UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-QSB/A
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the Quarterly Period ended June 30, 2005
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transitional period ________ to __________.
Commission File Number: 0-13316
BROADCAST INTERNATIONAL, INC.
(Exact name of small business issuer as specified in its charter)
Utah 87-0395567
(State of Incorporation) (IRS Employer Identification No.)
7050 Union Park Ave. #600, Salt Lake City, Utah 84047
(Address of Principal Executive Offices) (Zip Code)
(801) 562-2252
(Issuer's telephone number, including area code)
Check whether the issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file
such reports), and (2) has been subject to such filing requirements for the
past 90 days. ( x ) Yes ( ) No
Indicate by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange Act). ( ) Yes ( x ) No
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practicable date.
Class Outstanding as of July 31, 2005
------------ -------------------------------
Common Stock 20,839,851 shares
Transitional Small Business Disclosure Format: Yes ( ) No ( X )
1
Explanatory Note
The purpose of this Amendment No.1 to the Quarterly Report on Form
10-QSB is to restate the Company's consolidated condensed financial statements
for the three and six months ended June 30, 2005 (the "Financial Statements")
and to modify the related disclosures. Please see Note C to the Financial
Statements included in the accompanying Form 10-QSB. The Company raised
$3,000,000 of gross proceeds from Senior Secured Convertible Notes on May 16,
2005, and those notes included warrants and a conversion feature, which
conversion rate was subject to adjustment. The terms of these notes have been
previously disclosed, and the Company had previously accounted for this
offering under the provisions of EITF 00-27.
The restatement arose from the Company's determination, upon further
research and consideration, that the warrants and embedded conversion option
of the senior secured convertible notes entered into on May 16, 2005 are
accounted for as imbedded derivatives pursuant to EITF 00-19 and SFAS No. 133,
instead of accounting for such features using beneficial conversion feature
accounting pursuant to EITF 00-27. The Company has determined that the fair
value of the derivatives should be recorded as a liability, with any changes
in fair value of the derivatives between reporting dates as a derivative gain
or loss, as appropriate.
This amended Form 10-QSB/A does not attempt to modify or update any
other disclosures set forth in the original Form 10-QSB for the quarterly
period ended June 30, 2005, except as required to reflect the effects of the
restatement as described in Note C to the Financial Statements included in the
amended Form 10-QSB/A and to clarify the provisions of the senior secured
convertible notes. Additionally, this amended Form 10-QSB/A, except for the
restatement information, speaks as of the filing date of the original Form
10-QSB and does not update or discuss any other Company developments after the
date of the original filing. All information contained in this amended Form
10-QSB/A and the original Form 10-QSB is subject to updating and supplementing
as provided in the periodic reports that the Company has filed after the
original filing date with the Securities and Exchange Commission.
2
Broadcast International, Inc.
Form 10-QSB
Table of Contents
Part I - Financial Information Page
Item 1. Financial Statements 4
Item 2. Management's Discussion and Analysis or
Plan of Operation 16
Item 3. Controls and Procedures 24
Part II - Other Information
Item 1. Legal Proceedings 25
Item 2. Unregistered Sales of Equity Securities and
Use of Proceeds 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits 25
Signatures 28
3
BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEET
(Unaudited)
June 30,
2005
ASSETS -------------
- ------ (Restated)
Current assets
Cash and cash equivalents $ 2,267,340
Trade receivable, net 341,874
Inventory 22,642
Prepaid expenses 1,083,270
-------------
Total current assets 3,715,126
-------------
Non-current assets
Equipment and leasehold improvements, net 628,621
Patents net 192,273
Other assets 7,824
-------------
Total assets $ 4,543,844
=============
LIABILITIES AND STOCKHOLDERS' DEFICIT
- -------------------------------------
Current liabilities
Accounts payable $ 200,164
Accrued Payroll & related expenses 156,965
Other accrued liabilities 83,540
Unearned revenue 135,304
Current debt obligations 915,153
Derivative valuation liability 5,974,027
-------------
Total current liabilities 7,465,153
-------------
Long-term debt
Long-term obligations 265,373
Deferred bonus 600,000
-------------
Total liabilities 8,330,526
-------------
Stockholders' equity
Preferred stock, no par value, 10,000,000
shares authorized; no shares issued -
Common stock, $.05 par value, 40,000,000 shares
authorized; 20,839,851 shares issued and outstanding 1,041,993
Additional paid-in capital 20,941,776
Accumulated deficit (25,770,451)
-------------
Total stockholders' deficit (3,786,682)
-------------
Total liabilities and stockholders' deficit $ 4,543,844
=============
See accompanying notes to consolidated condensed financial statements
4
BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Six Months Ended
-------------------------- -----------------------------
June 30, June 30, June 30, June 30,
2005 2004 2005 2004
------------- ------------- -------------- --------------
(Restated) (Restated)
<s> <c> <c> <c> <c>
NET SALES $ 999,495 $ 1,556,040 $ 1,977,146 $ 2,931,896
COST OF SALES 1,232,373 1,511,644 2,335,722 2,869,691
------------- ------------- -------------- --------------
GROSS PROFIT (LOSS) (232,878) 44,396 (358,576) 62,205
OPERATING EXPENSES
Research and development in process - 10,343,945 - 11,519,377
Administrative and general 678,775 296,504 952,291 989,025
Selling and marketing 229,806 265,086 378,225 458,266
------------- ------------- -------------- --------------
TOTAL OPERATING EXPENSES 908,581 10,905,535 1,330,516 12,966,668
------------- ------------- -------------- --------------
LOSS FROM OPERATIONS (1,141,459) (10,861,139) (1,689,092) (12,904,463)
OTHER INCOME (EXPENSE):
Interest and other income 31,390 14,958 34,890 17,403
Derivative valuation gain (loss) (2,974,027) - (2,974,027) -
Interest expense (385,885) (445,657) (635,799) (795,306)
------------- ------------- -------------- --------------
TOTAL OTHER INCOME (EXPENSE) (3,328,522) (430,699) (3,574,936) (777,903)
------------- ------------- -------------- --------------
LOSS BEFORE INCOME TAXES (4,469,981) (11,291,838) (5,264,028) (13,682,366)
Income Tax Benefit - - - -
------------- ------------- -------------- --------------
NET LOSS $ (4,469,981) $(11,291,838) $ (5,264,028) $ (13,682,366)
============= ============= ============== ==============
TOTAL NET LOSS PER SHARE
- Basic and Diluted $ (.22) $ (.59) $ (.25) $ (.73)
============= ============= ============== ==============
Weighted average number of shares
of Common Stock outstanding
- Basic and Diluted 20,775,400 19,019,800 20,718,500 18,663,500
============= ============= ============== ==============
See accompanying notes to consolidated condensed financial statements
5
BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Six Months Ended
---------------------------
June 30, June 30,
2005 2004
-------------- --------------
(Restated)
<s> <c> <c>
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (5,264,028) $ (13,682,366)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization 183,440 202,199
Beneficial conversion 449,876 795,230
Common stock issued for services 235,170 420,000
Derivative liability valuation 2,974,027 -
Accretion of note payable 125,000 -
Common stock and options issued for research and
development in process - 10,228,019
Liabilities assumed for research and development in process - 1,291,358
Provision for losses on accounts receivable 6,747 26,000
(Increase) decrease in:
Receivables 129,477 (287,645)
Inventories (2,576) 50,334
Prepaid and other assets (208,193) (15,903)
Increase (decrease) in:
Accounts payable and accrued expenses 55,355 70,594
Unearned revenue (69,774) (51,822)
-------------- --------------
Net cash used in operating activities (1,385,479) (954,002)
-------------- --------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of equipment (47,151) (32,779)
Technology patents (13,329) (137,552)
-------------- --------------
Net cash used in investing activities (60,480) (170,331)
-------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on debt (35,093) (13,830)
Related party note receivable, net - (182,800)
Proceeds from the sale of stock 124,980 465,362
Loan proceeds, net 3,449,876 795,230
-------------- --------------
Net cash provided by financing activities 3,539,763 1,063,962
-------------- --------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2,093,804 (60,371)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 173,536 314,667
-------------- --------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,267,340 $ 254,296
============== ==============
See accompanying notes to consolidated condensed financial statements
6
BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (Unaudited)
June 30, 2005
NOTE A - BASIS OF PRESENTATION
The accompanying unaudited consolidated condensed financial
statements of Broadcast International, Inc. (the "Company") have been prepared
in accordance with U.S. generally accepted accounting principles for interim
financial information and the instructions to Form 10-QSB and Item 310 of
Regulation S-B. Accordingly, they do not include all of the information and
footnote disclosures required by accounting principles generally accepted in
the United States of America. In the opinion of management, all adjustments
(consisting only of normal recurring adjustments) considered necessary, in
order to make the financial statements not misleading, have been included.
Operating results for the three months and the six months ended June 30, 2005
are not necessarily indicative of the results that may be expected for the
year ending December 31, 2005. For further information, refer to the
consolidated financial statements and footnotes thereto for the year ended
December 31, 2004 included in the Company's Annual Report on Form 10-KSB (file
number 000-13316).
NOTE B - RECLASSIFICATIONS
Certain 2004 financial statement amounts have been reclassified to
conform to 2005 presentations.
NOTE C - RESTATEMENT OF FINANCIAL STATEMENTS
The Company's previously issued consolidated condensed financial
statements as of and for the three and six months ended June 30, 2005 have
been restated to record the accounting of the warrants and embedded conversion
option of the senior secured convertible notes, entered into on May 16, 2005,
as liabilities, resulting in an increase to current liabilities, rather than
as being recorded as equity. As a result of this restatement, the Company
recorded $5,974,027 of additional current liability related to the fair value
of the warrants and conversion feature of the notes, with a reduction of
$3,000,000 in equity along with an additional expense of $2,974,027 recorded
as loss for derivative valuation as of the three and six months ended June 30,
2005.
Additionally, the Company reclassified $31,390 and $14,598 of
interest and other income included as sales to other income and expense for
the three months ended June 30, 2005 and 2004, respectively, and $34,890 and
$17,403 of interest and other income included as sales to other income and
expense for the nine months ended June 30, 2005 and 2004, respectively. These
reclassifications had no effect on net loss in the respective periods.
The following table summarizes the effect of the restatement and
reclassification adjustments on the financial statements as of and for the
three and six months ended June 30, 2005.
7
Three Months Ended Six Months Ended
---------------------------- ----------------------------
June 30, June 30, June 30, June 30,
2005 2005 2005 2005
-------------- ------------- -------------- -------------
(Restated) (Previously (Restated) (Previously
Reported) Reported)
NET SALES $ 999,495 $ 999,495 $ 1,977,146 $ 1,977,146
COST OF SALES 1,232,373 1,232,373 2,335,722 2,335,722
TOTAL OPERATING EXPENSES 908,581 908,581 1,330,516 1,330,516
-------------- ------------- -------------- -------------
LOSS FROM OPERATIONS (1,141,459) (1,141,459) (1,689,092) (1,689,092)
OTHER INCOME (EXPSNSE):
Interest and other income 31,390 31,390 34,890 34,890
Derivative valuation
gain (loss) (2,974,027) - (2,974,027) -
Interest expense (385,885) (385,885) (635,799) (635,799)
-------------- ------------- -------------- -------------
TOTAL OTHER INCOME (EXPENSE) (3,328,522) (354,495) (3,574,936) (600,909)
-------------- ------------- -------------- -------------
NET LOSS $ (4,469,981) $ (1,495,954) $ (5,264,028) $ (2,290,001)
============== ============= ============== =============
June 30, 2005
--------------------------------
(Restate) (Previously
Reported)
Total current liabilities 7,465,153 1,491,126
Total liabilities 8,330,526 2,356,499
Additional paid-in capital 20,941,776 23,941,776
Accumulated deficit (25,770,451) (22,796,424)
Total stockholders' equity (deficit) (3,786,682) 2,187,345
NOTE D - WEIGHTED AVERAGE SHARES
The computation of basic earnings (loss) per common share is based on
the weighted average number of shares outstanding during each period.
The computation of diluted earnings per common share is based on the
weighted average number of common shares outstanding during the period, plus
the common stock equivalents that would arise from the exercise of stock
options and warrants outstanding, using the treasury stock method and the
average market price per share during the period. Options to purchase
7,775,596 and 6,030,903 shares of common stock at prices ranging from $.02 to
$60.00 per share were outstanding at June 30, 2005 and 2004, respectively, and
3,244,966 shares of stock would be issuable to the holders of the convertible
line of credit and the senior secured convertible notes and related warrants
if the conversion features of such instruments or the warrants were exercised.
All of the common stock equivalents were excluded for the calculation of
diluted earnings per share because the effect of including such common stock
equivalents would be anti-dilutive.
NOTE E - STOCK COMPENSATION
The Company accounts for stock-based compensation under the
recognition and measurement principles of APB Opinion No. 25, Accounting for
Stock Issued to Employees, and related interpretations. No common stock was
issued for compensation during the six months and three months ended June 30,
2005, however
8
during the six months ended June 30, 2004, 5,000 shares of common stock were
issued to an individual of the management of the Company. The amount of
expense recognized on the 2004 income statement was $20,000, which is included
in stock issues for services. No options to purchase shares of the Company's
common stock were granted as compensation to employees and management during
the three and six months ended June 30, 2005, as well as the three months
ended June 30, 2004, however, options to purchase 258,000 shares of the
Company's common stock were granted to employees and management for six months
ended June 30, 2004. All options granted had an exercise price equal to or
greater than the market value of the underlying common stock on the date of
grant. The options vested during the three and six months ended June 30, 2005
would have the following effect on net income and earnings per share if the
Company had applied the fair value recognition provisions of SFAS Statement
No. 123, Accounting for Stock-Based Compensation:
Three Months Ended Six Months Ended
June 30, June 30,
2005 2004 2005 2004
-------------- ------------- -------------- -------------
(Restated) (Restated)
<s> <c> <c> <c> <c>
Net loss, as reported $ (4,469,981) $(11,291,838) $ (5,264,028) $(13,682,366)
Addback:
Stock-based employee compen-
sation expense determined
under intrinsic value based
method for all awards, net
of related tax effects - - - -
Deduct:
Total stock-based employee
compensation expense
determined under fair value
based method for all awards,
net of related tax effects (52,427) (124,767) (177,194) (241,973)
-------------- ------------- -------------- -------------
Pro forma net loss $ (4,522,408) $(11,416,605) $ (5,441,222) $(13,924,339)
============== ============= ============== =============
(Loss) earnings per share:
Basic and diluted -
as reported $ (.22) $ (.59) $ (.25) $ (.73)
============== ============= ============== =============
Basic and diluted -
pro forma $ (.22) $ (.60) $ (.26) $ (.75)
============== ============= ============== =============
The weighted average fair value of options granted during the six months ended
June 30, 2004 was $3.07 per share. The fair value for the options granted in
the six months ended June 30, 2004 were estimated at the date of grant using a
Black Scholes option pricing model with the following weighted average
assumptions:
Risk free interest rate 4.04%
Expected life (in years) 8
Expected volatility 37.49%
Expected dividend yield 0.00%
NOTE F - SIGNIFICANT ACCOUNTING POLICIES
Revenue Recognition
The Company recognizes revenue when evidence exists that an
arrangement exists between the Company and its customers, delivery of the
Company's product or service has occurred, the Company's selling price to its
customers is fixed and determinable, and collectibility is reasonably assured.
The Company recognizes, as deferred revenue, billings made to clients for
services for which the services have not yet been provided, and therefore the
earnings process is not complete.
9
When the Company enters into a multi-year contract to provide
customers with network management and on-site service, the Company recognizes
the network management fee, as far as can be determined, equally over the
period of the agreement. 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. These occasional on-site visits are preformed by third-party
technicians, with the associated revenue and cost recognized in the period the
work is completed. Additionally, in some cases the Company installs, for an
additional fee, new or replacement equipment to customer locations, which
immediately becomes the property of the customer, with the associated revenue
and cost recorded in the period in which the work is completed.
Patents
Patents represent legal and filing costs incurred to apply for United
States as well as international patents on the CodecSys technology. Once
granted these costs are amortized on a straight-line basis over their useful
life, averaging approximately 15 years. As of June 30, 2005 one patent has
been granted with the associated amortization expense recognized of $139 for
the six months ended June 30, 2005. If all additional patents were granted
prior to December 31, 2005 the estimated amortization expense on patents for
each of the next five years would be as follows:
Year ending December 31:
2005 $ 5,965
2006 11,930
2007 11,930
2008 11,930
2009 11,930
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.
NOTE G - LONG-TERM NOTES PAYABLE
On May 16, 2005, the Company 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.
The senior secured convertible notes are due May 16, 2008, and are convertible
into 1,200,000 shares of common stock at a conversion price of $2.50 per
share. Specifically, this transaction may ultimately result in gross proceeds
to the Company of up to $13,800,000 if the additional investment rights and
warrants to purchase common stock of the Company are exercised in full. In
connection with
10
these notes, the Company has filed a registration statement on Form SB-2 with
the Securities and Exchange Commission registering the resale of shares of
common stock issuable upon conversion of the notes and upon exercise of the
warrants.
The Company issued to the note holders a total of 600,000 A warrants
and 600,000 B warrants to purchase common stock with an exercise price of
$2.50 and $4.00, respectively. The $2.50 conversion price of the senior
secured convertible notes and the $2.50 and $4.00 exercise price of the A
Warrants and the B Warrants, respectively, are subject to adjustment pursuant
to standard anti-dilution rights. These rights include (i) equitable
adjustments in the event we effect a stock split, dividend, combination,
reclassification or similar transaction; (ii) "weighted average" price
protection adjustments in the event we issue new shares of common stock or
common stock equivalents in certain transactions at a price less than the then
current market price of our common stock; and (iii) "full ratchet" price
protection adjustments in the event we issue new shares of common stock or
common stock equivalents in certain transactions at a price less than $2.50
per share. The conversion price of the notes and the exercise price of the
warrants are also subject to adjustment pursuant to a "reset" provision which
is effective as of February 16, 2006. If the moving average closing price of
our common stock for the 30 days prior to such date is lower than the
applicable conversion price of the notes or the exercise price of the
warrants, then the applicable conversion price and/or exercise price will be
adjusted to the lower moving average closing price. In no event, however,
will the conversion price or exercise price be adjusted below $0.50 per share.
The conversion features of the notes were accounted for as embedded
derivatives and valued on the transaction date using a Black-Scholes pricing
model and recorded as a liability. The warrants were accounted for as
derivatives and valued on the transaction date using a Black-Scholes pricing
model and recorded as a liability as well. At each reporting date, the value
of the conversion feature and the warrants and are evaluated and adjusted to
current market value. The note conversion feature and the warrants may be
exercised at any time and have, therefore, been reported as current
liabilities. The fair value of the aggregate derivative liability of the
conversion feature and the warrants as of June 30, 2005 was $5,974,027.
The principal value of the senior secured convertible notes is being
accreted over the term of the obligation, and for the three and six months
ended June 30, 2005, $125,000 has been included in interest expense. The notes
bear a 6% annual interest rate payable semi annually, and for the three and
six months ended June 30, 2005, $22,500 is included in interest expense.
The lending agreements contain a requirement that the Company secure
an effective registration statement with the Securities and Exchange
Commission within 120 days from the date of the borrowings. The registration
statement filed by the Company has not been declared effective and therefore,
the Company is required to pay a penalty of 2% of the borrowed amount per
month commencing September 15, 2005. Additional information regarding this
funding transaction may be found in our Form 8-K filed with the Securities and
Exchange Commission dated May 16, 2005.
NOTE H - SUPPLEMENTAL CASH FLOW INFORMATION
For the six months ended June 30, 2005 and 2004, non-cash expenses of
$235,170 and $400,000 was recorded in administrative and general expense for
services rendered by consultants compensated by the issuance of 67,000 and
11
100,000 shares of common stock, respectively. During the six months ended
June 30, 2004, a non-cash expense of $20,000 was recorded in administrative
and general expense for services rendered by an individual of management
compensated by the issuance of 5,000 shares of common stock.
For the six months ended June 30, 2005, the Company issued 100,000
shares of common stock and warrants to purchase 120,000 shares of the
Company's common stock, at a purchase price of $2.50 per share, valued at
approximately $351,000 and $331,147, respectively, to the affiliates of a
placement agent in connection with the senior secured convertible notes
described above. Additionally, the placement agent received $240,000 in cash.
The cumulative value of the stock, warrants and cash totaling approximately
$922,147 was recorded as prepaid expense and will be recognized as interest
expense over the three-year term of the notes. As of June 30, 2005, $38,423
has been included in interest expense; future expense recognition will be
approximately $25,615 per month.
On December 23, 2003, the Company entered into a convertible line of
credit for up to $1,000,000 with Meridel LTD and Pascoe Holdings LTD, both
foreign corporations. The Company may obtain advances as needed to fund
operating expenses. On June 30, 2004, the line of credit was amended to
increase the limit from $1,000,000 to $2,000,000 with the original due date of
the line of credit extended from March 31, 2005 to April 1, 2006. Any portion
of the note under the line of credit is convertible at the lenders' sole
discretion for common shares of the Company at the rate of $1.00 per share.
During the six months ended June 30, 2005 and 2004, the Company borrowed
$449,876 and $795,230, respectively. The balance of the note at June 30, 2005
was $844,966, and is included in current debt obligations.
The note bears an annual interest rate of 6%. Accrued interest,
however, is forgiven upon conversion pursuant to the terms of the line of
credit. The Company believes the entire amount of the note will be converted.
During the six months June 30, 2005 and 2004, the Company recorded $449,876
and $795,230, respectively, for the beneficial conversion feature associated
with the advances made under the line of credit. These amounts are included in
interest expense.
On May 18, 2004 an Order Confirming the Debtor in Possession's Plan
of Reorganization (the Plan) in the bankruptcy case for Interact Devices, Inc.
(IDI) was issued. As a result of this action, the Company was issued
approximately 50,127,218 shares of the common stock of IDI representing
approximately 79% of the outstanding stock of IDI. The Company recorded the
following amounts related to the acquisition of research and development in
process from IDI from the assumption of liabilities and consolidation of IDI:
Receivable from IDI $ (265,008)
Liabilities assumed from IDI (994,988)
Research and development in process 1,291,573
Trade receivables, net 13,506
Inventory 6,997
Prepaid expenses 2,166
Equipment 46,450
Accounts payable and accrued liabilities (28,696)
12
In accordance with the Plan, in exchange for the common shares of IDI, the
Company issued 111,842 shares of common stock of Broadcast International, Inc.
valued at approximately $682,222 to the former creditors of IDI. Additional
payments totaling approximately $312,766 will be made to the former IDI
creditors in equal quarterly installments of approximately $18,000 over of the
next four years, which together total the $994,988 liabilities assumed by the
Company.
The principals of Streamware Solutions AB, a Swedish Corporation,
purchased 187,500 shares of common stock below fair market value pursuant to a
Stock Purchase and Option Grant Agreement dated February 6, 2004. Streamware
was issued an additional 1,000,000 shares of common stock pursuant to a Stock
Issuance Stock Transfer and Option Grant Agreement dated effective as of
February 26, 2004. The Company also issued to Streamware or its principals
2,812,500 options to purchase common shares of the Company at an exercise
price of $4.50 per share, expiring February 6, 2006, associated with the
agreements mentioned above. These agreements were entered concurrently with
IDI entering into an amended Partner Agreement with Streamware, and all
expenses associated with Streamware and the IDI bankruptcy settlement above
were recorded as research and development in process, as part of the on-going
development costs of the CodecSys technology. The Company recorded the
following related to these agreements:
Research and development in process expense,
stock issued below market 375,000
Research and development in process expense,
additional stock issued 6,000,000
Research and development in process expense,
fair value of stock options 3,853,019
___________
Total research and development in process
expensed from Streamware $10,288,019
The Company paid no cash for income taxes or interest expense during
the three and six months ended June 30, 2005 and 2004, but as of June 30,
2005, $22,500 has been accrued due to be paid in November 2005.
NOTE I - RECENT ACCOUNTING PRONOUNCEMENTS
In December 2004, the FASB issued SFAS No. 153, Exchanges of
Nonmonetary Assets, which amends Accounting Principles Board Opinion No. 29,
Accounting for Nonmonetary Transactions. The guidance in APB Opinion 29 is
based on the principle that exchanges of nonmonetary assets should be measured
based on the fair value of the assets exchanged. The guidance in APB Opinion
29, however, included certain exceptions to that principle. SFAS 153 amends
APB Opinion 29 to eliminate the exception for nonmonetary exchanges of similar
productive assets and replaces it with a general exception for exchanges of
nonmonetary assets that do not have commercial substance. A nonmonetary
exchange has commercial substance if the future cash flows of the entity are
expected to change significantly as a result of the exchange. SFAS 153 is
effective for fiscal periods beginning after June 15, 2005. We do not expect
that the adoption of SFAS 153 will have a material impact on our consolidated
financial position, results of operations or cash flows.
13
In December 2004, the FASB issued SFAS No. 123R, Share-Based Payment,
which requires companies to measure and recognize compensation expense for all
stock-based payments at fair value. SFAS 123R is effective for small business
insurers for interim periods or the fiscal year beginning after December 15,
2005 and, thus, will be effective for us beginning with the first quarter of
2006. Early adoption is encouraged and retroactive application of the
provisions of SFAS 123R to the beginning of the fiscal year that includes the
effective date is permitted, but not required. In March 2005, the SEC issued
Staff Accounting Bulletin No. 107 ("SAB 107"), to provide further guidance
regarding the interaction of the provisions of SFAS 123R and certain SEC rules
and regulations. We are currently evaluating the impact of SFAS 123R and
expect the adoption to have a material impact on our financial position and
results of operations. See Stock Compensation in Note D for more information
related to the pro forma effects on our reported net income and net income per
share of applying the fair value recognition provisions of the previous SFAS
123, Accounting for Stock-Based Compensation, to stock-based employee
compensation.
In December 2004, the FASB issued FASB Staff Position No. FAS 109-1
("FAS 109-1"), "Application of FASB Statement No. 109, "Accounting for Income
Taxes," to the Tax Deduction on Qualified Production Activities Provided by
the American Jobs Creation Act of 2004 ("AJCA"). The AJCA introduces a special
9% tax deduction on qualified production activities. FAS 109-1 clarifies that
this tax deduction should be accounted for as a special tax deduction in
accordance with Statement 109. The Company does not expect the adoption of
these new tax provisions to have a material impact on the Company's
consolidated financial position, results of operations, or cash flows.
In May 2005, the FASB issued Statement 154, Accounting Changes and
Error Corrections, which requires retrospective application (the application
of the changed accounting principle to previously issued financial statements
as if that principle had always been used) for voluntary changes in accounting
principle unless it is impracticable to do so. Previously, the cumulative
effect of such changes was recognized in net income of the period of the
change. The effective date is for changes made in fiscal year beginning after
December 15, 2005.
In June 2005, the Emerging Issues Task Force ("EITF") issued three
consensuses that are subject to later ratification by the FASB:
The first consensus is EITF 04-5 which establishes a framework for
evaluating whether a general partner or a group of general partners controls a
limited partnership and therefore should consolidate it. Unless the limited
partners have "kick-out rights" allowing them to dissolve or liquidate the
partnership or otherwise remove the general partner "without cause", or
"participating rights" allowing the limited partners to participate in
significant decisions made in the ordinary course of the partnership's
business, the general partner(s) hold effective control and should consolidate
the limited partnership. This would be effective immediately for newly-formed
limited partnerships and for existing limited partnership agreements that are
modified. For existing limited partnership agreements that are not modified,
it would be effective for the beginning of the first reporting period after
December 15, 2005. The Company does not expect the adoption of EITF 04-5 to
have a material impact on the Company's consolidated financial position,
results of operations or cash flows.
14
<PAGE
The second consensus is EITF 05-2 which provides guidance for issuers
of debt and preferred-stock instruments with conversion features that may need
to be accounted for as derivatives. The Company does not expect the adoption
of EITF 05-2 to have a material impact on the Company's consolidated financial
position, results of operations or cash flows.
The third consensus is EITF 05-6, "Determining the Amortization
Period for Leasehold Improvements." The guidance requires that leasehold
improvements acquired in a business combination or purchased subsequent to the
inception of a lease be amortized over the lesser of the useful life of the
assets or a term that includes renewals that are reasonably assured at the
date of the business combination or purchase. The guidance is effective for
periods beginning after June 29, 2005. The Company does not expect the
adoption of EITF 05-6 to have a material impact on the Company's consolidated
financial position, results of operations or cash flows
15
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
Forward-Looking Information
This report on Form 10-QSB includes "forward-looking statements"
within the meaning of Section 27A of the Securities Act of 1933, and Section
21E of the Securities Exchange Act of 1934. These forward-looking statements
may relate to such matters as anticipated financial performance, future
revenues or earnings, business prospects, projected ventures, new products and
services, anticipated market performance and similar matters. When used in
this report, the words "may," "will," expect," anticipate," "continue,"
"estimate," "project," "intend," and similar expressions are intended to
identify forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934
regarding events, conditions, and financial trends that may affect the
Company's future plans of operations, business strategy, operating results,
and financial position. The Private Securities Litigation Reform Act of 1995
provides a safe harbor for forward-looking statements. To comply with the
terms of the safe harbor, we caution readers that a variety of factors could
cause our actual results to differ materially from the anticipated results or
other matters expressed in forward-looking statements. These risks and
uncertainties, many of which are beyond our control, include (i) competitive
factors; (ii) general economic and market conditions; (iii) rapid
technological change; (iv) dependence on commercialization of our CodecSys
technology; (v)dependence on significant customers; (vi) our ability to raise
sufficient additional capital; (vii) restrictions under our senior secured
convertible notes; (viii) our ability to execute our business model; (ix) our
ability to hire and retain qualified software personnel; (x) uncertainty of
intellectual property protection; (xi) one-time or non-recurring events; and
(xii) other factors identified in the Company's Annual Report on Form 10-KSB
for the year ended December 31, 2004 under the heading "Risk Factors" in Part
I, Item 1. Given these uncertainties, shareholders and prospective investors
are cautioned not to place undue reliance on such forward-looking statements.
Forward-looking statements speak only as of the date on which such statements
are made. The Company disclaims any obligation to update any such factors or
to announce publicly the results of any revisions to any of the
forward-looking statements contained herein to reflect future events or
developments.
The restatement arose from the Company's determination that it had
not accounted for the warrants and embedded conversion option of the senior
secured convertible notes entered into on May 16, 2005 as liabilities, but had
instead improperly accounted for such features using beneficial conversion
feature accounting and recorded the conversion option and related warrants as
equity. The Company has determined that the fair value of the derivatives
should be recorded as a liability, with any changes in fair value of the
derivatives between reporting dates as a derivative gain or loss, as
appropriate.
Results of Operations for the three months ended June 30, 2005 and June 30,
2004
Net Sales
The Company generated approximately $999,000 in revenue during the three
months ended June 30, 2005. During the same three-month period in 2004, the
Company generated revenue of approximately $1,556,000. The decrease in
16
revenue of $557,000 was due primarily to a decrease in sales of equipment to
customers of $360,144, a decrease in revenue from video production services of
$130,306. These factors are related to the timing of customer contracts and
the level of activity required by such contracts. We also recorded a decrease
of $60,053 in customer license fees, due to the expiration of a customer
contract during the quarter ended June 30, 2005.
Cost of Sales
Costs of Sales decreased by approximately $279,000 to approximately
$1,232,000 for the three months ending June 30, 2005, from $1,511,644 for the
three months ending June 30, 2004. The decrease was due primarily to the
decreased sales of equipment referenced above, which resulted in a decrease in
the cost of equipment sold to the Company's customers of $247,114. The
remainder of the decrease was due to a decrease in the cost of delivering the
services related to primarily lower employee costs in the quarter ended June
30, 2005 compared to the quarter ended June 30, 2004. There was not a
decrease in the cost of equipment relative to the sales price of the
equipment.
Expenses
Operating Expenses for the three months ending June 30, 2005 were
$908,581 compared with operating expenses for the three months ending June 30,
2004 of $10,905,535. The decrease of approximately $10,000,000 resulted from
the issuance of common stock and grants of options in the three months ended
June 30, 2004 and recording the value thereof as a $10,343,945 non cash
research and development in process expense related to the Company's CodecSys
technology. This expense was not repeated in the current quarter.
Administrative and General expenses increased by $382,271 in the current
quarter primarily from an increase in legal fees, and from the issuance of
stock for investor relations services. The increase in administrative and
general expenses was partially offset by a decrease in selling and marketing
expenses of $35,280.
Other
For the three months ended June 30, 2005, the Company recorded an
expense of $2,974,027 related to the valuation of the embedded derivates
contained in the senior secured convertible notes and the related warrants
issued in connection with the May 16, 2005 financing, which constitute
derivative securities and for which quarterly gains or losses are recorded
based upon the prevailing market price of the underlying common stock.
The Company incurred interest expense of $385,885 compared to
interest expense for the three months ended June 30, 2004 of $445,657. The
Company recorded approximately $238,000 of interest expense related to a
convertible note's beneficial conversion feature compared with approximately
$448,000 of interest expense in the three months ended June 30, 2004 for the
same note. The decrease was partially offset by recording interest expense of
$22,500 related to the senior secured convertible notes on the May 16, 2005
financing.
Net Loss
The Company realized a net loss for the three months ending June 30,
2005 of $4,469,981 compared with a net loss for the three months ended June
30, 2004 of $11,291,838. Adjusting for the $2,974,027 valuation for the
embedded derivatives in 2005 and absent the $10,343,945 research and
development in process expense for the quarter ended June 30, 2004, the net
loss for the three months ended June 30, 2005 increased by approximately
$548,000 when compared to the net loss for the three months ended June 30,
2004. This approximate $548,000 increase in net loss excluding the impact of
the 2004 research and development in progress expense and the 2005 expense
related to the valuation for the derivatives, as mentioned above, is due
primarily to the decrease in revenue and the increase in administrative and
general expenses as discussed above.
17
Results of Operations for the six months ended June 30, 2005 and June
30, 2004
Sales
The Company generated approximately $1,977,147 in revenue during the
six months ended June 30, 2005. During the same six-month period in 2004, the
Company generated revenue of approximately $2,931,896. The decrease in
revenue of $954,749 was primarily a combination of a decrease in sales of
equipment to customers of $ 640,015 and a decrease in studio and video
production revenue of $249,223. These factors are related to the timing of
customer contracts and the level of activity required by such contracts.
During the period, network management fees and advertising fees also
decreased, but the decrease was partially offset by an increase in satellite
fees.
Cost of Sales
Cost of sales decreased by approximately $534,000 to $2,335,722 for
the six months ended June 30, 2005, from $2,869,691 for the six months ended
June 30, 2004. The decrease was due primarily to the decreased sales of
equipment referenced above, which resulted in a decrease in the cost of
equipment sold to the Company's customers of $436,722. In addition the cost of
delivering the services decreased by $138,734 due primarily to a decrease of
employee salaries and related expenses. There was not a decrease in the cost
of equipment relative to the sales price of the equipment. The decrease in
costs of revenues was partially offset by an increase of $60,246 in satellite
distribution costs and an increase of $18,758 in depreciation and amortization
of equipment and leasehold improvements.
Expenses
Operating Expenses for the six months ending June 30, 2005 were
$1,330,516 compared with operating expenses for the six months ending June 30,
2004 of $12,966,668. The decrease of approximately $11,636,000 resulted
primarily from one non-cash expense, which included $11,519,377 of research
and development in process expenses, related to the Company's CodecSys
technology. In addition selling and marketing expenses decreased by
approximately $80,000 due primarily to a decrease in trade shows attended and
Administrative and General expenses decreased by approximately $36,000.
Other
For the six months ended June 30, 2005, the Company recorded an
expense of $2,974,027 related to the valuation of the embedded derivatives
from the conversion feature of the senior secured convertible notes and the
warrants of the May 16, 2005 funding. The Company incurred interest expense of
$635,799 compared to interest expense for the six months ended June 30, 2004
of $795,306. The primary amount of the decrease resulted from the Company
recording interest expense of approximately $488,000 in the six month period
ending June 30, 2005 related to the convertible line of credit's beneficial
conversion feature compared to approximately $795,000 of interest expense
related to the same note in the six months ended June 30, 2004. The decrease
was partially offset by the Company recording interest expense of $125,000 for
the accretion of the long-term senior secured convertible notes and recording
interest expense of $22,500 related to the notes on the May 16, 2005
financing.
18
Net Loss
The Company realized a net loss for the six months ending June 30,
2005 of $5,264,028 compared with a net loss for the six months ended June 30,
2004 of $13,682,366. The decrease in the net loss for the six months ended
June 30, 2005 of $8,418,338 resulted from a combination of the absence of any
Research and Development in Process expenses in the current six-month period
which is offset by the additional expense recorded for the derivative
valuation of the warrants and conversion feature of the May 2005 financing. If
the recorded net loss for the six months ended June 30, 2004 of $13,682,366
were adjusted for the Research and Development in Process expenses of
$11,519,377 the adjusted net loss would have been $2,162,989. If the recorded
net loss for the six months ended June 30, 2005 of $5,264,028 were adjusted
for the expense recorded for the valuation of the embedded derivatives on the
May 2005 financing of $2,974,027, the adjusted net loss would have been
$2,290,001. The adjusted net loss for the six months ended June 30, 2005 would
have increased by approximately $127,012 when compared to adjusted net loss
for the six months ended June 30, 2004. The increase in net loss resulted
primarily from decreased revenue offset by a decrease in various expenses as
explained above.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements.
Liquidity and Capital Resources
At June 30, 2005, we had cash of $2,267,340, total current assets of
$3,715,126, total current liabilities of $7,465,153 and total stockholders'
deficit of $3,786,682. Of the approximately $7,500,000 of current liabilities,
$5,974,027 relates to the value of the embedded derivatives in the senior
secured convertible notes and related warrants and approximately $915,000
relates to the convertible line of credit note.
Our audited consolidated financial statements for the year ended
December 31, 2004 contain a "going concern" qualification. As discussed in
Note J of the Notes to Consolidated Financial Statements, we have incurred
losses and have not demonstrated the ability to generate sufficient cash flows
from operations to satisfy our liabilities and sustain operations. Because of
these conditions, our independent auditors have raised substantial doubt about
our ability to continue as a going concern.
For the six months ended June 30, 2005, we used $1,385,479 of cash
for operating activities compared to cash used for operating activities for
the six months ended June 30, 2004 of $954,002. The cash used for operations
was provided from proceeds from sales of our common stock and from the
financing described below.
We have entered into a convertible line of credit dated December 23,
2003, as amended and restated June 30, 2004. The line of credit involves a
loan to us, the principal amount of which is convertible into shares of our
common stock at $1.00 per share. As of September 30, 2005, a total of
$1,644,966 had been advanced to us under the line of credit, of which $800,000
has been previously converted to 800,000 shares of common stock. As of
September 30, 2005, the outstanding principal balance of the convertible note
was $844,966. The convertible note is due April 1, 2006 and bears interest at
an annual rate of 6%. Accrued interest, however, is forgiven upon conversion
pursuant to the terms of the line of credit. Any portion of the note is
convertible at any time at the lenders' sole discretion.
19
On May 16, 2005, we entered into a securities purchase agreement and
completed a financing with a consortium of four institutional funds. In the
financing, we received $3,000,000 gross proceeds in cash pursuant to the
issuance of senior secured convertible notes to the funds. We are using the
proceeds from this financing to support our CodecSys research and development
and for general working capital purposes. The senior secured convertible
notes are due May 16, 2008 and bear interest at 6% per annum. Interest-only
payments are due semi-annually with the first payment of $90,000 due November
16, 2005. The notes are convertible into 1,200,000 shares of our common stock
at $2.50 per share, convertible any time during the term of the notes.
In connection with the financing, the funds received A Warrants to
acquire 600,000 shares of our common stock exercisable at $2.50 per share and
B Warrants to acquire 600,000 shares of our common stock at $4.00 per share.
The warrants are exercisable any time for a five-year period beginning on the
date of grant. The funds also received additional investment rights to make an
additional loan of $3,000,000 on the same terms as the senior secured
convertible notes and receive additional A Warrants and B Warrants with the
same terms as the warrants already received by the funds. The additional
investment rights must be exercised within 90 days following the date the
Company's registration statement on Form SB-2 filed with the SEC is declared
effective. In the event the funds exercise their additional investment rights
and exercise all of their warrants, we would receive approximately up to
$10,800,000 in additional financing. We paid approximately $345,000 in cash
for commissions, finders fees and expenses in securing this financing,
$240,000 of which is included in prepaid expenses as of June 30, 2005 and will
be amortized over the term of the notes.
The $2.50 conversion price of the senior secured convertible notes
and the $2.50 and $4.00 exercise price of the A Warrants and the B Warrants,
respectively, are subject to adjustment pursuant to standard anti-dilution
rights. These adjustment rights include (i) equitable adjustments in the event
we effect a stock split, dividend, combination, reclassification or similar
transaction; (ii) "weighted average" price protection adjustments in the event
we issue new shares of common stock or common stock equivalents in certain
transactions at a price less than the then current market price of our common
stock; and (iii) "full ratchet" price protection adjustments in the event we
issue new shares of common stock or common stock equivalents in certain
transactions at a price less than $2.50 per share.
The conversion price of the notes and the exercise price of the
warrants are also subject to adjustment pursuant to a "reset" provision which
is effective as of February 16, 2006. If the moving average closing price of
our common stock for the 30 days prior to such date is lower than the
applicable conversion price of the notes or the exercise price of the
warrants, then the applicable conversion price and/or exercise price will be
adjusted to the lower moving average closing price. In no event, however,
will the conversion price or exercise price be adjusted below $0.50 per share
for the reset provision.
The securities purchase agreement contains, among other things,
covenants that may restrict our ability to finance future operations, 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 notes, in which event holders of
the notes 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 securities purchase agreement provides that we cannot do any
of the following without the prior written consent of the holders of at least
85% of the principal amount of the outstanding senior secured convertible
notes:
20
.. issue debt securities or incur, assume, suffer to exist, guarantee or
otherwise become or remain, directly or indirectly, liable with respect to
certain indebtedness;
.. except for those created under the securities purchase agreement, create,
incur, assume or suffer to exist, directly or indirectly, any liens,
restrictions, security interests, claims, rights of another or other
encumbrances on or with respect to any of our assets, of any kind, whether
now owned or hereafter acquired, or any income or profits therefrom;
.. complete a private equity or equity-linked financing prior to the first
anniversary of the closing date;
.. 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;
.. cause, permit or suffer, directly or indirectly, any change in control
transaction as defined in the senior secured convertible notes;
.. directly or indirectly enter into or permit to exist any transaction with
any of our affiliates or any of our subsidiaries, if any, except for
transactions that are in the ordinary course of our business, upon fair and
reasonable terms, that are fully approved by our Board of Directors, and
that are no less favorable to us than would be obtained in an arm's length
transaction with a non-affiliate;
.. declare or pay a dividend or return any equity capital to any holder of any
of our equity interests or authorize or make any other distribution to any
holder of our equity interests in such holder's capacity as such, or
redeem, retire, purchase or otherwise acquire, directly or indirectly, for
consideration any of our equity interests outstanding (or any options or
warrants issued to acquire any of our equity interests); provided that the
foregoing shall not prohibit (i) the performance by us of our obligations
under the warrants related to the senior secured convertible notes or the
registration rights agreement entered into in connection with the
securities purchase agreement, or (ii) us and any of our subsidiaries, if
any, from paying dividends in common stock issued by us or such subsidiary
that is neither putable by any holder thereof nor redeemable, so long as,
in the case of any such common stock dividend made by any such subsidiary,
the percentage ownership (direct or indirect) of us in such subsidiary is
not reduced as a result thereof; or
.. directly or indirectly, lend money or credit (by way of guarantee or
otherwise) or make advances to any person, or purchase or acquire any
stock, bonds, notes, debentures or other obligations or securities of, or
any other interest in, or make any capital contribution to, any other
person, or purchase or own a future contract or otherwise become liable for
the purchase or sale of currency or other commodities at a future date in
the nature of a futures contract, with very limited exceptions.
21
Under the securities purchase agreement, holders of the senior
secured convertible notes were granted preemptive rights, subject to standard
exceptions, with respect to new issuances of our common stock and securities
convertible into shares of our common stock. The preemptive rights continue
until May 16, 2006 and may further restrict our ability to obtain additional
capital.
During the quarter ended June 30, 2005, we secured a new customer
contract which we believe will result in an increase in revenues, although
there is no assurance this will happen. We are in the process of training our
existing installation technicians on the new equipment and procedures required
by the new customer. We anticipate that our negative cash flow will diminish
as the new customer makes projects and equipment available and as we are able
to perform under the contract.
Our monthly operating expenses currently exceed our monthly net sales
by approximately $200,000 per month. This amount could increase
significantly. Given our current level of CodecSys development activity, 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 the new customer contract
described above, and (iii) sales related to commercial applications of our
CodecSys technology. We anticipate executing on our business model to realize
the additional revenue needed to address our liquidity and cash flow position.
If we are successful in our execution efforts, we do not anticipate requiring
additional capital in the next fiscal year. To the extent we are unable to
generate additional revenue from these sources, however, we will need to
obtain an infusion of capital in 2006, of which there can be no assurance.
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 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 funds available to us. The
availability of funding will also determine, in large measure, the timing and
introduction of new product applications in the marketplace. Capital required
for CodecSys is expected to come from internally generated cash flow from
operations or from external financing.
To date, we have met our working capital needs through funds received
from sales of our common stock, borrowings under a convertible line of credit
and the senior secured convertible note financing described above. There can
be no assurance that the institutional funds will exercise their additional
investment rights or exercise their outstanding warrants, which would provide
additional investment capital for us. Until our operations become profitable,
we must continue to sell equity or find another source of operating capital.
We have entered into an engagement agreement dated October 11, 2005
with First Securities ASA, a leading Norwegian investment banking firm, to
provide investment banking services regarding a potential initial public
offering of our common stock on the Oslo Stock Exchange. The agreement
contemplates, among other things, that we will raise between $10 and $25
million by the end of the first quarter of 2006, subject to development of our
revenues and profitability, market conditions in general, acceptance for
listing by the Oslo Stock Exchange and the interest for our shares in the
capital markets. The agreement is also
22
subject to normal and customary legal and financial due diligence. Except for
agreements currently in force with other parties, First Securities will have
the exclusive right to provide equity capital and perform certain other
investment banking functions with regard to mergers and acquisitions during
the term of the agreement and for a six month period following termination of
the agreement. The agreement required that we pay First Securities a
non-refundable retainer fee of $200,000. Given the numerous conditions and
uncertainties related to the proposed initial public offering on the Oslo
Stock Exchange, there can be no assurance we will be able to complete such
offering.
Recent Accounting Pronouncements
See Note I above for recent accounting pronouncements.
23
Item 3. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures as defined in Rule
13a-15(e) of the Securities Exchange Act of 1934, as amended (the "Exchange
Act"). Our disclosure controls and procedures include controls and procedures
designed to ensure that information required to be disclosed in our reports
filed or submitted under the Exchange Act is accumulated and communicated to
our management, including our Chief Executive Officer and Chief Financial
Officer, as appropriate to allow timely decisions regarding required
disclosures.
As required by Rule 13a-15(b) of the Exchange Act, we conducted an
evaluation, under the supervision of our Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the design and operation of our
disclosure controls and procedures as of June 30, 2005. Based on this
evaluation, our Chief Executive Officer and Chief Financial Officer concluded
that our disclosure controls and procedures were not effective as of June 30,
2005 in alerting them in a timely manner to material information required to
be included in our reports filed under the Exchange Act. This evaluation
identified a material weakness in our disclosure controls and procedures with
respect to applying existing accounting pronouncements related to derivative
securities and required accounting entries. Management is taking steps to
implement appropriate corrective action in this regard.
For the six months ended June 30, 2005, management of the Company,
under the supervision and with the participation of our Chief Executive
Officer and Chief Financial Officer, implemented corrective action with
respect to a significant deficiency previously identified regarding beneficial
conversion features and associated accounting entries. This action included
changes to the way we process and evaluate instruments with a beneficial
conversion feature, including development of internal resources required to
complete the necessary accounting analysis.
Other than the items described above, there has been no change in our
internal control over financial reporting during the period ended June 30,
2005 that has materially affected, or is reasonably likely to materially
affect, our internal control over financial reporting.
Important Considerations
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, there can
be no assurance that any system of disclosure controls and procedures or
internal control over financial reporting will 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.
24
Part II - Other Information
Item 1. Legal Proceedings
None.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
On May 16, 2005, the Company issued 100,000 shares of common stock to
two affiliates of the placement agent as commissions for securing the Senior
Secured Convertible Notes described above.
On June 1, 2005, the Company issued 67,000 shares of common stock for
services to two individuals.
In each of the forgoing transactions, the Company relied on the
exemption from registration under the 1933 Act set forth in Section 4(2)
thereof.
See Part I "Management's Discussion and Analysis or Plan of
Operation-Liquidity and Capital Resources" for a discussion of working capital
restrictions and other limitations on the payment of dividends.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to Vote of Security Holders.
None.
Item 5. Other Information
None.
Item 6. Exhibits.
Exhibit No.
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-QSB for the quarter ended June
30, 2005 filed with the SEC on August 12, 2005.)
3.2 Bylaws of Broadcast International. (Incorporated by reference to
Exhibit No. 3.2 of the Company's Quarterly Report on Form 10-QSB for
the quarter ended June 30, 2005 filed with the SEC on August 12,
2005.)
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, pre-effective
Amendment No.3 filed with the SEC on October 11, 2005)
25
4.2 Form of 6.0% Senior Secured Convertible Note dated May 16, 2005
executed by Broadcast International in favor of Gryphon Master Fund,
L.P., GSSF Master Fund, LP, Bushido Capital Master Fund, LP and Gamma
Opportunity Capital Partners, LP (the "Institutional Funds").
(Incorporated by reference to Exhibit No. 4.2 of the Company's
Registration Statement on Form SB-2, pre-effective Amendment No.3
filed with the SEC on October 11, 2005)
4.3 Form of A Warrant issued by Broadcast International to each of the
Institutional Funds. (Incorporated by reference to Exhibit No. 4.3 of
the Company's Registration Statement on Form SB-2, pre-effective
Amendment No.3 filed with the SEC on October 11, 2005)
4.4 Form of B Warrant issued by Broadcast International to each of the
Institutional Funds(Incorporated by reference to Exhibit No. 4.4 of
the Company's Registration Statement on Form SB-2, 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 Randy Turner dated April 28, 2004.
(Incorporated by reference to Exhibit No. 10.2 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.)
10.3 Employment Agreement of Reed L. Benson dated April 28, 2004.
(Incorporated by reference to Exhibit No. 10.3 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.)
10.4 Broadcast International Long-Term Incentive Plan. (Incorporated by
reference to Exhibit No. 10.4 of the Company's Annual Report of Form
10-KSB for the year ended December 31, 2003 filed with the SEC on
March 30, 2004.)
10.5 Securities Purchase Agreement dated May 16, 2005 among Broadcast
International and the Institutional Funds. (Incorporated by reference
to Exhibit No. 10.5 of the Company's Registration Statement on Form
SB-2, pre-effective Amendment No.3 filed with the SEC on October 11,
2005)
10.6 Security Agreement dated May 16, 2005 between Broadcast International
and Gryphon Master Fund, L.P., as collateral agent for the
Institutional Funds. (Incorporated by reference to Exhibit No. 10.6
of the Company's Registration Statement on Form SB-2, pre-effective
Amendment No.3 filed with the SEC on October 11, 2005)
26
10.7 Registration Rights Agreement dated May 16, 2005 among Broadcast
International and the Institutional Funds. (Incorporated by reference
to Exhibit No. 10.7 of the Company's Registration Statement on Form
SB-2, pre-effective Amendment No.3 filed with the SEC on October 11,
2005)
10.8 Form of Additional Investment Rights dated May 16, 2005 issued by
Broadcast International to each of the Institutional Funds.
(Incorporated by reference to Exhibit No. 10.8 of the Company's
Registration Statement on Form SB-2, pre-effective Amendment No.3
filed with the SEC on October 11, 2005)
10.9 Stock Purchase and Option Grant Agreement dated February 6, 2004
among Broadcast International and certain principals and shareholders
of Streamware Solutions AB. (Incorporated by reference to Exhibit No.
10.9 of the Company's Registration Statement on Form SB-2,
pre-effective Amendment No.3 filed with the SEC on October 11, 2005)
10.10 Stock Issuance, Stock Transfer and Option Grant Agreement dated
effective as of February 26, 2004 among Broadcast International and
certain principals and shareholders of Streamware Solutions AB.
(Incorporated by reference to Exhibit No. 10.10 of the Company's
Registration Statement on Form SB-2, pre-effective Amendment No.3
filed with the SEC on October 11, 2005)
10.11 Amended and Restated Convertible Line of Credit dated June 30, 2004
among Broadcast International, Meridel, Ltd. and Pascoe Holdings,
Ltd. (Incorporated by reference to Exhibit No. 10.11 of the Company's
Registration Statement on Form SB-2, pre-effective Amendment No.3
filed with the SEC on October 11, 2005)
10.12 Engagement Agreement dated October 11, 2005 between Broadcast
International, Inc. and First Securities ASA. (Incorporated by
reference to Exhibit No. 10.1 of the Company's Current Report on Form
8-K filed with the SEC on October 17, 2005.). (Incorporated by
reference to Exhibit No. 10.12 of the Company's Registration
Statement on Form SB-2, pre-effective Amendment No.3 filed with the
SEC on October 11, 2005)
31.1 Certification of Chief Executive Officer pursuant to Rule 13a -14(a)
of the Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
27
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
28
SIGNATURES
In accordance with the requirements of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
Broadcast International, Inc.
Date: November 21, 2005 /s/ Rodney M. Tiede
-------------------------------------------
By: Rodney M. Tiede
Its: President and Chief Executive Officer
(Principal Executive Officer)
Date: November 21, 2005 /s/ Randy Turner
-------------------------------------------
By: Randy Turner
Its: Chief Financial Officer (Principal
Financial and Accounting Officer)
29