of the codification with regards to the SEC’s position on various matters. There is no new guidance, but adjustments to the SEC’s position on already issued updates. Some of the main topics covered are as follows: 1) Requirements for using push down accounting in an acquisition 2) appropriate balance sheet presentation of unvested, forfeitable equity instruments are issued to nonemployees as consideration for future services - these are to be treated as not issued and no entry recorded until the instruments are earned. 3) intangible assets arising from insurance contracts acquired in a business combination. The corrections are applicable for 2009 since the updates relate to already issued guidance. The main issue that may impact the Company is the accounting for unvested, forfeitable equity instruments. The Company will evaluate and determine if there are any contracts with non-employees for which equity instruments are granted and ensure they are accounted for in accordance with the update.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements required by this Item 8 begin on Page and are located following the signature page. All information which has been omitted is either inapplicable or not required.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A
ITEM 9A CONTROLS AND PROCEDURES
Disclosure Controls and Procedures
Our management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Exchange Act. As of December 31, 2010, an evaluation was performed, under the supervision and with the participation of management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures, as of December 31, 2010, were effective in ensuring that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and in ensuring that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our system of internal control over financial reporting within the meaning of Rules 13a-15(f) and 15d-15(f) of the Exchange Act is designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of our published financial statements in accordance with U.S. generally accepted accounting principles.
Our management, including the chief executive officer and the chief financial officer, assessed the effectiveness of our system of internal control over financial reporting as of December 31, 2010. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of December 31, 2010, our system of internal control over financial reporting was effective to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of our financial statements for external purposes in accordance with U.S. generally accepted accounting principles.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by our registered public accounting firm pursuant to temporary rules of the SEC that permit us to provide only management’s report in this annual report.
Changes in Internal Control Over Financial Reporting
For the quarter ended December 31, 2010 we made enhancements to our internal controls over financial reporting by strengthening documentation of corporate governance, and journal entries, we also further restricted access to our accounting database.
Limitations on Controls and Procedures
The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision
making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, any system of disclosure controls and procedures or internal control over financial reporting may not be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.
The foregoing limitations do not qualify the conclusions set forth above by our chief executive officer and our chief financial officer regarding the effectiveness of our disclosure controls and procedures and our internal control over financial reporting as of December 31, 2010.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The following table sets forth the names, ages and positions of our executive officers and directors:
William Boyd has been a director of ours since November 2007. Mr. Boyd has served as the Chairman of the Board of Agility Recovery Solutions, a privately held disaster recovery and business continuity company since 2006. He was CEO of Muzak Corporation from 1996 to 2000 and continued with Muzak in an advisory executive position and on the Board until August 2006. He became associated with Muzak Corporation in 1968 as a sales representative and continued as a manager and franchise owner until he became CEO in 1996. Mr. Boyd received a Bachelor of Arts degree in political science in 1963 from Beloit College in Wisconsin. Mr. Boyd’s CEO level experience with Muzak and his overall experience in satellite networks, management, operations and financing matters are qualities and expertise that were determined to be particularly useful as a member of our Board.
Rodney M. Tiede has been our chief executive officer, president and a director since the acquisition of Broadcast International, or BI, in October 2003. From August 2000 to the present, Mr. Tiede has been the president, chief executive officer and a director of BI, a wholly-owned subsidiary. From April 2003 to the present, Mr. Tiede has also been the chief executive officer and a director of Interact Devices, Inc., or IDI, a consolidated subsidiary. From November 1987 to August 2000, Mr. Tiede was employed as director of sales, vice president and general manager of Broadcast International, Inc., the predecessor of BI. Mr. Tiede received a Bachelor of Science Degree in Industrial Engineering from the University of Washington in 1983. Mr. Tiede has been a part of our operations for more than 20 years and as a result has significant knowledge, insight and understanding that he provides as a director.
James E. Solomon has been a director since September 2005 and has served as Chief Financial Officer and Secretary from September 2008. From 1995 to January 2002, Mr. Solomon was a business consultant primarily for emerging growth companies. In January 2002, he formed Corporate
Development Services, Inc., a business consulting firm, and has served as President since its formation. From June 1993 to the present, Mr. Solomon has been an adjunct professor at the Graduate School of Business at the University of Utah. Mr. Solomon served on the Board of Directors of Nevada Chemicals, Inc., a public company, until October 2008, as well as several privately-held companies. Mr. Solomon received a Bachelor of Science Degree in Finance from the University of Utah in 1972. Mr. Solomon became a Certified Public Accountant in 1974. Mr. Solomon’s experience in finance, accounting and business consulting, together with his role as our CFO and prior public company directorship, provide Mr. Solomon with expertise enabling critical input to our Board decision-making process.
R. Phillip Zobrist has been a member of our board of directors since June 2009. He currently manages his own investments and since 1996 has been President and Chairman of the Board of Valley Property Management, a privately held real estate management company headquartered in Las Vegas, Nevada, which he founded. He also serves as an independent consultant for Sundance Builders, LLC, a privately held real estate construction company and serves on the board of directors of Greffex, Inc., a start up bio-technology company in Aurora, Colorado. Mr. Zobrist was the president and CEO of a $150 million enterprise for more than ten years and gained valuable business experience in dealing with financing, employee relations, and sales and marketing that make his advice and counsel valuable for the Company.
Mark F. Spagnolo has been a director of ours since May 2010. Mr. Spagnolo has served as the President of Spagnolo Group, LP, a privately held technology consulting company from 2002 to the present. From 2005 to 2009 he served as the President and CEO of Airband Communications, Inc., a privately held communications company specializing in providing services to enterprises using wireless technology. From July, 2003 to September, 2004, Mr. Spagnolo served as the CEO of Broadwing Communications, Inc., a privately held communications company, which provided communications to enterprises and operated nationwide fiber optic networks. He served as the President and CEO of MFN from 2001 to 2002, as President and CEO of SiteSmith, a privately held company founded to deliver internet outsourcing services to Global 2000 customers from 200 to 2001. He served as President and CEO of UUNET, an industry leading internet communications company from 1997 to 2000. Mr. Spagnolo earned a Bachelor of Science Degree in Industrial Engineering from Newark College of Engineering in 1973. Mr. Spagnolo has been active in the technology and communications industry throughout his career including developing products and bringing them to market. Since we are engaged in bringing a software product used in the communications industry to market, his experience was deemed valuable to us.
Our directors generally serve until the next annual or special meeting of shareholders held for the purpose of electing directors. Our officers generally serve at the discretion of the board of directors. Two of our directors, Mr. Tiede and Mr. Solomon, are employees who serve as our president and chief executive officer and our chief financial officer and secretary, respectively. The employment service of Mr. Tiede and Mr. Solomon are governed by the terms of their respective employment contracts. See “Employment Contracts” in Item 11
ITEM 11. EXECUTIVE COMPENSATION
Overview of Compensation Program
Throughout this section, the individuals who served as our chief executive officer and chief financial officer during 2010 are collectively referred to as the “named executive officers.”
The compensation committee has overall responsibility to review and approve our compensation structure, policy and programs and to assess whether the compensation structure establishes appropriate incentives for management and employees. The compensation committee annually reviews and determines the salary and any bonus and equity compensation that may be awarded to our chief executive officer, or CEO, and our chief financial officer, or CFO. The compensation committee oversees the administration of our long-term incentive plan and employee benefit plans.
The compensation committee’s chairman regularly reports to the board on compensation committee actions and recommendations. The compensation committee has authority to retain, at our expense, outside counsel, experts, compensation consultants and other advisors as needed.
2010 Company Performance. Because of the stage of our company’s development, the compensation committee looks at various factors in evaluating the progress the company has made and the services provided by the named executive officers. In considering executive compensation, the compensation committee noted certain aspects of our financial performance and accomplishments in 2010 including the following:
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Operations. Our revenues increased approximately 102% from $3,627,571 in 2009 to $7,313,218 in 2010, which was principally the result of entering into a service agreement with a Fortune 10 financial customer, which was our largest customer in 2010. This customer has more retail locations than all of our other existing customers combined. We were able to install our proprietary digital signage delivery and management hardware and software, which incorporates portions of our CodecSys software, at approximately 2,100 locations and commenced receiving revenues from this new customer in the fourth quarter of 2009. We expanded the network in 2010 and received a grade of 100% vendor satisfaction from the customer’s vendor evaluation team.
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CodecSys Milestones. Our executive officers also made significant progress on the development of our CodecSys technology. As a result of these efforts, IBM, Microsoft and HP have included our video compression technology as a video compression solution and have proceeded with sales presentations and testing with their large video customers, which include large broadcasters, cable companies and satellite companies.
·
During 2010 we installed our CodecSys version 2.0 in 14 test locations consisting principally of large international telecommunication companies and have moved toward contract with most of the test sites.
·
Throughout 2010, we were required to continually seek investment capital to allow us to continue our operations. We were successful in December of 2010 in completing an equity raise that allowed us to restructure our senior secured convertible debt in which we decreased our debt from $17,500,000 to $5,500,000 through repayment, issuance of common stock, and inducing the holder of the debt to forgive approximately $7,100,000 of the debt. The due date of the existing debt of the Company has all been extended for three years giving us the time needed to fully commercialize our CodecSys technology.
Compensation Philosophy. Our general compensation philosophy is designed to link an employee’s total cash compensation with our performance, the employee’s department goals and individual performance. Given our stage of operations and limited capital resources, we are subject to various financial restraints in our compensation practices. As an employee’s level of responsibility increases, there is a more significant level of variability and compensation at risk. The compensation committee believes linking incentive compensation to our performance creates an environment in which our employees are stakeholders in our success and, thus, benefits all shareholders.
Executive Compensation Policy. Our executive compensation policy is designed to establish an appropriate relationship between executive pay and our annual performance, our long-term growth objectives, individual performance of the executive officer and our ability to attract and retain qualified executive officers. The compensation committee attempts to achieve these goals by integrating competitive annual base salaries with bonuses based on corporate performance and on the achievement of specified performance objectives, and to a lesser extent, awards through our long-term incentive plan, since the executive officers are founders and already large shareholders. The compensation committee believes that cash compensation in the form of salary and bonus provides our executives with short-term rewards for success in operations. The compensation committee also believes our executive compensation policy and programs do not promote inappropriate risk-taking behavior by executive officers that could threaten the value of our company.
In making compensation decisions, the compensation committee compares each element of total compensation against companies referred to as the “compensation peer group.” The compensation peer group is a group of companies that the compensation committee selected from readily available information about small companies engaged in similar businesses and with similar resources. The compensation committee selected these companies from research on its own and with limited consultation with outside consultants given the size of the company and its resources to retain such experts. The types of companies selected for the peer group included publically-traded technology
development companies in the software industry. In two instances, software development companies in the video compression industry were selected, but since there are relatively few companies in the rather narrow field of software development for video compression, additional software development companies engaged in development of non-related software were also selected. The compensation committee determined these companies were appropriate for inclusion in the peer group because of the similar nature of their businesses and their general stage of development and financial resources.
Role of Executive Officers in Compensation Decisions
The compensation committee makes all compensation decisions for the named executive officers and approves recommendations regarding equity awards to all of our other senior management personnel. The CEO annually reviews the performance of the CFO and other senior management. The conclusions reached and recommendations based on these reviews, including with respect to salary adjustments and annual award amounts, are presented to the compensation committee. The compensation committee is charged with the responsibility of ensuring a consistent compensation plan throughout the company and providing an independent evaluation of the proposed adjustments or awards at all levels of management. As such, the compensation committee has determined that it have the discretion to modify or adjust any proposed awards and changes to management compensation to be able to satisfy these responsibilities.
2010 Executive Compensation Components
For the fiscal year ended December 31, 2010, the principal components of compensation for the named executive officers were:
·
base salary; and
·
performance-based bonus compensation.
Base Salary. The compensation committee determined that the executive officers had been compensated fairly relative to similarly situated executives, and approved no 2010 increases to the base salary of the CEO and CFO. Due to fiscal restraints, 10% of the executives’ base compensation was deferred until the completion of the equity raise. In determining the base salary of each executive officer, the compensation committee relied on publicly available information gathered by the compensation committee related to salaries paid to executive officers of similarly situated small public companies.
Performance-based Incentive Compensation. Annual incentives for the executive officers are intended to recognize and reward those employees who contribute meaningfully to an increase in shareholder value and move the company toward profitability. No bonuses were paid for 2010 due to fiscal restraints, but future bonuses will depend on achievement of objectives related to sales of products that include our CodecSys technology and anticipated revenues resulting therefrom. During the year, however, the company was able to complete the development of products that are now ready for sale. Actual bonuses payable for 2011 will depend on the level of achievement of performance objectives established for the executive officers for the coming year and our financial condition.
Long-term Equity Incentive Compensation. Long-term incentive compensation encourages participants to focus on our long-term performance and provides an opportunity for executive officers and certain designated key employees to increase their stake in our company through grants of options to purchase our common stock. No stock options or other awards were granted during 2010 to any of the named executive officers. The board made awards of stock options to other employees under our equity incentive plan.
All awards made under our equity incentive plan are made at the market price at the time of the award. Annual awards of stock options to executives are made at the discretion of the compensation committee at such times throughout the year at it deems most desirable. Newly hired or promoted executives, other than executive officers, generally receive their award of stock options on the first business day of the
month following their hire or promotion. Grants of stock options to newly hired executive officers who are eligible to receive them are made at the next regularly scheduled compensation committee meeting following their hire date.
Perquisites and Other Personal Benefits. We provide no perquisites to our named executive officers other than matching 401(k) contributions described below and other group benefits offered generally to all salaried employees.
Retirement and Related Plans. We maintain a 401(k) profit sharing plan for all non-temporary employees. Employee contributions are matched by us in an amount of 100% of employee contributions up to 3% of employee salaries and 50% of employee contributions up to an additional 2% of their salaries. Participants vest immediately in the company matching contributions.
Compensation of Chief Executive Officer. For the fiscal year ended December 31, 2010, we paid Rodney M. Tiede, CEO, a salary of $225,000. The compensation committee met with Mr. Tiede once during 2010 to review his performance and individual objectives and goals versus results achieved. The compensation committee reviewed all components of the CEO’s compensation, including salary, bonus, and equity incentive compensation, and under potential severance and change-in-control scenarios. Mr. Tiede’s compensation package was determined to be reasonable and not excessive by the compensation committee based on compensation surveys for chief executive officers of small public companies. The compensation committee determined that the recent economic recession and market conditions did not have a material impact on the compensation of the CEO or other management personnel.
Employment Contracts
In April 2004, we and Mr. Tiede entered into an employment agreement covering Mr. Tiede’s employment for a term commencing upon the execution thereof and continuing until December 31, 2006. The contract continues for additional terms of one year each until terminated by us. The agreement calls for payment of a gross annual salary of not less than $120,000, payable in equal bi-weekly installments for the year ended December 31, 2004, subject to such increases as the board of directors may approve. The employment agreement further provides that Mr. Tiede shall receive a performance bonus on an annual basis equal to up to 100% of his base salary for the fiscal year then ended, the exact percentage to be determined in the sole discretion of the board of directors (or the compensation committee thereof) based upon an evaluation of the performance of Mr. Tiede during the previous fiscal year. The agreement also provides for participation in our stock option plan, the payment of severance pay, and other standard benefits such as vacation, participation in our other benefit plans and reimbursement for necessary and reasonable business expenses. In the event of a change in control of the company, defined as the purchase of shares of our capital stock enabling any person or persons to cast 20% or more of the votes entitled to be voted at any meeting to elect directors, Mr. Tiede shall have the right to terminate the employment agreement and receive severance pay equal to the base salary and a bonus equal to 50% of the salary for the remainder of the employment term or two years, whichever is longer. In addition, if the change of control event results in our shareholders exchanging their shares for stock or other consideration, Mr. Tiede shall receive an amount equal to the per share price paid to the shareholders less the pre-announcement price multiplied by 50,000.
In September 2008, we and Mr. Solomon entered into an employment agreement covering Mr. Solomon’s employment for a term commencing upon the execution thereof and continuing until December 31, 2011. The contract continues for additional terms of one year each until terminated by us. The agreement calls for payment of a gross annual salary of not less than $225,000, payable in equal bi-weekly installments for the year ended December 31, 2008, subject to such increases as the board of directors may approve. The employment agreement further provides that Mr. Solomon shall receive a performance bonus on an annual basis equal to up to 100% of his base salary for the fiscal year then ended, the exact percentage to be determined in the sole discretion of the board of directors (or the compensation committee thereof) based upon an evaluation of the performance of Mr. Solomon during the previous fiscal year. The agreement also provides for participation in our stock option plan, the payment of severance pay, and other standard benefits such as vacation, participation in our other benefit plans and reimbursement for
necessary and reasonable business expenses. In the event of a change in control of the company, defined as the purchase of shares of our capital stock enabling any person or persons to cast 20% or more of the votes entitled to be voted at any meeting to elect directors, Mr. Solomon shall have the right to terminate the employment agreement and receive severance pay equal to the base salary and a bonus equal to 50% of the salary for the remainder of the employment term or two years, whichever is longer. In addition, if the change of control event results in our shareholders exchanging their shares for stock or other consideration, Mr. Solomon shall receive an amount equal to the per share price paid to the shareholders less the pre-announcement price multiplied by 50,000.
Stock Option Plans
Under our 2004 Long-term Incentive Plan (the “2004 Plan”), the board of directors may issue incentive stock options to employees and directors and non-qualified stock options to consultants of the company. Options generally may not be exercised until twelve months after the date granted and expire ten years after being granted. Options granted vest in accordance with the vesting schedule determined by the board of directors, usually ratably over a three-year vesting schedule upon the anniversary date of the grant. Should an employee’s director’s or consultant’s relationship with the company terminate before the vesting period is completed, the unvested portion of each grant is forfeited. We continue to maintain and grant awards under our 2004 Plan which will remain in effect until it expires by its terms. The number of unissued stock options authorized under the 2004 Plan at December 31, 2010 was 1,936,065.
The Broadcast International, Inc. 2008 Equity Incentive Plan (the “2008 Plan”) has become our primary plan for providing stock-based incentive compensation to our eligible employees and non-employee directors and consultants of the company. The provisions of the 2008 Plan are similar to the 2004 Plan except that the 2008 Plan allows for the grant of share equivalents such as restricted stock awards, stock bonus awards, performance shares and restricted stock units in addition to non-qualified and incentive stock options. The number of unissued shares of common stock reserved for issuance under the 2008 Plan was 2,765,000 at December 31, 2010.
The purpose of our incentive plans is to advance the interests of our shareholders by enhancing our ability to attract, retain and motivate persons who are expected to make important contributions to us by providing them with both equity ownership opportunities and performance-based incentives intended to align their interests with those of our shareholders. These plans are designed to provide us with flexibility to select from among various equity-based compensation methods, and to be able to address changing accounting and tax rules and corporate governance practices by optimally utilizing stock options and shares of our common stock.
Summary Compensation Table
The table below summarizes the total compensation paid or earned by each of the named executive officers in their respective capacities for the fiscal years ended December 31, 2010, 2009 and 2008. When setting total compensation for each of the named executive officers, the compensation committee reviewed tally sheets which show the executive’s current compensation, including equity and non-equity based compensation. We have omitted in this report certain tables and columns otherwise required to be included because there was no compensation made with respect to such tables and columns, as permitted by applicable SEC regulations. The amounts shown as salary in the following table for 2009 do not include an amount equal to 10% of total salary for each executive which had been accrued, but the payment was deferred as explained above and was paid and included in 2010 compensation shown below.
(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Name and
Principal Position
Year
Salary
($)
Bonus
($)
Option
Awards
($)
Restricted
Stock Unit
Awards
($)
All Other
Compen-
sation
($)(1)
Total
($)
Rodney M. Tiede
President & Chief Executive Officer
$273,078
226,923
248,835
--
--
150,000
--
--
--
--
--
--
$7,333
7,333
6,889
$280,411
234,256
405,724
James E. Solomon
Chief Financial Officer and Secretary (2)
$283,270
204,231
56,358
--
--
--
--
--
--
--
--
$480,000
$11,331
9,069
--
$294,601
213,300
536,358
(1)
The amounts shown in column (g) reflect for each named executive officer matching contributions made by us to our 401(k) employee retirement plan. The amounts shown in column (g) do not reflect premiums paid by us for any group health or other insurance policies that apply generally to all salaried employees on a nondiscriminatory basis.
(2)
Effective September 19, 2008, Mr. Solomon became our chief financial officer and secretary. Mr. Solomon received a total of 200,000 restricted stock units in 2008. The amount in column (f) for Mr. Solomon reflects the dollar amount recognized for financial statement reporting purposes for the years ended December 31, 2008, in accordance with ASC Topic 718, of restricted stock units granted in such year.
Other Compensation
We do not have any non-qualified deferred compensation plan.
Outstanding Equity Awards at Fiscal Year-End
Potential Payments Upon Termination or Change of Control
The amount of compensation payable to the named executive officers upon voluntary termination, retirement, involuntary not-for-cause termination, termination following a change of control and in the event of disability or death of the executive is shown below. The amounts shown assume that such termination was effective as of December 31, 2010, and thus includes amounts earned through such time
and are estimates of the amounts which would be paid out to the executives upon their termination. The actual amounts to be paid out can only be determined at the time of such executive’s separation.
Payments Made Upon Termination
Regardless of the manner in which a named executive officer’s employment is terminated, he is entitled to receive amounts earned during his term of employment. Such amounts include:
·
salary;
·
grants under our stock option and equity plans, subject to the vesting and other terms applicable to such grants;
·
amounts contributed and vested under our 401(k) plan; and
·
unused vacation pay.
Payments Made Upon Death or Disability
In the event of the death or disability of a named executive officer, in addition to the benefits listed under the headings “Payments Made Upon Termination,” the named executive officers will receive benefits under any group life or disability insurance plan, as appropriate, we may have in effect from time to time. We currently maintain a group term life insurance plan that generally pays a death benefit equal to two times base salary up to a maximum of $300,000.
Payments Made Upon a Change of Control
If there is a change of control, which is defined as the purchase of shares of capital stock of the company enabling any person or persons to cast 20% or more of the votes entitled to be voted at any meeting to elect directors, Mr. Tiede and/or Mr. Solomon may elect to terminate employment and would receive under the terms of their employment agreements:
·
a lump sum severance payment up to the sum of two years of the base salary ;
·
any bonus compensation earned, if any; and
·
If the change of control event results in the shareholders exchanging their shares for stock, the executive would receive an amount equal to the per share price paid to shareholders, less the pre-announcement share price, multiplied by 50,000. For example and illustration purposes only, if the share price paid to shareholders were $3.00 and the pre-announcement share price were $1.50, Mr. Tiede and Mr. Solomon would receive an amount equal to $75,000 under this provision.
In the event of a change in control as defined above, Mr. Tiede would receive a lump sum payment of $500,000 and Mr. Solomon would receive a lump sum payment of $510,000. In addition, they would be entitled to receive the share price differential, if any, as discussed above.
Non-compete Agreement
Included in Mr. Tiede’s and Mr. Solomon’s employment agreements is a two year non-compete agreement.
Director Compensation
We use a combination of cash and stock-based incentive compensation to attract and retain qualified candidates to serve on the board. In setting director compensation, we consider the significant amount of
time that directors expend in fulfilling their duties as well as the skill-level required by us of members of the board.
Our non-employee directors receive fees of $48,000 per year, paid quarterly, and an initial grant of stock options to purchase 100,000 shares (thereafter annual grants of 25,000 options or restricted stock units) of our common stock with an exercise price equal to the fair market value of the stock on the date of grant. In addition, non-employee directors may be entitled to receive special awards of stock options from time to time as determined by the board. In addition to the standard director compensation mentioned above, the chairman of the board and the chairman of each of the audit and compensation committees receive no additional fees for serving in such capacities. There is no additional compensation for meeting attendance. Directors who are employees of Broadcast International receive no additional compensation for serving as directors. All stock options granted to outside directors are immediately exercisable and expire ten years from the date of grant. All restricted stock units granted to outside directors are immediately vested and are settled by the issuance of our common stock upon their respective retirements from the Board of Directors. Directors are reimbursed for ordinary expenses incurred in connection with attending board and committee meetings. The directors voluntarily deferred 25% of their 2009 and 2010 compensation until the equity raise was completed.
Director Summary Compensation Table
The table below summarizes the compensation paid by us to our directors for the fiscal year ended December 31, 2010.
(1)
Messers. Tiede and Solomon receive no compensation for serving as a director, but are compensated in their capacity as our president and CEO and CFO, respectively.
(2)
Of the 2010 compensation for Mr. Boyd, 25,900 was deferred from 2009 and paid in 2010. Of the 2010 compensation for Mr. Zobrist $23,800 was deferred from 2009 and paid in 2010. In addition to the compensation paid in 2010, each of Messers. Boyd, Zobrist and Spagnolo earned $12,000, which was accrued in 2010, but not paid until 2011.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth the beneficial ownership of our common stock at March 17, 2011 by each director, executive officer, each person known by us to own beneficially more than 5% of our common stock, and all directors and executive officers as a group.
Beneficial Owner
Beneficial Ownership
Percent of Class
Gem Asset Management LC (1)
100 State Str. #2b
Teaneck, New Jersey 07666
9,999,999
12.9%
Castlerigg Master Investments Ltd. (2)
c/o Sandell Asset Management
40 West 57th St., 26th Floor
New York, NY 10019
8,874,074
11.3%
Rodney M. Tiede (3)
c/o Broadcast International, Inc.
7050 Union Park Avenue, Suite 600
Salt Lake City, UT 84047
3,518,541
4.7%
Leon Frenkel (4)
401 City Avenue, Suite 802
Bala Cynwyd, PA 19004
4,060,183
5.4%
R. Phil Zobrist (5)
1,691,366
2.2%
James E. Solomon (6)
720,000
*
William Boyd (7)
475,000
*
Mark F. Spagnolo (8)
200,000
*
All directors and executive officers
as a group (5 persons) (9)
6,852,907
8.2%
* Represents less than 1% of our common stock outstanding.
(1)
Includes 6,666,666 shares of common stock and a warrant to purchase 3,333,333 shares of common stock. The control person of Gem Asset Management, LC is Daniel Lewis.
(2)
Includes 4,800,000 shares of common stock and a senior convertible note that is convertible into 4,074,074 shares of common stock. Castlerigg Master Investments Ltd., or CMI, is a master trading vehicle that is primarily engaged in the business of investing in securities and other investment opportunities. Castlerigg International Limited, or CIL, is a private investment fund that is primarily engaged in the business of investing in securities and other investment opportunities. Castlerigg International Holdings Limited, or CIHL, is the controlling shareholder of CMI and CIL is the controlling shareholder of CIHL. Sandell Asset Management Corp., or SAMC, is the discretionary investment manager of CIL, CIHL and CMI. Thomas Sandell is the controlling shareholder, Chief Executive Officer and Portfolio Manager of SAMC.
(3)
Includes 500,000 restricted stock units, which are settled by the issuance of one share of common stock for each unit upon Mr. Tiede’s retirement from the Company and presently exercisable options to acquire 50,000 shares of common stock.
(4)
Includes 2,393,517 shares of common stock, and an unsecured convertible note that is convertible into1,666,666 shares of common stock.
(5)
Includes 1,377,908 shares, presently exercisable options to acquire 100,000 shares, warrants to purchase 63,458 shares, and Restricted Stock Units that may be settled by the issuance of 150,000 shares of our common stock.
(6)
Includes 70,000 shares of common stock, presently exercisable options to acquire a total of 100,000 shares of common stock and 550,000 restricted stock units, which are settled by the issuance of one share of common stock for each unit upon Mr. Solomon’s retirement from the Board of Directors.
(7)
75,000 shares of common stock, presently exercisable options to acquire a total of 100,000 shares of common stock and 300,000 restricted stock units, which are settled by the issuance of one share of common stock for each unit upon Mr. Boyd’s retirement from the Board of Directors.
(8)
Includes 200,000 restricted stock units, which are settled by the issuance of one share of common stock for each unit upon Mr. Spagnolo’s retirement from the Board of Directors.
(9)
Includes warrants, presently exercisable options and vested restricted stock units to acquire a total of 2,113,458 shares of common stock held by all directors and executive officers.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth, as of December 31, 2010, information regarding our compensation plans under which shares of our common stock are authorized for issuance.
(1)
Our 2008 equity incentive plan provides for the grant of stock options, stock appreciation rights, restricted stock and share equivalents, such as restricted stock units, to our employees, directors and consultants. The plan covers a total of 4,000,000 shares of our common stock. As of December 31, 2010, restricted stock units representing 285,000 shares of our common stock had been settled. All awards must be granted at fair market value on the date of grant. The plan is administered by our board of directors or compensation committee of the board. Awards may be vested on such schedules determined by the plan administrator.
(2)
Our 2004 long-term incentive plan provides for the grant of stock options, stock appreciation rights and restricted stock to our employees, directors and consultants. The plan covers a total of 6,000,000 shares of our common stock. As of December 31, 2010, options to purchase 232,291 shares of common stock had been exercised. All awards must be granted at fair market value on the date of grant. The plan is administered by our board of directors or compensation committee of the board. Awards may be vested on such schedules determined by the plan administrator.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS,
AND DIRECTOR INDEPENDENCE
On December 23, 2009, we entered into an amendment agreement with the holder of our unsecured convertible note in the principal amount of $1.0 million. The holder is an affiliate of ours due to his beneficial ownership of 5.9% of our outstanding common stock. Pursuant to the amendment agreement, we extended the maturity date of the unsecured convertible note to December 22, 2010 and increased the interest rate on the note to 8%.
On November 15, 2010 we entered into an amendment dated November 15, 2010 with the holder of our $1,000,000 unsecured convertible note due December 22, 2010, pursuant to which the maturity date of such note was extended to January 1, 2011.
In connection with the Debt Restructuring, the Company amended its note with the holder of its $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We issued to the holder of the note 150,000 shares of our common stock In addition, we committed to pay accrued interest on the note through the issuance of common stock and warrants on the same terms and conditions of the Equity Financing.
On March 26, 2010, we entered into an amendment and extension agreement with Castlerigg, the holder of our senior secured convertible note in the principal amount of $15.0 million. Castlerigg is an affiliate of ours due to its beneficial ownership of 9.9% of our outstanding common stock. Pursuant to the amendment and extension agreement, we extended the maturity date of the senior secured convertible note from December 21, 2010 to December 21, 2011. This extension of the maturity date was conditioned upon us raising at least $6,000,000 of gross proceeds from the sale of our equity securities by September 30, 2010. If the additional funding were not completed, the maturity date reverted back to December 21, 2010. In exchange for extending the maturity date, we issued to Castlerigg 1,000,000 shares of our common stock. In addition, we agreed to the inclusion of three additional terms and conditions in the note: (i) from and after the additional funding, we would be required to maintain a cash balance of at least $1,250,000 and provide monthly certifications of the cash balance to Castlerigg; (ii) we would not make principal payments on our $1.0 million unsecured convertible note without the written permission of Castlerigg; and (iii) we grant board observation rights to Castlerigg.
On July 30, 2010, we amended our 6.25% senior secured convertible promissory note (“Note”) and related warrants. The amendment provided for (i) the change of the maturity date from December 21, 2011 to June 21, 2012; (ii) the requirement to maintain a balance of cash and marketable securities equal to or greater than $950,000 was added as an additional condition of default in the event we completed the required capital raise described below; (iii) in the event of the completion of the required capital raise, the conversion price of the Note would be reduced to $1.80 per share instead of the price at which the new equity is sold; (iv) in the event of the completion of the required capital raise, the exercise price of the Warrants would be reduced to $1.80 per share instead of the price at which new equity were sold; (v) in the event of the completion of the required capital raise the number of warrants were to be increased from 1,875,000 to 5,208,333. The amendment was conditioned upon the Company raising at least $6,000,000 of gross proceeds from the sale of its equity securities by September 30, 2010. If the additional funding were not completed by September 30, 2010, certain provisions of the amendment agreement would have been void in that the maturity date would have reverted back to December 21, 2010, the conversion price would have become the lowest price at which equity securities had been sold, the exercise price would have become the lowest price at which equity securities have been sold, and the number of warrants then outstanding would have be determined by the original purchase documents and the Company would not have had an obligation to maintain a balance of cash and marketable securities equal to $950,000. In exchange for the amendments, the Company issued to the holder 2,000,000 shares of the Company’s common stock, par value $0.05 per share, and committed to issue another 800,000 shares upon completion of the equity financing.
On September 24, 2010, the holder of the Note extended the due date for the equity financing required by the July 30, 2010 amendment to the Note to October 31, 2010. If the additional funding were not completed by October 31, 2010, certain provisions of the amendment agreement would have been void in that the maturity date would have reverted back to December 21, 2010, the conversion price of the Note would become the lowest price at which equity securities had been sold, the exercise price of the holder’s warrants would have become the lowest price at which equity securities had been sold, and the number of warrants then outstanding would have been determined by the original purchase documents and we would not have an obligation to maintain a balance of cash and marketable securities equal to $950,000.
On October 29, 2010, we entered into an extension and amendment agreement with the holder of the Note, which provided; (i) the definition of a “Qualified Financing Transaction” was amended to mean a capital raise of $8,000,000; (ii) in the event of the completion of the required capital raise, the conversion price of the Note would be reduced to an amount equal to 150% of the lowest price at which Company common stock were sold during calendar year 2010; (iii) paragraph 9 of the 6.25% senior secured convertible promissory note entitled “Company Redemption Right” was deleted in its entirety; (iv) in the event of the completion of the required capital raise, the exercise price of the Warrants was to be reduced to an amount equal to 150% of the lowest price at which Company common stock was sold during calendar year 2010; (v) in the event of the completion of the required capital raise the number of warrants was to be increased as provided in the 6.25% senior secured convertible promissory note; and (vi) the Expiration Date of the warrants was to be amended to December 30, 2013. The amendment was conditioned upon the Company raising at least $8,000,000 of gross proceeds from the sale of its equity securities by December 3, 2010. If the additional funding was not completed by October 31, 2010, certain provisions of the amendment agreement would have been void in that the maturity date would revert back to December 21, 2010, the conversion price of the Note would become the lowest price at which equity securities had been sold in 2010, the exercise price of the holder’s warrants would have become the lowest price at which equity securities had been sold, and the number of warrants then outstanding would have been determined by the original purchase documents and we would not have an obligation to maintain a balance of cash and marketable securities equal to $950,000.
On November 15, 2010, we entered into a Fifth Amendment and Extension Agreement dated as of November 15, 2010 (the “Fifth Amendment”) with the holder of the Note. The Fifth Amendment provided that the date by which the Company must consummate a Qualified Financing Transaction (as defined in prior amendments to the Note) was extended from December 3, 2010 to December 31, 2010. If a Qualified Financing Transaction occurred by December 31, 2010, the maturity date of the Note was to be extended to June 21, 2012 (as set forth in prior amendments). If a Qualified Financing Transaction was not completed by December 31, 2010, certain provisions of the amendment agreement would have been void in that the maturity date would revert back to December 21, 2010, the conversion price of the Note would become the lowest price at which equity securities had been sold in 2010, the exercise price of the holder’s warrants would have become the lowest price at which equity securities had been sold in 2010, and the number of warrants then outstanding would have been determined by the original purchase documents and we would not have an obligation to maintain a balance of cash and marketable securities equal to $950,000.
On December 24, 2010, we closed the Debt Restructuring. In connection therewith, we (i) issued the Amended and Restated Note in the principal amount of $5.5 million to Castlerigg, (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the Loan Restructuring Agreement, and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010 under the terms of which we agreed to register up to 2,500,000 of Castlerigg’s shares of our common stock. 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, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year’s interest of approximately $344,000 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.
The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
For a description of our policies and procedures related to the review, approval or ratification of related person transactions, see “Conflict of Interest Policy” under Item 10, “Directors, Executive Officers and Corporate Governance.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees for professional services provided by our current independent auditors for each of the last two fiscal years, in each of the following categories, are as follows:
Audit fees included fees associated with the annual audit and reviews of our annual and quarterly reports for 2010 and 2009. In addition, these fees for 2009 included fees associated with our registration statement under the Securities Act of 1933, as amended, filed with the SEC. All audit fees incurred during 2010 and 2009 were pre-approved by the audit committee.
Tax fees included fees associated with tax compliance and tax consultations. All tax fees incurred during 2010 and 2009 were pre-approved by the audit committee.
All other fees related to reviews of registration statements during each respective year and were pre-approved by the audit committee.
The audit committee has adopted a policy that requires advance approval of all services performed by the independent auditor when fees are expected to exceed $15,000. The audit committee has delegated to the audit committee chairman, Mr. Boyd, authority to approve services, subject to ratification by the audit committee at its next committee meeting.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements. See the financial statements included in Item 8 of this report.
(2) Financial Statement Schedules. All applicable schedule information is included in our financial statements included in Item 8 of this report. (a) Exhibits
Exhibit
Number
Description of Document
3.1
Amended and Restated Articles of Incorporation of Broadcast International. (Incorporated by reference to Exhibit No. 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
3.2
Amended and Restated Bylaws of Broadcast International. (Incorporated by reference to Exhibit No. 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
4.1
Specimen Stock Certificate of Common Stock of Broadcast International. (Incorporated by reference to Exhibit No. 4.1 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
10.1*
Employment Agreement of Rodney M. Tiede dated April 28, 2004. (Incorporated by reference to Exhibit No. 10.1 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)
10.2*
Employment Agreement of James E Solomon dated September 19, 2008. (Incorporated by reference to Exhibit No. 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 31, 2010.)
10.3*
Broadcast International 2004 Long-Term Incentive Plan. (Incorporated by reference to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 filed with the SEC on March 30, 2004.)
10.4*
Broadcast International 2008 Long-Term Incentive Plan. (Incorporated by reference to the Company's definitive Proxy Statement on schedule 14A filed with the SEC on April 17, 2009.)
10.5
Securities Purchase Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.6
5% Convertible Note dated October 16, 2006 issued by Broadcast International to Leon Frenkel. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.7
Registration Rights Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.8
Securities Purchase Agreement dated as of December 21, 2007, by and among Broadcast International and the investors listed on the Schedule of Buyers attached thereto. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.9
Registration Rights Agreement dated as of December 21, 2007, by and among Broadcast International and the buyers listed therein. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.10
6.25% Senior Secured Convertible Promissory Note dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.11
Warrant to Purchase Common Stock dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.12
Loan Restructuring Agreement between the Company and Castlerigg Master Investments Ltd., dated December 16, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
10.13
Amendment to 8% Convertible Note Due 2010 between the Company and Leon Frenkel, dated December 22, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
10.14
Placement Agency Agreement between the Company and Philadelphia Brokerage Corporation, dated December 17, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.15
Form of Subscription Agreement (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.16
Form of Warrant (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.17
Amended and Restated Senior Convertible Note issued by the Company to Castlerigg master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.18
Investor Rights Agreement between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.19
Letter between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
14.1
Code of Ethics. (Incorporated by reference to Exhibit No. 14 of the Company’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004.)
21.1
Subsidiaries. (Incorporated by reference to Exhibit No. 21.1 of the Company’s Annual Report on Form 10-KSB filed with the SEC on April 1, 2005.)
* Management contract or compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Broadcast International, Inc.
Date: March 31, 2011
/s/ Rodney M. Tiede
By: Rodney M. Tiede
Its: President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Date: March 31, 2011
/s/ Rodney M. Tiede
By: Rodney M. Tiede
Its: President, Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 31, 2011
/s/ James E. Solomon
By: James E. Solomon
Its: Chief Financial Officer and Director
(Principal Financial and Accounting Officer)
Date: March 31, 2011
/s/ R. Phil Zobrist
By: R. Phil Zobrist
Its: Director
Date: March 31, 2011
/s/ Mark Spagnolo
By: Mark Spagnolo
Its: Director
Date: March 31, 2011
/s/ William Boyd
By: William Boyd
Its: Director
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Shareholders of
Broadcast International, Inc.
Salt Lake City, Utah
We have audited the accompanying consolidated balance sheets of Broadcast International, Inc. and subsidiaries as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' deficit, and cash flows for the years then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Broadcast International, Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
/s/ HJ & Associates, LLC
HJ & Associates, LLC
Salt Lake City, Utah
March 31, 2011
BROADCAST INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
DEC 31, 2009
DEC 31, 2010
ASSETS:
Current Assets
Cash and cash equivalents
$
263,492
$
6,129,632
Trade accounts receivable, net
1,187,660
1,125,055
Inventory
105,410
52,175
Prepaid expenses
128,042
190,877
Total current assets
1,684,604
7,497,739
Property and equipment, net
3,811,377
2,419,891
Other Assets, non current
Debt offering costs
447,525
--
Patents, net
177,413
167,410
Long-term investments
274,264
--
Deposits and other assets
422,974
624,598
Total other assets, non current
1,322,176
792,008
Total assets
$
6,818,157
$
10,709,638
LIABILITIES AND STOCKHOLDERS DEFICT
LIABILITIES
Current Liabilities
Accounts payable
$
2,023,378
$
1,552,006
Payroll and related expenses
385,349
341,255
Other accrued expenses
180,695
381,015
Unearned revenue
91,729
139,437
Current portion of notes payable (net of discount of $4,078,631
and $0, respectively)
13,354,166
775,000
Other current obligations
1,238,779
1,426,834
Derivative valuation
969,900
14,759,300
Total current liabilities
18,243,996
19,374,847
Long-term Liabilities
Long-term portion of notes payable (net of discount of $0 and
$992,832, respectively)
162,500
6,187,984
Other long-term obligations
2,494,512
1,067,649
Total long-term liabilities
2,657,012
7,255,633
Total liabilities
20,901,008
26,630,480
Commitments and contingencies
--
--
STOCKHOLDERS’ DEFICIT:
Preferred stock, no par value, 20,000,000 shares authorized;
None issued
--
--
Common stock, $.05 par value, 180,000,000 shares authorized;
39,690,634 and 74,078,153 shares issued as of December 31,
2009 and December 31, 2010, respectively
1,984,532
3,703,908
Additional paid-in capital
77,760,811
92,867,561
Accumulated deficit
(93,828,194)
(112,492,311)
Total stockholders’ deficit
(14,082,851)
(15,920,842)
Total liabilities and stockholders’ deficit
$
6,818,157
$
10,709,638
See accompanying notes to consolidated financial statements
BROADCAST INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying notes to consolidated financial statements
BROADCAST INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS DEFICIT
YEARS ENDED DECEMBER 31, 2010 AND 2009
See accompanying notes to consolidated financial statements
BROADCAST INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS DEFICIT
YEARS ENDED DECEMBER 31, 2010 AND 2009 (Continued)
See accompanying notes to consolidated financial statements
BROADCAST INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to consolidated financial statements
BROADCAST INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
DECEMBER 31, 2010 AND 2009
Note 1 - Organization and Basis of Presentation
Broadcast International, Inc. (the Company) is the consolidated parent company of BI Acquisitions, Inc. (BI), a wholly-owned subsidiary, and Interact Devices, Inc. (IDI), a 94% owned subsidiary.
BI was incorporated in Utah in December 1999 and began operations in January 2000. BI provides satellite uplink services and related equipment services, communication networks, and video and audio production services primarily to large retailers, other businesses, and to a third-party provider of in-store music and video.
On October 1, 2003, the Company (formerly known as Laser Corporation) acquired BI by issuing shares of its common stock representing 98% of the total equity ownership in exchange for all of the issued and outstanding BI common stock. The transaction was accounted for as a reverse acquisition, or recapitalization of BI, with BI being treated as the accounting acquirer. Effective January 13, 2004, the company changed its name from Laser Corporation to Broadcast International, Inc.
On May 18, 2004, the Debtor-in-Possession’s Plan of Reorganization for IDI was confirmed by the United States Bankruptcy Court. As a result of this confirmation and subsequent share acquisitions, for the years ended December 31, 2010 and 2009, the Company owned, on a fully diluted basis, approximately 55,482,997 and 55,415,997 common share equivalents of IDI, representing approximately 94% of the equity of IDI.
The audited consolidated financial statements herein include operations from January 1, 2008 to December 31, 2010. IDI produced losses from operations during the period; therefore, 100% of the results from operations have been included in the Company’s consolidated statements.
Note 2 - Significant Accounting Policies
Management Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
We consider all cash on hand and in banks, and highly liquid investments with maturities of three months or less, to be cash equivalents. At December 31, 2010 and 2009, we had bank balances of $6,860,418 and $0, respectively in the excess of amounts insured by the Federal Deposit Insurance Corporation. We have not experienced any losses in such accounts, and believe we are not exposed to any significant credit risk on cash and cash equivalents.
Current financial market conditions have had the effect of restricting liquidity of cash management investments and have increased the risk of even the most liquid investments and the viability of some financial institutions. We do not believe, however, that these conditions will materially affect our business or our ability to meet our obligations or pursue our business plans.
Account Receivables
Trade account receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.
A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 90 days. After the receivable becomes past due, it is on non-accrual status and accrual of interest is suspended.
Inventories
Inventories consisting of electrical and computer parts are stated at the lower of cost or market determined using the first-in, first-out method.
Property and Equipment
Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the property, generally from three to five years. Repairs and maintenance costs are expensed as incurred except when such repairs significantly add to the useful life or productive capacity of the asset, in which case the repairs are capitalized.
Patents and Intangibles
Patents represent initial legal costs incurred to apply for United States and international patents on the CodecSys technology, and are amortized on a straight-line basis over their useful life of approximately 20 years. We have filed several patents in the United States and foreign countries. As of December 31, 2010, the United States Patent and Trademark Office had approved four patents. Additionally, eleven foreign countries had approved patent rights. While we are unsure whether we can develop the technology in order to obtain the full benefits, the patents themselves hold value and could be sold to companies with more resources to complete the development. On-going legal expenses incurred for patent follow-up have been expensed from July 2005 forward.
Amortization expense recognized on all patents totaled $10,003 and $7,777 for the year ended December 31, 2010 and 2009, respectively.
Estimated amortization expense, if all patents were issued at the beginning of 2011, for each of the next five years is as follows:
Year ending
December 31:
$12,231
12,231
11,763
11,763
11,763
Long-Lived Assets
We review our long-lived assets, including patents, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset to future un-discounted net cash flows
expected to be generated by the asset. If such assets are considered to be impaired, then the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Fair value is determined by using cash flow analyses and other market valuations. After our review at December 31, 2010 it was determined that no adjustment was required.
Stock-based Compensation
In accordance with ASC Topic 718, stock-based compensation cost is estimated at the grant date, based on the estimated fair value of the awards, and recognized as expense ratably over the requisite service period of the award for awards expected to vest.
Income Taxes
We account for income taxes in accordance with the asset and liability method of accounting for income taxes prescribed by ASC Topic 740. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in the years in which those temporary differences are expected to be recovered or settled.
Revenue Recognition
We recognize revenue when evidence exists that there is an arrangement between us and our customers, delivery of equipment sold or service has occurred, the selling price to our customers is fixed and determinable with required documentation, and collectability is reasonably assured. We recognize as deferred revenue, payments made in advance by customers for services not yet provided.
When we enter into a multi-year contract with a customer to provide installation, network management, and satellite transponder and help desk, or combination of these services, we recognize this revenue as services are performed and as equipment is sold. These agreements typically provide for additional fees, as needed, to be charged if on-site visits are required by the customer in order to ensure that each customer location is able to receive network communication. As these on-site visits are performed the associated revenue and cost are recognized in the period the work is completed. If we install, for an additional fee, new or replacement equipment to an immaterial number of new customer locations, and the equipment immediately becomes the property of the customer, the associated revenue and cost are recorded in the period in which the work is completed.
In instances where we have entered into license agreements with a third parties to use our technology within their product offering, we recognize any base or prepaid revenues over the term of the agreement and any per occurrence or periodic usage revenues in the period they are earned.
Research and Development
Research and development costs are expensed when incurred. We expensed $2,711,933 and $3,584,019 of research and development costs for the years ended December 31, 2010 and 2009, respectively.
Concentration of Credit Risk
Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of trade accounts receivable. In the normal course of business, we provide credit terms to our customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have been within the range of management’s expectations.
In 2010 and 2009, we had one customer that individually constituted 87% and 72%, respectively of our total revenues, with no other single customer representing more than 5% of total revenues. Our largest customer signed a three year contact which we began servicing in the second half of 2009.
Loss per Common Share
The computation of basic loss per common share is based on the weighted average number of shares outstanding during each year.
The computation of diluted earnings per common share is based on the weighted average number of shares outstanding during the year, plus the dilutive common stock equivalents that would rise from the exercise of stock options, warrants and restricted stock units outstanding during the year, using the treasury stock method and the average market price per share during the year. Options and warrants to purchase 20,442,170 shares of common stock at prices ranging from $.33 to $36.25 per share were outstanding at December 31, 2010. Options and warrants to purchase 13,167,337 shares of common stock at prices ranging from $.04 to $36.25 per share were outstanding at December 31, 2009. There were 950,000 and 975,000 restricted stock units outstanding at December 31, 2010 and 2009, respectively. As we experienced a net loss during the years ended December 31, 2010 and 2009, no common stock equivalents have been included in the diluted earnings per common share calculation as the effect of such common stock equivalents would be anti-dilutive.
Advertising Expenses
We follow the policy of charging the costs of advertising to expense as incurred. Advertising expense for the years ended December 31, 2010 and 2009 were $7,704 and $4,013, respectively.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Recent Accounting Pronouncements
In August 2010, the FASB issued ASU No 2010-22, Accounting for Various Topics. Technical Corrections to SEC Paragraphs- An announcement made by the staff of US Securities and Exchange Commission. This Update makes changes to several of the SEC guidance literature within the Codification. Some of the changes relate to (1) Oil and Gas Exchange Offers, (2) Accounting for Divestiture of a Subsidiary or Other Business Operations, (3) Replaces “Push Down” basis accounting references with “New” basis of accounting to be used in the acquired companies financial statements, (4) Fees paid to an investment banker in connection with an acquisition or asset purchase, when the investment banker is also providing interim financing or underwriting services must be allocated between the related service and debt issue costs. The amendments in this Update are effective immediately. The Company doesn’t expect this guidance to have a significant impact on its financials since there are no changes to accounting that were not already being applied by the Company.
In July 2010, the FASB issued ASU No 2010-20, Receivables (Topic 310) - Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. This Update requires additional disclosures for financing receivables, excluding short-term trade accounts receivables and or receivables measured at fair value. The new disclosures are designed to allow a user to better evaluate a company’s credit risk in the portfolio of financing receivables, how the risk is analyzed and in allowing for credit losses and the reason for the changes in the allowance for credit losses. Some of the additional disclosures required are to provide a rollforward of allowance for credit losses by portfolio segment basis, credit quality of indicators of financing receivables by class of financing receivables, the aging of financing receivables by class of financing receivable, significant purchases and sales of financing receivables by portfolio segment, amongst other requirements. The amendments in this Update are effective for reporting periods ending on or after December 15, 2010 for disclosures as of the end of the reporting period and disclosures related to
activity are effective for reporting periods beginning on or after December 15, 2010 for public entities. For nonpublic entities, the disclosures are effective for annual reporting periods ending on or after December 15, 2011. Comparative disclosures for earlier reporting periods are encouraged, but not required. The Company doesn’t expect this guidance to have a significant impact on its financials since it doesn’t have any finance receivables. The receivables are short-term trade receivables.
In February 2010, the FASB issued ASU No 2010-10, Consolidation (Topic 810) - Amendments for Certain Investment Funds. This update provides for the deferral of the consolidation requirements under Topic 810 for a reporting entity’s interest in an entity 1) that has all the attributes of an investment company or 2) for which it is industry practice to apply measurement principles for financial reporting purposes that are consistent with those followed by investment companies. The amendments are effective as of the first annual period that begins after November 15, 2009, and for interim periods within that period. The Company will adopt this Update on January 1, 2010 and it didn’t have a significant impact on the financials since the Company has no interest in investment type companies.
In February 2010, the FASB issued ASU No 2010-08, Technical Corrections to Various Topic. This update provides clarifications, eliminates inconsistencies and outdated provisions within the guidance. None of the provisions fundamentally change US GAAP, but certain clarifications regarding hedging and derivatives may cause a change in the application of that Subtopic. The amendments are effective for the first reporting beginning after issuance - March 31, 2010 for the Company. The amendments were reviewed and no items of significance were noted. As such, this update is not expected to have a significant impact on the Company’s financial statements.
In January 2010, the FASB issued ASU No 2010-06, Fair Value Measurements and Disclosures (Topic 820) Improving Disclosures about Fair Value Measurements. This update provides amendment to the codification regarding the disclosures required for fair value measurements. The key additions area as follows: 1) Disclose transfer in and out of Level 1 and 2, 2) Activity in Level 3 should show information about purchases, sales, settlements, etc on a gross basis rather than as net basis, and 3) Additional disclosures about inputs and valuation techniques. The new disclosure requirements are effective for interim and annual periods beginning after December 31, 2009, except for the gross disclosures of purchases, etc which is effective for periods beginning after December 15, 2010. The Company will adopt this Update on January 1, 2010 and doesn’t expect it will have a significant impact on the financials since there aren’t many items recorded at fair value, but additional disclosures about inputs and valuation techniques will be made.
In January 2010, the FASB issued ASU No 2010-04, Accounting for Various Topics - Technical Corrections to SEC Paragraphs. This update provides updates/corrections to various topics of the codification with regards to the SEC’s position on various matters. There is no new guidance, but adjustments to the SEC’s position on already issued updates. Some of the main topics covered are as follows: 1) Requirements for using push down accounting in an acquisition 2) appropriate balance sheet presentation of unvested, forfeitable equity instruments are issued to nonemployees as consideration for future services - these are to be treated as not issued and no entry recorded until the instruments are earned. 3) intangible assets arising from insurance contracts acquired in a business combination. The corrections are applicable for 2009 since the updates relate to already issued guidance. The main issue that may impact the Company is the accounting for unvested, forfeitable equity instruments. The Company will evaluate and determine if there are any contracts with non-employees for which equity instruments are granted and ensure they are accounted for in accordance with the update.
Note 3 - Accounts Receivable
Included in our $1,125,055 and $1,187,660 net accounts receivable for the years ending December 2010 and 2009, respectively, were (i) $1,031,796 and $1,211,815 for billed trade receivables, respectively; (ii) $143,542 and $69,833 of unbilled trade receivables, respectively; (iii) $207 and $179 for employee travel advances and other receivables, respectively; less (iv) $50,490 and $94,167 for allowance for uncollectible accounts, respectively.
Included in the numbers above is our single largest customer for each year ended December 31, 2010 and, 2009, which provided 87% and 72% of total revenue and represented 88% of our trade receivables on December 31, 2010 and 2009, respectively. Our largest customer signed a three year agreement which we began servicing in the second half of 2009. Any material reduction in revenues generated from our largest customer could harm our results of operations, financial condition and liquidity.
Note 4 - Equity Financing and the Debt Restructuring
On December 24, 2010, we closed on an equity financing (the “Equity Financing”) as well as a restructuring of our outstanding convertible indebtedness (the “Debt Restructuring”). The Equity Financing and the Debt Restructuring are described as follows.
We entered into a Placement Agency Agreement, dated December 17, 2010, with Philadelphia Brokerage Corporation (“PBC”), pursuant to which PBC agreed to act as the exclusive agent of the Company on a “best efforts” basis with respect to the sale of up to a maximum gross consideration of $15,000,000 of units of the Company’s securities, subject to a minimum gross consideration of $10,000,000. The Units consisted of two shares of our common stock and one warrant to purchase a share of our common stock. The Company agreed to pay PBC a commission of 8% of the gross offering proceeds received by the Company, to issue PBC 40,000 shares of its common stock for each $1,000,000 raised, and to pay the reasonable costs and expenses of PBC related to the offering. The Company also agreed to pay PBC a restructuring fee in the amount of approximately $180,000 upon the closing of the Equity Financing and the simultaneous Debt Restructuring.
Pursuant to the Placement Agency Agreement, we entered into Subscription Agreements dated December 23, 2010 with select institutional and other accredited investors for the private placement of 12,500,000 units of our securities. The Subscription Agreements included a purchase price of $1.20 per unit, with each unit consisting of two shares of common stock and one warrant to purchase an additional share of common stock. The warrants have a term of five years and an exercise price of $1.00 per share.
Net proceeds from the Equity Financing, after deducting the commissions and debt restructuring fees payable to PBC and the estimated legal, printing and other costs and expenses related to the financing, were approximately $13.5 million. We used a portion of the net proceeds of the Equity Financing to pay down debt and the remainder will be used for working capital.
On November 29, 2010, we entered into a bridge loan transaction with three accredited investors pursuant to which we issued unsecured notes in the aggregate principal amount of $1.0 million. Upon the closing of the Equity Financing, the lenders converted the entire principal amount plus accrued interest into the same units offered in the Equity Financing and the proceeds from the bridge loan transaction were treated as funds raised with respect to the financing.
In connection with the Equity Financing and under the terms of the Subscription Agreements, the Company agreed to prepare and file, and did file, within 60 days following the issuance of the securities, a registration statement covering the resale of the shares of common stock sold in the financing and the shares of common stock underlying the warrants. If the Company fails to have the registration statement declared effective within 120 days following the date of the filing of the registration statement, the Company will be obligated to issue additional warrants to the investors to purchase an additional 1,250,000 shares for each 30-day period after the deadlines, until either the registration statement is filed or declared effective, as the case may be.
On December 24, 2010, we also closed on the Debt Restructuring. In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the “Amended and Restated Note”) to Castlerigg Master Investment Ltd. (“Castlerigg”), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants
as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents was issued (the “Loan Restructuring Agreement”), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest.
The Amended and Restated Note, dated December 23, 2010, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year’s interest of approximately $344,000 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.
The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
In connection with the Debt Restructuring, the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We also issued 150,000 shares to the holder of this note as consideration to extend the term of the note.
Warrants totaling 12,499,980 issued under the Placement Agency Agreement contain price protection adjustments in the event we issue new common stock or common stock equivalents in certain transactions at a price less than $1.00 per share and were accounted for as embedded derivatives and valued on the transaction date using a Black Schools pricing model. We recorded an aggregate derivative liability of $10,750,000 at December 31, 2010 related to these warrants and valuation gain of $2,250,000 for the year ended December 31, 2010 to reflect the change in value of the aggregate derivative. The aggregate derivative liability of $10,750,000 was calculated at December 31, 2010 using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate of 2.01%, (ii) expected life (in years) of 5.0 for the; (iii) expected volatility of 87.38%, (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.20.
Note 5 - Notes Payable
The recorded value of our notes payable (net of debt discount) for the years ending December 31, 2010 and 2009 was as follows:
December 31, 2009
December 31, 2010
Senior Secured 6.25% Convertible Note
$
12,317,619
$
6,180,816
Unsecured Convertible Note
1,000,000
7,168
Auction Rate Preferred Securities Secured Note
162,500
-
AFCO Note Payable
36,547
-
Pledged A/R Note Payable
-
775,000
Total
13,516,666
6,962,984
Less Current Portion
(13,354,166)
(775,000)
Total Long-term
$
162,500
$
6,187,984
Secured 6.25% Convertible Note
On December 24, 2007, we entered into a securities purchase agreement in which we raised $15,000,000 (less $937,000 of prepaid interest). We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. Pursuant to the financing, we issued a senior secured convertible note in the principal amount of $15,000,000 (which principal amount has been increased as discussed below).The senior secured convertible note was originally due December 21, 2010, but has been conditionally extended to December 21, 2011 depending on our future financing efforts as discussed below. Because of this financing condition, the note may revert back to December 21, 2010. The senior secured convertible note bears interest at 6.25% per annum (which rate has been changed as discussed below) if paid in cash. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 are due quarterly and commenced in April 2009. Interest payments may be made through issuance of common stock in certain circumstances or may be capitalized and added to the principal. The original principal of the note was convertible into 2,752,294 shares of our common stock at a conversion price of $5.45 per share, convertible any time during the term of the note. We granted a first priority security interest in all of our property and assets and of our subsidiaries to secure our obligations under the note and related transaction agreements. In August 2009 we received a waiver from the note holder releasing their security interest for the equipment purchased under our sale lease back financing. See Note 9.
In connection with the 2007 financing, the senior secured convertible note holder received warrants to acquire 1,875,000 shares of our common stock exercisable at $5.00 per share. We also issued to the convertible note holder 1,000,000 shares of our common stock valued at $3,750,000 and incurred an additional $1,377,000 for commissions, finders fees and other transaction expenses, including the grant of a three-year warrant to purchase 112,500 shares of our common stock to a third party at an exercise price of $3.75 per share, valued at $252,000. A total of $1,377,000 was included in debt offering costs and is being amortized over the term of the note.
From March 26, 2010 through October 29, 2010, we entered into a series of amendments to the senior secured convertible note. Each of these amendments is described below.
On March 26, 2010, we entered into an amendment and extension agreement with the holder of the senior secured convertible note. The agreement conditionally amended the maturity date of the note to December 21, 2011. If we are unsuccessful in raising at least $6.0 million in equity financing before September 30, 2010, the maturity date of the note will automatically be restored to its original date of December 21, 2010. In consideration of entering into the agreement, the note holder was issued 1,000,000 shares of our restricted common stock valued at $990,000. In addition, we agreed to the inclusion of three additional terms and conditions in the note: (i) from and after the additional funding, we will be required to maintain a cash balance of at least $1,250,000 and provide monthly certifications of the cash balance to the note holder; (ii) we will not make principal payments on our outstanding $1.0 million unsecured convertible note without the written consent of the holder of the senior secured convertible note; and (iii) we will grant board observation rights to the note holder. Given these additional terms, unless the senior secured convertible note holder provides consent, of which there can be no assurance, we will be precluded from repaying the $1.0 million unsecured convertible note when it becomes due on December 22, 2010.
On July 30, 2010, we entered into a further amendment agreement with the holder of the senior secured convertible note regarding the note and warrant reset provisions. The July 30, 2010 amendment conditionally amended the maturity date of the note to June 21, 2012. If we are unsuccessful in raising the $6.0 million in equity financing referenced above, the maturity date of the note will automatically be restored to its original date of December 21, 2010. The holder of the note agreed to a conversion price of the note of $1.80 per share instead of the price at which we sell equity between now and September 30, 2010 and reduced the required cash balance referenced in the March 26, 2010 amendment above from $1,250,000 to $950,000. In addition, the number of warrants originally granted to the holder pursuant to the 2007 financing increased from 1,875,000 to 5,208,333 and were exercisable at $1.80 per share instead of $5.00 per share. The warrants continued to be exercisable any time for the five years from the original date of grant. In consideration of entering into the July 30, 2010 amendment the note holder was issued 2,000,000 shares of
common stock and would be issued an additional 800,000 shares of our common stock contingent upon completion of the required equity raise.
On September 27, 2010, we entered into a further amendment agreement with the holder of the senior secured convertible note regarding the note. Pursuant to this amendment, the due date for the required equity financing was extended to October 31, 2010.
On October 29, 2010, we entered into a fourth amendment agreement with the holder of the senior secured convertible note regarding the note and warrant provisions. The fourth amendment (i) increased the amount of the required equity raise to $8.0 million, approximately $2.5 million of which had been raised or committed by investors at the time of the amendment; (ii) extended the time in which we can complete the equity financing to December 3, 2010; (iii) deleted the provision of the senior secured convertible note that granted the Company the option to redeem the note prior to its maturity date; (iv) changed the conversion price of the note upon successful completion of the required capital raise to an amount equal to 150% of the lowest price at which Company common stock is sold during calendar year 2010; (v) changed the exercised price of the warrants to an amount equal to 150% of the lowest price at which Company common stock is sold during calendar year 2010; (vi) provides that if we are successful in completing the required capital raise the number of warrants will be increased as currently provided in the 6.25% senior secured convertible promissory note; and (vii) extended the expiration date of the warrants to December 31, 2013.
If the additional funding was not completed by December 3, 2010, certain provisions of the prior amendments became void in that the maturity date will revert back to December 21, 2010, the conversion price became the lowest price at which equity securities had been sold, the exercise price became the lowest price at which equity securities have been sold, the number of warrants then outstanding would be determined by the original purchase documents, and the Company would not have an obligation to maintain a balance of cash and marketable securities equal to $950,000.
On December 24, 2010, we closed on the Debt Restructuring. In connection therewith, we (i) issued an Amended and Restated Senior Convertible Note in the principal amount of $5.5 million (the “Amended and Restated Note”) to Castlerigg Master Investment Ltd. (“Castlerigg”), (ii) paid $2.5 million in cash to Castlerigg, (iii) cancelled warrants previously issued to Castlerigg that were exercisable for a total of 5,208,333 shares of common stock, (iv) issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment, (v) entered into the Letter Agreement pursuant to which we paid Castlerigg an additional $2.75 million in cash in lieu of the issuance of $3.5 million in stock and warrants as provided in the loan restructuring agreement under which the Amended and Restated Note and other documents was issued (the “Loan Restructuring Agreement”), and (vi) entered into an Investor Rights Agreement with Castlerigg dated December 23, 2010. As a result of the foregoing, Castlerigg forgave approximately $7.2 million of principal and accrued but unpaid interest. The Debt Restructuring was considered a troubled-debt restructuring and a gain on debt restructuring of $3,062,457 was recorded during the year ended December 31, 2010, which was the difference between the adjusted carrying value of the original note and the carrying value of the Amended and Restated Note.
The Amended and Restated Note, dated December 23, 2010, is a senior, unsecured note that matures in three years from the closing and bears interest at an annual rate of 6.25%, payable semi-annually. We paid the first year’s interest of approximately $344,000 at the closing. The Amended and Restated Note is convertible into shares of common stock at a conversion price of $1.35 per share, subject to adjustment. The Amended and Restated Note is convertible in whole or in part at any time upon notice by Castlerigg to us. The Amended and Restated Note also contains various restrictions, acceleration provisions and other standard and customary terms and conditions. Two of our consolidated subsidiaries guaranteed our obligations under the Amended and Restated Note.
The Investor Rights Agreement provides Castlerigg with certain registration rights with respect to the Company’s securities held by Castlerigg. These registration rights include an obligation of the Company to issue additional warrants to Castlerigg if certain registration deadlines or conditions are not satisfied. The agreement also contains full-ratchet anti-dilution price protection provisions in the event the Company issues
stock or convertible debt with a purchase price or conversion price less than the conversion price described above.
We recorded an aggregate derivative liability of $2,607,400 and $765,300 at December 31, 2010 and 2009, respectively, related to the conversion features of the Amended and Restated Note and the conversion feature and warrants related to the Original Note. A derivative valuation loss of $1,240,711 and a derivative valuation gain of $3,017,600 was recorded during the years ended December 31, 2010 and 2009, respectively, to reflect the change in value of the aggregate derivative. The value of the warrants of the Original Note at time of cancellation was $1,354,167 was recorded to additional paid in capital. The aggregate derivative liability of $2,607,400 for the Amended and Restated Note conversion feature was calculated at December 31, 2010 using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate of 1.02%, (ii) expected life (in years) of 3.0 for the; (iii) expected volatility of 87.42% for the conversion feature, (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.20.
During the year ended December 31, 2009, the principal value of the 6.25% senior secured convertible note was increased by $1,396,250 to $16,396,250 (convertible into 3,008,486 common shares), for interest capitalized rather than making a payment in cash. During the year ended December 31, 2010, the principal value of the 6.25% senior secured convertible note was increased by $1,491,161 for interest capitalized. Capitalized interest is computed at 9%.
Debt discounts were accreted over the term of the obligation, for which $4,078,631 and $4,191,300 was included in interest expense for the years ended December 31, 2010 and 2009, respectively. The note bears a 6.25% annual interest rate payable quarterly. For the year ended December 31, 2010, $1,465,543 ($1,491,162 offset by $25,619 note interest accrued in 2009) was included in interest expense for capitalized interest. For the year ended December 31, 2009, $1,372,812 ($1,396,250 offset by $23,438 note interest accrued in 2008) was included in interest expense for capitalized interest.
The $6,180,816 value of the note at December 31, 2010 consists of $5,500,000 for the principal due of the note plus $1,031,250 for aggregate future interest less $350,434 for interest withheld at closing for interest due from the initial date of the debt restructuring transaction until December 31, 2011.
Unsecured Convertible Note
On September 29, 2006, we entered into a letter of understanding with Triage Capital Management, or Triage, dated September 25, 2006. The letter of understanding provided that Triage loan $1,000,000 to us in exchange for us entering into, on or prior to October 30, 2006, a convertible note securities agreement. It was intended that the funding provided by Triage be replaced by a convertible note and accompanying warrants, as described below. Effective November 2, 2006, we entered into securities purchase agreement, a 5% convertible note, a registration rights agreement, and four classes of warrants to purchase our common stock, all of which were with an individual note holder, the controlling owner of Triage, who caused our agreement with Triage to be assigned to him, which satisfied our agreement with Triage.
Pursuant to the securities purchase agreement, (i) we sold to the convertible note holder a three-year convertible note in the principal amount of $1,000,000 representing the funding received by us on September 29, 2006; (ii) the convertible note bears an annual interest rate of 5%, payable semi-annually in cash or shares of our common stock; (iii) the convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share subject to full-ratchet anti-dilution price protection provisions ; and (iv) we issued to the convertible note holder four classes of warrants (A Warrants, B Warrants, C Warrants and D Warrants), which give the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock as described below. The A and B Warrants originally expired one year after the effective date of a registration statement filed under the Securities Act of 1933, as amended (the “Securities Act”), to register the subsequent sale of shares received from exercise of the A and B Warrants. The C Warrants and D Warrants originally expired eighteen months and twenty four months, respectively, after the effective date of a registration statement to be filed under the Securities Act. The A Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.60 per share, the B Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an
exercise price of $1.75 per share, the C Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $2.10 per share, and the D Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $3.00 per share.
During the year ended December 31, 2007, the convertible note holder exercised 454,000 A Warrants. We entered into an exchange agreement dated October 31, 2007 in which the convertible note holder received 650,000 shares of our common stock in exchange for cancellation of the C and the D Warrants. The expiration date of the A Warrants and the B Warrants was extended from January 11, 2008 to December 3, 2008. During the year ended December 31, 2008, the convertible note holder exercised 64,400 A Warrants. On December 3, 2008, the remaining 231,600 A Warrants and 750,000 B Warrants were unexercised and expired.
On December 23, 2009 we entered into an amendment with the holder of our unsecured convertible note in the principal amount of $1.0 million which (i) extended the note maturity date to December 22, 2010 and (ii) increased the annual rate of interest from 5% to 8% commencing October 16, 2009. All other terms and conditions of the note remain unchanged.
On December 24, 2010 we closed on a Debt Restructuring as mentioned above, In connection with that Debt Restructuring the Company amended the note with the holder of a $1.0 million unsecured convertible note, pursuant to which the maturity date of the note was extended to December 31, 2013. We issued 150,000 shares to the holder of this note as consideration to extend the term of the note.
We recorded an aggregate derivative liability of $1,401,900 and $200,000 as of December 31, 2010 and 2009, respectively, related to the conversion feature of the note. A derivative valuation loss of $336,900 and $526,700, respectively, was recorded to reflect the change in value of the aggregate derivative liability since December 31, 2009 and December 31, 2008, respectively. The aggregate derivative liability of $1,401,900 for the conversion feature of the note was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk free interest rate 1.02%, (ii) expected life (in years) of 3; (iii) expected volatility of 86.96%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.20.
The principal value of $1,000,000 of the unsecured convertible note was accreted over the initial term of the obligation, for which $274,188 was included in interest expense for the year ended December 31, 2009. In connection with the amendment, the principal value of the note will be accreted due to the difference in the value of the conversion feature before and after the amendment. The accretion for the year ended December 31, 2010, was $7,168 and was included in interest expense. The note currently bears an 8% annual interest rate payable semi-annually, and for the years December 31, 2010 and 2009, $159,666 and $57,689, respectively, was included in interest expense.
Unsecured 3% Convertible Notes
During the year ended December 31, 2010, we entered into four convertible notes with three individuals and one corporation totaling $925,000. We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. The unsecured 3% convertible notes bore an interest rate of 3% per annum paid in cash and was due on December 31, 2012. The principal of the notes was convertible into shares of our common stock at a conversion price of $1.00 per share or at the price per share of the equity sold before September 30, 2010, and were convertible any time during the term of the notes at the option of the holders or the Company.
During the year December 31, 2010, $900,000 of the principal balance plus $8,925 of accrued interest was converted into 908,925 shares of our common stock. The remaining $25,000 principal balance was returned, at the individual’s request, and the transaction was voided.
In connection with the financing, the unsecured 3% convertible note holders received warrants to acquire 900,000 shares of our common stock exercisable at $1.50 per share. The warrants were exercisable any time for a three-year period beginning on the date of grant. The warrants and the embedded conversion feature and prepayment provision of the unsecured 3% convertible notes were accounted for as derivatives.
The principal value of $900,000 of the unsecured 3% convertible notes were accreted over the term of the obligations, until they were converted, for which $107,885 was included in interest expense. The notes bore a 3% annual interest rate, and $8,925 was included in interest expense.
The unsecured 3% convertible note holders subsequently were allowed a one-time opportunity to convert their note values into common stock at a conversion price of $.60 per share and receive one warrant for every two shares of stock with an exercise price of $1.00 per share or accept the original conversion. All holders selected the new conversion offer. As a result we issued an additional 605,949 shares of common stock to the note holders. Additionally we canceled the previously issued 900,000 warrants and issued 757,437 warrants with an exercise price of $1.00 per share.
The unsecured 3% convertible notes contained price protection adjustments in the event we issue new common stock in certain transactions at a price less than $1.00 per share and were accounted for as embedded derivatives and valued on the transaction date using a Black Schools pricing model. We recorded no aggregate derivative liability at December 31, 2010 related to these notes and valuation loss of $345,500 for the year ended December 31, 2010 to reflect the change in value of the aggregate derivative prior to conversion into equity.
Accounts Receivable Purchase Agreements
During the year ended December 31, 2010 we entered into two Accounts Receivable Purchase Agreements with one individual for an aggregate amount of $675,000. In these agreements, we pledged certain outstanding accounts receivable in exchange for advanced payment and a commitment to remit to the purchaser the amount advanced upon collection from our customer. Terms of the first agreement under which we were advanced $175,000 include a 3% discount with a 3% interest fee for every 30 days the advances remain outstanding. Terms of the second agreement under which we were advanced $500,000 include a 10% discount with a 0.5% interest fee for every 30 days the advances remain outstanding. For the year ended December 31, 2010 we recorded $89,658 in interest expense.
Auction Rate Preferred Securities Secured Note
In January 5, 2009, we received a $1,400,000 loan from the brokerage company that sold us our Auction Rate Preferred Securities (“ARPS”). This loan was subject to the terms and conditions contained in a promissory note and securities agreement with the brokerage company dated December 11, 2008. The loan was secured by the ARPS held by the Company in an account at the brokerage company, and bore an interest rate equal to the federal funds rate (as quoted by Bloomberg) plus 1.75%. Interest accrued monthly and was payable on the fifth business day of every month. The principal and any accrued interest were immediately due upon demand by the lender. During the year ended December 31, 2009, we redeemed $2,350,000 (par value) of our ARPS and paid $1,237,500 of the principal balance of our ARPS note. During the year ended December 31, 2010, we redeemed the remaining ARPS balance of $300,000 (par value) and recognized a $49,264 loss on sale of available for sale securities and paid the remaining $162,500 balance of the ARPS secured note.
AFCO Note Payable
On November 6, 2009, we entered into a Commercial Premium Finance Promissory Note with AFCO Credit Corporation. The beginning principal of the note was $36,547 and is payable in 11 monthly installments beginning Jan 1, 2010 and bears a 7.8% annual interest rate. During the year ended December 31, 2010 the note was paid in full and retired. For the year ended December 31, 2010 we recorded $1,372 in interest expense.
Senior Secured 6% Convertible Notes
On May 16, 2005, we consummated a private placement of $3,000,000 principal amount of 6% senior secured convertible notes and related securities, including common stock warrants and additional investment
rights, to four institutional funds. The senior secured convertible notes were originally due May 16, 2008 and were originally convertible into 1,200,000 shares of our common stock at a conversion price of $2.50 per share. On March 16, 2006, we entered into a waiver and amendment agreement, which adjusted the conversion rate to $1.50 per share. The warrants and the embedded conversion feature of the senior secured convertible notes have been accounted for as derivatives. As of December 31, 2008, the entire $3,000,000 principal balance had been converted into 1,200,000 shares of our common stock. As of December 31, 2008, 1,167,298 of the original 1,200,000 warrants had been exercised leaving 32,702 which remained unexercised and expired on May 15, 2010.
As of December 31, 2010, we recorded no aggregate derivative liability and a derivative valuation gain of $4,600 to reflect the change in value of the aggregate derivative liability associated with the expiration of 32,702 warrants on May 16, 2010. As of December 31, 2009, we recorded an aggregate derivative liability $12,800 and a derivative valuation gain of $27,100 to reflect the change in value of the aggregate derivative liability since December 31, 2008.
Unsecured Short Term Notes
During the year ended December 31, 2010, we entered into five short-term notes with two individuals and three corporations totaling $700,000 of which $650,000 has been repaid to the note holders, and $50,000 (plus $1,150 of earned interest) was converted into 51,150 shares of our common stock. We used the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. The notes with the two individuals were dated June 7, 2010, each in the principal amount of $50,000 and due on July 31, 2010 with an annual interest rate of 12%. During the year ended December 31 2010, one of these notes was paid in full and the other was converted into shares of our common stock mentioned above.
One of the notes with one of the corporations was dated June 29, 2010 in the principal amount of $100,000, with an annual interest rate of 12%, and was originally due on July 31, 2010. The due date, however, had been extended to December 31, 2010 and was paid in full at December 31, 2010. Another obligation resulting from payment due on a commission agreement of $50,000, with an annual interest rate of 1% per month was paid in full during the year ended December 31, 2010. On July 1, 2010, we entered into a revolving line of credit promissory note with a company with a maximum line of credit of $500,000 to finance the purchase of equipment to be placed at customer locations. Payment on this note is due the earlier of December 31, 2010 or receipt of payment from our customer for the financed equipment. During the year ended December 31, 2010, we borrowed $500,000 on the line of credit note and repaid the balance in full. For the year December 31, 2010, an aggregate of $39,908, net of $1,150 converted into equity above, was included in interest expense related to these obligations.
Note 6 - Investment in Interact Devices, Inc (IDI)
We began investing in and advancing monies to IDI in 2001. IDI was developing technology which became CodecSys.
On October 23, 2003, IDI filed for Chapter 11 Federal Bankruptcy protection. We desired that the underlying patent process proceed and that the development of CodecSys technology continue. Therefore, we participated in IDI’s plan of reorganization, whereby we would satisfy the debts of the creditors and obtained certain licensing rights. On May 18, 2004, the debtor-in-possession’s plan of reorganization for IDI was confirmed by the United States Bankruptcy Court. As a result of this confirmation, we issued to the creditors of IDI approximately 111,800 shares of our common stock, and cash of approximately $312,768 in exchange for approximately 50,127,218 shares of the common stock of IDI, which increased our aggregate common share equivalents in IDI to approximately 51,426,719 shares.
Since May 18, 2004, we have acquired an aggregate of 4,056,278 additional common share equivalents IDI. During the years ended December 31, 2010 and 2009, we acquired 67,000 and 2,457,714 IDI common share equivalents in exchange for 4,467 and 165,048 shares of our common stock valued at $4,024 and $256,265,
respectively. As of December 31, 2010, we owned approximately 55,482,997 IDI common share equivalents, representing approximately 94% of the total outstanding IDI share equivalents
Since May 18, 2004, we have advanced additional cash to IDI for the payment of operating expenses, which continues development and marketing of the CodecSys technology. As of December 31, 2010 and 2009, we have advanced an aggregate amount of $2,847,430 and $2,586,929 respectively, pursuant to a promissory note that is secured by assets and technology of IDI.
Note 7 - Operating Leases
Our executive offices are located at 7050 Union Park Avenue, Suite 600, Salt Lake City, Utah 84047. We occupy the space at the executive offices under a 12-month lease, the term of which ends October 31, 2011. The lease covers approximately 13,880 square feet of office space leased at a rate of $26,316 per month. We occupy a production studio located at 6952 South 185 West, Unit C, Salt Lake City, Utah 84047, which consists of approximately 15,200 square feet on a month to month basis, at the rate of $11,551 per month. We have no other properties. We recognized rent expense of approximately $459,283 and $516,684, in 2010 and 2009, respectively.
We also lease copy machines on multi-year leases that expire in March 2012 at a minimum rate of $672 per month.
Future minimum payments under non-cancelable operating leases at December 31, 2010 are as follow:
$271,224
1,344
$272,568
Note 8 - Income Taxes
Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
Net deferred tax liabilities consist of the following components as of December 31, 2009 and 2010:
Deferred tax assets
NOL carryforward
$
19,100,275
$
19,540,852
General business credit carryforwards
490,228
1,045,243
Deferred compensation
76,931
79,594
Unearned revenues
35,774
--
Allowance for doubtful accounts
36,725
19,691
Deferred tax liabilities
Depreciation
(647,895)
(413,391)
Valuation allowance
(19,092,038)
(20,271,989)
Net deferred tax asset
$
-
$
-
The income tax provision differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income from continuing operations for the years ended December 31, 2009 and 2010 due to the following:
Federal income tax (expense) benefit at statutory rates
$
4,125,407
$
524,317
State income tax (expense) benefit at statutory rates
217,127
27,595
Options issues in contract terminations
-
Other
-
Change in valuation allowance
(4,342,534)
(551,912)
$
-
$
-
At December 31, 2010, the Company had net operating loss carryforwards of approximately $50,000,000 that may be offset against future taxable income from the year 2011 through 2030. No tax benefit has been reported in the December 31, 2010 consolidated financial statements since the potential tax benefit is offset by a valuation allowance of the same amount.
Due to change in ownership provisions of the Tax Reform Act of 1986, net operating loss carryforwards for Federal income tax reporting purposes are subject to annual limitations. Should a change in ownership occur, net operating loss carryforwards may be limited as to use in future years.
Note 9 - Preferred and Common Stock
We have authorized two classes of stock, 20,000,000 shares of preferred stock with no par value and 180,000,000 shares of common stock with a $0.05 par value. No preferred stock has been issued, while 74,078,153 shares of common stock were issued and outstanding at December 31, 2010. Holders of shares of common stock are entitled to receive dividends if and when declared and are entitled to one vote for each share on all matters submitted to a vote of the shareholders.
During the year ended December 31, 2010, we issued 34,387,519 (net) shares of our common stock as follows: (i) 27,558,306 for equity funding, (ii) 3,150,000 for convertible note extensions, (iii) 1,590,049 for debt to equity conversions, (iv) 600,000 commissions on equity funding, (v) 800,000 debt restructuring (vi) 458,974 shares to consultants (vii) 35,000 shares for restricted stock unit settlements, (viii) 200,000 shares for purchase of a software license, (ix) 168,233 for interest instead of cash, (x) 4,467 shares for conversion of IDI share equivalents, (xi) less 177,500 shares cancelled and converted to warrants.
During the year ended December 31, 2009, we issued 928,874 shares of our common stock as follows: (i) 250,000 shares for restricted stock unit settlements, (ii) 250,000 shares for purchase of a software license, (iii) 207,432 shares to consultants, (iv) 165,048 shares for conversion of IDI share equivalents (v) 50,000 shares for warrant conversions, and (vi) 6,394 shares for stock based compensation.
Note 10 - Stock-based Compensation
In accordance with ASC Topic 718, stock-based compensation cost is estimated at the grant date, based on the estimated fair value of the awards, and recognized as expense ratably over the requisite service period of the award for awards expected to vest.
Stock Incentive Plans
Under the Broadcast International, Inc. 2004 Long-term Incentive Plan (the “2004 Plan”), the board of directors may issue incentive stock options to employees and directors and non-qualified stock options to consultants of the company. Options generally may not be exercised until twelve months after the date granted and expire ten years after being granted. Options granted vest in accordance with the vesting schedule determined by the board of directors, usually ratably over a three-year vesting schedule upon
anniversary date of the grant. Should an employee terminate before the vesting period is completed, the unvested portion of each grant is forfeited. We have used the Black-Scholes valuation model to estimate fair value of our stock-based awards, which requires various judgmental assumptions including estimated stock price volatility, forfeiture rates, and expected life. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The number of unissued stock options authorized under the 2004 Plan at December 31, 2010 was 1,936,065.
The Broadcast International, Inc. 2008 Equity Incentive Plan (the “2008 Plan”) has become our primary plan for providing stock-based incentive compensation to our eligible employees and non-employee directors and consultants of the company. The provisions of the 2008 Plan are similar to the 2004 Plan except that the 2008 Plan allows for the grant of share equivalents such as restricted stock awards, stock bonus awards, performance shares and restricted stock units in addition to non-qualified and incentive stock options. We continue to maintain and grant awards under our 2004 Plan which will remain in effect until it expires by its terms. The number of unissued shares of common stock reserved for issuance under the 2008 Plan was 2,765,000 at December 31, 2010.
Stock Options
We estimate the fair value of stock option awards granted beginning January 1, 2006 using the Black-Scholes option-pricing model. We then amortize the fair value of awards expected to vest on a straight-line basis over the requisite service periods of the awards, which is generally the period from the grant date to the end of the vesting period. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and expected option term. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the stock option award was granted with a maturity equal to the expected term of the stock option award. The expected option term is derived from an analysis of historical experience of similar awards combined with expected future exercise patterns based on several factors including the strike price in relation to the current and expected stock price, the minimum vest period and the remaining contractual period.
The fair values for the options granted in 2010 and 2009 were estimated at the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions:
The weighted average fair value of options granted during the years ended December 31, 2010 and 2009, was $0.80 and $1.11, respectively.
Warrants
We estimate the fair value of issued warrants on the date of issuance as determined using a Black-Scholes pricing model. We amortize the fair value of issued warrants using a vesting schedule based on the terms and conditions of each associated underling contract, as earned. The Black-Scholes valuation model requires various judgmental assumptions including the estimated volatility, risk-free interest rate and warrant expected exercise term. Our computation of expected volatility is based on a combination of historical and market-based implied volatility. The risk-free interest rate was based on the yield curve of a zero-coupon U.S. Treasury bond on the date the warrant was issued with a maturity equal to the expected term of the warrant.
The fair values for the warrants granted in 2010 and 2009 were estimated at the date of grant using the Black Scholes option-pricing model with the following weighted average assumptions:
The weighted average fair value of warrants granted during the years ended December 31, 2010 and 2009, was $0.53 and $0.65, respectively.
For the year ended December 31, 2010 we recognized $1,113,398 of stock based compensation expense with $351,263 and $762,135 recorded in our research and development and general and administrative departments, respectively, for (i) $80,000 for 100,000 options granted to one member of the board of directors, (ii) $93,000 for 150,000 warrants issued to three new members of our advisory board, (iii) $113,576 for 460,000 warrants issued to five individuals and two corporations for consulting services, (iv) $732,822 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2010 and (v) $94,000 for 100,000 restricted stock units issued to a member of the board of directors. Additionally, we issued (i) 278,824 warrants to a former member of the board of directors in exchange for the return and cancellation of 177,500 shares of our common stock, (ii) 12,499,980 warrants to investors in our Equity Financing, (iii) 4,374,297 warrants to other equity investors and (iii) 3,333,333 warrants with the July 2010 amendment to our 6.25% senior secured convertible note. There were no warrants exercised in the year ending December 31, 2010.
For the year ended December 31, 2009 we recognized $1,843,848 of stock based compensation expense with $328,163 and $1,515,685 recorded in our research and development and general and administrative departments, respectively, for (i) $56,571 for the vested portion of 354,997 options granted to twenty six employees, (ii) $652,018 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2009, (iii) $458,572 for the earned portion of 2,280,000 warrants issued to one corporation and six individuals, (iv) $8,687 for the issuance of an aggregate of 6,394 shares of common stock for two members of the board of directors for services rendered prior to their resignation, (v) $748,000 for 550,000 restricted stock units awarded to two employees in exchange for surrendering 1,016,112 incentive stock options and (vi) $80,000 valuation credit related to 125,000 restricted stock units awarded to six members of the board of directors and 35,000 restricted stock units awarded to two consultants of the company for services rendered in 2007 and 2008 awarded in 2009. At December 31, 2008, a $352,000 liability was recorded for the value of the above mentioned restricted stock units. At February 16, 2009, the award date, the value was $272,000 resulting in the $80,000 expense credit mentioned above. There were 50,000 warrants exercised in the year ending December 31, 2009.
The following table summarizes option and warrant activity during the years ended December 31, 2010 and 2009.
Options
and
Warrants
Outstanding
Weighted
Average
Exercise
Price
Outstanding at December 31, 2008
14,943,393
$
2.20
Options granted
354,997
1.33
Warrants issued
2,280,000
1.26
Expired
(1,696,257)
2.98
Forfeited
(2,664,796)
0.84
Exercised
(50,000)
1.17
Outstanding at December 31, 2009
13,167,337
2.20
Options granted
100,000
1.05
Warrants issued
21,096,434
1.18
Expired
(6,322,527)
1.80
Forfeited
(7,589,074)
2.51
Exercised
-
-
Outstanding at December 31, 2010
20,442,170
$
1.13
The following table summarizes information about stock options and warrants outstanding at December 31, 2010.
There were no options exercised in the years ended December 31, 2010 and 2009. The total intrinsic value of options and warrants available and exercisable at December 31, 2010 was approximately $3,959,159.
Restricted Stock Units
For the years ended December 31, 2010 and 2009, 100,000 and 710,000 restricted stock units were awarded, respectively. The cost of restricted stock units is determined using the fair value of our common stock on the date of the grant and compensation expense is recognized in accordance with the vesting schedule. All of the restricted stock units vested during the year they were awarded.
The following is a summary of restricted stock unit activity for the years ended December 31, 2010 and 2009:
Restricted
Stock Units
Weighted
Average
Grant
Date Fair
Value
Outstanding at December 31, 2008
425,000
$ 2.40
Awarded at fair value
710,000
1.55
Canceled/Forfeited
--
--
Settled by issuance of stock
(250,000)
2.19
Outstanding at December 31, 2009
885,000
1.69
Awarded at fair value
100,000
0.94
Canceled/Forfeited
--
--
Settled by issuance of stock
(35,000)
1.70
Outstanding at December 31, 2010
950,000
$ 1.61
Vested at December 31, 2010
950,000
$ 1.61
For the year ended December 31, 2010, we recognized a $94,000 expense in general and administrative expenses related to the award of 100,000 restricted stock units to one member of our board of directors. During the year ended December 31, 2010, 35,000 restricted stock units were settled by two individuals through the issuance of 35,000 shares of our common stock.
For the year ended December 31, 2009, we recognized a $668,00 net expense in general and administrative expenses related to restricted stock units as follows: (i) $748,000for 550,000 restricted stock units awarded to two employees in exchange for 1,016,112 outstanding options, (ii) $80,000 valuation credit of (a) $62,500 for 125,000 restricted stock units which had been awarded to five directors for services rendered in 2007 with a value of $275,000 at December 31, 2008 and with a value of $212,500 on February 16, 2009, the award date, and (b) $17,500 for 35,000 restricted stock units which had been awarded to two consultants of the company for services rendered in 2008 with a value of $77,000 on December 31, 2008 and with a value of $59,500 on February 16, 2009, the award date.
The impact on our results of operations for recording stock-based compensation for the years ended December 31, 2010 and 2009 is as follows:
Total unrecognized stock-based compensation was $461,575 at December 31, 2010, which we expect to recognize over the next two years in accordance with vesting provisions as follows:
$ 396,811
64,764
Total
$ 461,575
Note 11 - Equipment Financing
On August 27, 2009, we completed an equipment lease financing transaction with a financial institution. Pursuant to the financing, we entered into various material agreements with the financial institution. These agreements are identified and summarized below.
We entered into a Master Lease Agreement dated as of July 28, 2009 with the financial institution pursuant to which we will sell to the financing institution certain telecommunications equipment to be installed at 1981 of our customer’s retail locations in exchange for a one time payment of $4,100,670 by the financial institution. We will pay to the financial institution 36 monthly lease payments and at the expiration of the equipment lease will pay the greater of the then in place fair market value of the equipment or 10% of the original purchase price.
We also entered into a security agreement with the financial institution pursuant to which we granted a first priority security interest in the equipment, whether now owned or hereafter acquired, and in our customer service agreement and service payments thereunder during the term of the equipment lease. We received a waiver from our 6.25% convertible note holder releasing their security interest in the equipment purchased under this sale lease-back financing.
The sale lease-back financing arrangement with the financial institution related to the purchase and deployment of certain digital signage equipment for a new customer. As a result of this financing, we incurred an obligation to make 36 monthly payments of approximately $141,000 plus applicable sales taxes. The proceeds of the financing are being used to purchase and install the digital signage equipment for our customer and for general working capital purposes. We have the right to terminate the lease after making 33 payments for a termination fee of approximately $451,000 after which time we would own all of the equipment. We have accounted for this arrangement as a capital lease.
For the year ended December 31, 2009, we had purchased approximately $2,004,623 of the equipment that will be placed at the customer sites. During 2009 we had made lease payments totaling approximately $562,794 of which $374,290 was applied toward the outstanding lease and $188,504 was included in interest expense. Additionally, we paid a lease acquisition fee of $150,792 which is being expensed over the life of the lease of which $16,744 was included in interest expense for the year ended December 31, 2009.
For the year ended December 31, 2010, we had purchased approximately $101,013 of additional equipment that will be placed at the customer sites. During 2010 we had made lease payments totaling approximately $1,688,382 of which $1,235,203 was applied toward the outstanding lease and $453,179 was included in interest expense. Additionally, we expensed $50,268 of our lease acquisition fee of $150,792 which is being recognized over the life of the lease included in interest expense for the year ended December 31, 2010.
Note 12 - Fair Value Measurements
We adopted ASC Topic 820 (originally issued as SFAS 157, “Fair Value Measurements”) as of January 1, 2008 for financial instruments measured at fair value on a recurring basis. ASC Topic 820 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:
·
Level 1, defined as observable inputs such as quoted prices for identical instruments in active markets;
·
Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable such as quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active; and
·
Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions, such as valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at December 31, 2010:
The table below presents our assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) at December 31, 2010. We classify financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model.
Money Market Funds and Treasury Securities
The money market funds and treasury cash reserve securities balances are classified as cash and cash equivalents on our consolidated balance sheet.
Auction Rate Preferred Securities
As of December 31 2009, we had investments in ARPS, which are classified as long-term investments on our consolidated balance sheet and were reflected at fair value. The fair values of these securities were estimated utilizing a discounted cash flow analysis of the estimated future cash flows for the ARPS as of December 31, 2009.
The ARPS held by us at December 31, 2009, totaling $300,000 ($274,264 fair value) were in AAA rated funds. During the year ended December 31, 2009, $2,350,000 of our $2,650,000 ARPS, held at December 31, 2008, were redeemed at 100% of their par value. As a result of this redemption, we recorded a $208,019 gain on sale of securities held for sale and a net reduction of $2,141,971 in our securities available for sale.
During the year ended December 31, 2010, we redeemed our remaining $300,000 ARPS ($274,264 fair value) for $225,000 through a second market broker and recognized a $49,264 loss on sale of available for sale securities. Additionally, we retired our $162,500 ARPS secured note for which the ARPS had been held as collateral.
Fair Value of Other Financial Instruments
The carrying amounts of our accounts receivable, accounts payable and accrued liabilities approximate their fair values due to their immediate or short-term maturities. The aggregate carrying amount of the notes payable approximates fair value as the individual notes bear interest at market interest rates and there hasn’t been a significant change in our operations and risk profile.
Note 13 - Retirement Plan
We have implemented a 401(k) employee retirement plan. Under the terms of the plan, participants may elect to contribute a portion of their compensation, generally up to 60%, to the plan, subject to IRS Code Section 415 limitations. We match contributions up to 100% of the first 3% of a participant’s compensation contributed to the plan and 50% of the next 2%. Employees are eligible to participate in the plan after three months of service as defined by the plan. For the years ended December 31, 2010 and 2009, we made matching contributions totaling $99,919 and $109,893, respectively.
Note 14 - Supplemental Cash Flow Information
·
During the year the December 31, 2010, we issued 458,974 shares of our common stock valued in aggregate at $437,501 to three companies and three individuals for consulting services rendered the expense for which is included in our general and administrative expense.
·
During the year ended December 31, 2010 we issued 200,000 shares our common stock valued at $216,000 to a corporation for the purchase of a H.264 codec software license to be used in our CodecSys product development. We have included it as an asset on our balance sheet and will amortize it as part of cost of sales.
·
During the year ended December 31, 2010 we acquired 67,000 IDI common share equivalents in exchange for 4,467 shares of our common stock valued at $4,024 which was expensed to research and development.
·
During the year ended December 31, 2010, we recognized $1,572,934 in depreciation and amortization expense from the following: (i) $806,321 related to cost of sales for equipment used directly by or for customers, (ii) $756,610 related to equipment other property and equipment, and (iii) $10,003 for patent amortization.
·
For the year ended December 31, 2010, an aggregate non-cash expense of $4,193,684 was recorded for the accretion of our convertible notes of which (i) $4,078,631 was related to our the senior secured 6.25% note (ii) $7,168 is for our unsecured convertible note and (iii) $107,885 was for unsecured 3%convertible notes.
·
During the year ended December 31, 2010, we issued 3,000,000and 150,000 shares our common stock valued at $3,290,000 and $135,000 to our senior secured 6.25% convertible note holder and unsecured convertible note holder , respectively as part of amendment and extension agreements.
·
During the year ended December 31, 2010 we issued 35,000 shares of our common stock to two individuals for the settlement of restricted stock units which had been awarded in 2009.
·
On December 24, 2010, we closed on the debt restructuring of our senior secured 6.25% note and issued 800,000 shares of common stock to Castlerigg in satisfaction of an obligation under a prior loan amendment.
·
On December 24, 2010, we closed on our equity financing and issued 600,000 shares our common stock to ten individuals of Philadelphia Brokerage Corporation as part of the commission due for services rendered. During the year ended December 31, 2010 we issued an aggregate of 1,758,282 shares of our common stock of which 1,590,049 shares was for debt conversions and 168,223 shares were for interest conversion. The 1,590,019 shares valued at $1,567,500 was for three individuals and one corporation. The 168,233 valued at $104,964 was for interest on the above mentioned notes valued at $10,075 with the remaining $94,889 for interest owed our unsecured convertible note holder.
·
During the year ended December 31, 2009 we issued 207,432 shares of our commons stock valued at $244,000 to two individuals for services rendered which is included in our general and administrative expense.
·
During the year ended December 31, 2009 we issued 250,000 shares of our common stock valued at $325,000 for the purchase of a software license which we are using as part of our services provided to our single largest customer. We have included it as an asset on our balance sheet and are recognizing expense over the life or our associated customer’s contract.
·
During the year ended December 31, 2009 we acquired 2,274,714 IDI common share equivalents in exchange for 165,048 shares of our common stock valued at $256,265 which was expensed to research and development.
·
During the year ended December 31, 2009, we received $58,500 from the exercise of 50,000 warrants for one individual at an exercise price of $1.17 per share.
·
For the year ended December 31, 2009, an aggregate non-cash expense of $4,465,488 was recorded for the accretion of our convertible notes of which $4,191,300 is for the senior secured 6.25% note and $274,188 is for the unsecured convertible note.
·
For the year ended December 31, 2009 we recognized $1,843,848 of stock based compensation expense with $328,163 and $1,515,685 recorded in our research and development and general and administrative departments, respectively, for (i) $56,571 for the vested portion of 354,997 options granted to twenty six employees, (ii) $652,018 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2009, (iii) $458,572 for the earned portion of 2,280,000 warrants issued to one corporation and six individuals, (iv) $8,687 for the issuance of an aggregate of 6,394 shares of common stock for two members of the board of directors for services rendered prior to their resignation, (v) $748,000 for 550,000 restricted stock units awarded to two employees in exchange for surrendering 1,016,112 incentive stock options and (vi) $80,000 valuation credit related to 125,000 restricted stock units awarded to six members of the board of directors and 35,000
restricted stock units awarded to two consultants of the company for services rendered in 2007 and 2008 awarded in 2009. At December 31, 2008, a $352,000 liability was recorded for the value of the above mentioned restricted stock units. At February 16, 2009, the award date, the value was $272,000 resulting in the $80,000 expense credit mentioned above.
We paid no cash for income taxes during the years ended December 31 2010 and 2009.
Note 15 - Subsequent Events
During December 2010 we issued 158,148 shares of common stock and March, 2011, we issued an additional 135,369 shares of common stock to the holder of our unsecured convertible note in satisfaction of $176,110 of interest on the unsecured convertible note. Also, in March 2011, in connection with the satisfaction of the accrued interest we granted to the holder a warrant to acquire up to 221,758 additional shares of our common stock at an exercise price of $.90 per share. The warrant is exercisable at any time for a five year period
On March 21, 2011, we converted $784,292 of our short-term debt into equity through the issuance of common stock and warrants to two lenders at the same unit pricing as the Company’s recent equity raise in December 2010. In consideration of converting the short- term loans on the basis of $1.20 for two shares of common stock plus one warrant at an exercise price of $1.00, we issued 1,307,153 shares of common stock and warrants to acquire up to 653,576 shares of common stock, which warrants have a five year term and are exercisable at $1.00 per share. Our objective for converting the short-term debt into equity was to conserve cash.
.
Exhibit Index
(a)
Exhibits
Exhibit
Number
Description of Document
3.1
Amended and Restated Articles of Incorporation of Broadcast International. (Incorporated by reference to Exhibit No. 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
3.2
Amended and Restated Bylaws of Broadcast International. (Incorporated by reference to Exhibit No. 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
4.1
Specimen Stock Certificate of Common Stock of Broadcast International. (Incorporated by reference to Exhibit No. 4.1 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
10.1*
Employment Agreement of Rodney M. Tiede dated April 28, 2004. (Incorporated by reference to Exhibit No. 10.1 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)
10.2*
Employment Agreement of James E Solomon dated September 19,2008. (Incorporated by reference to Exhibit No. 10.2 of the Company's Annual Report on Form 10-K for the year ended December 31, 2009 filed with the SEC on March 31, 2010.)
10.3*
Broadcast International 2004 Long-Term Incentive Plan. (Incorporated by reference to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 filed with the SEC on March 30, 2004.)
10.4*
Broadcast International 2008 Long-Term Incentive Plan. (Incorporated by reference to the Company's definitive Proxy Statement on schedule 14A filed with the SEC on April 17, 2009.)
10.5
Securities Purchase Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.6
5% Convertible Note dated October 16, 2006 issued by Broadcast International to Leon Frenkel. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.7
Registration Rights Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.8
Securities Purchase Agreement dated as of December 21, 2007, by and among Broadcast International and the investors listed on the Schedule of Buyers attached thereto. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.9
Registration Rights Agreement dated as of December 21, 2007, by and among Broadcast International and the buyers listed therein. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.10
6.25% Senior Secured Convertible Promissory Note dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.11
Warrant to Purchase Common Stock dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.12
Loan Restructuring Agreement between the Company and Castlerigg Master Investments Ltd., dated December 16, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
10.13
Amendment to 8% Convertible Note Due 2010 between the Company and Leon Frenkel, dated December 22, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 22, 2010.)
10.14
Placement Agency Agreement between the Company and Philadelphia Brokerage Corporation, dated December 17, 2010 (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.15
Form of Subscription Agreement (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.16
Form of Warrant (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.17
Amended and Restated Senior Convertible Note issued by the Company to Castlerigg master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.18
Investor Rights Agreement between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
10.19
Letter between the Company and Castlerigg Master Investments Ltd., dated December 23, 2010 (Incorporated by reference to Exhibit 10.6 of the Company’s Current Report on Form 8-K filed with the SEC on December 28, 2010.)
14.1
Code of Ethics. (Incorporated by reference to Exhibit No. 14 of the Company’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004.)
21.1
Subsidiaries. (Incorporated by reference to Exhibit No. 21.1 of the Company’s Annual Report on Form 10-KSB filed with the SEC on April 1, 2005.)
* Management contract or compensatory plan or arrangement.