Document/Exhibit Description Pages Size
1: 10KSB Annual Report on Form 10-Ksb for the Year Ended 68 312K
December 31, 2005
2: EX-31.1 Section 302 Certification -CEO 2± 9K
3: EX-31.2 Section 302 Certification - CFO 2± 9K
4: EX-32.1 Section 906 Certification - CEO 1 7K
5: EX-32.2 Section 906 Certification - CFO 1 6K
10KSB — Annual Report on Form 10-Ksb for the Year Ended December 31, 2005
Document Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-KSB
[X] Annual Report Under Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the fiscal year ended December 31, 2005
[ ] Transition Report Under Section 13 or 15(d) of the Securities
Exchange Act of 1934.
For the transition period from ________ to __________.
Commission File Number: 0-13316
BROADCAST INTERNATIONAL, INC.
----------------------------------------------
(Name of Small Business Issuer in its Charter)
Utah 87-0395567
------------------------------ ------------------
(State or other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
7050 Union Park Avenue Suite 600, Salt Lake City, UT 84047
----------------------------------------------------------
(Address of Principal Executive Offices) (Zip Code)
Issuer's Telephone Number, including Area Code: (801) 562-2252
Securities Registered Under Section 12(b) of the Exchange Act: None.
Securities Registered Under Section 12(g) of the Exchange Act: Common Stock,
Par Value $0.05
Check whether the Issuer is not required to file reports pursuant to Section
13 or 15 (d) of the Exchange Act . Yes [ ] No [X]
Check whether the Issuer (1) filed all reports required to be filed by Section
13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter
period that the Issuer was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Check if there is no disclosure of delinquent filers in response to Item 405
of Regulation S-B contained in this form, and no disclosure will be
contained, to the best of Issuer's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-KSB or any amendment to this Form 10-KSB. [X]
Indicate by check mark whether the Issuer is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
State Issuer's revenues for its most recent fiscal year. $5,380,869.
The aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the average bid and asked prices of
such stock, as of March 2, 2006, was $33,272,129.
As of March 15, 2006, the Issuer had outstanding 23,632,818 shares of its
common stock.
Transitional Small Business Disclosure Format: Yes [ ] No [X]
1
TABLE OF CONTENTS
ITEM NUMBER AND CAPTION
PART I Page No.
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Item 1. Description of Business..........................................1
Item 2. Description of Property.........................................14
Item 3. Legal Proceedings...............................................14
Item 4. Submission of Matters to a Vote of Security Holders.............14
PART II
-------
Item 5. Market for Common Equity, Related Stockholder Matters
and Small Business Issuer Purchases of Equity Securities........15
Item 6. Management's Discussion and Analysis or Plan of Operation.......18
Item 7. Financial Statements.......................................27, F-1
Item 8. Changes In and Disagreements with Accountants on
Accounting and Financial Disclosure.............................27
Item 8A. Controls and Procedures.........................................27
Item 8B. Other Information...............................................28
PART III
--------
Item 9. Directors, Executive Officers, Promoters and Control Persons;
Compliance with Section 16(a) of the Exchange Act...............29
Item 10. Executive Compensation..........................................31
Item 11. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters......................35
Item 12. Certain Relationships and Related Transactions..................36
Item 13. Exhibits........................................................36
Item 14. Principal Accountant Fees and Services..........................39
Signatures...............................................................40
PART I
ITEM 1. DESCRIPTION OF BUSINESS
Background
We were organized as a Utah corporation under the name "Laser
Corporation" on January 12, 1983. Laser Corporation completed a public
offering and registered its class of common stock under Section 12(g) of the
Securities Exchange Act of 1934, as amended. In July 2003, Laser Corporation
discontinued its laser equipment business and ceased active operations.
On October 1, 2003, Laser Corporation completed the acquisition of BI
Acquisitions, Inc., or BI, pursuant to a stock exchange agreement among Laser
Corporation, BI and the shareholders of BI. Under the stock exchange
agreement, Laser Corporation issued shares of its common stock to the
shareholders of BI in exchange for all of the issued and outstanding shares of
BI. As a result of the transaction, (i) the BI shareholders acquired, in the
aggregate, 98% of the equity ownership of Laser Corporation, (ii) BI became a
wholly-owned subsidiary of Laser Corporation, and (iii) Laser Corporation
recommenced active operations by continuing BI's business of managing private
satellite communication networks and providing video and audio production
services. For accounting purposes, the transaction was treated as a reverse
acquisition of Laser Corporation by BI.
On January 13, 2004, pursuant to the stock exchange agreement, the name
of our corporation was changed from Laser Corporation to "Broadcast
International, Inc." and a 10:1 reverse stock split of our common stock was
effected. References used herein to "we," "our," "us" and "Broadcast
International" refer to Broadcast International, Inc. and our consolidated
subsidiaries.
On May 18, 2004, we acquired a majority ownership interest in Interact
Devices, Inc. ("IDI") pursuant to the confirmation of IDI's plan of
reorganization under the federal bankruptcy laws. Prior to the plan of
reorganization, we had assumed operating control of IDI and its business of
developing and commercializing the CodecSys technology. Under the plan of
reorganization, we agreed to issue shares of our common stock and pay cash to
creditors of IDI in exchange for shares of the common stock of IDI
representing majority ownership of IDI. Since confirmation of the plan of
reorganization, the operations of IDI have been consolidated with those of
Broadcast International.
Prior to the IDI plan of reorganization, Broadcast International and IDI
entered into various transactions with Streamware Solutions AB, a licensee of
the CodecSys technology. These transactions were effected in February 2004 in
order to clarify IDI's rights to such technology and limit Streamware's
license. Pursuant to the transactions with Streamware, we issued shares of
our common stock and stock options to certain Streamware principals and
shareholders.
Following the IDI plan of reorganization, we entered into settlement
agreements with the IDI co-founders and certain entities affiliated with the
co-founders. These agreements were effected in September 2004 in order to
consolidate the ownership and control of the CodecSys technology, to settle
outstanding disputes and to satisfy certain obligations of the parties
reflected in the plan of reorganization. Pursuant to the settlement
agreements, we cancelled a prior agreement with the co-founders, terminated
various obligations to the affiliates of the co-founders, and issued stock
options and made a cash payment to the IDI co-founders. In return, the
co-founders surrendered their stock in IDI for cancellation.
1
The plan of reorganization and consolidation of IDI, including the
related transactions with Streamware and the settlement agreement with the
co-founders of IDI, as summarized above, were material transactions affecting
Broadcast International in 2004. Each of these transactions is more fully
described in Note 5 of the Notes to Consolidated Financial Statements included
elsewhere in this report.
Overview
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 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 specific needs and applications
of our clients. All of the communication networks we are involved with
utilize industry standard products and equipment sold by other companies. We
sell a limited number of proprietary network products in connection with the
services we provide. We also offer audio and video production services for
our clients.
Services
Following are some of the ways in which businesses utilize our services.
Internal Business Applications
. Deliver briefings from the CEO or other management
. Launch new products or services
. Present new marketing campaigns
. Train employees
. Announce significant changes or implement new policies and
procedures
. Respond to crisis situations
External Business Applications
. Make promotional presentations to prospective customers or
recruits
. Provide product/service training to customers
. Train and communicate with sales agents, dealers, VARs,
franchisees, association members, etc.
. Sponsor satellite media tours
. Provide video/audio news releases
Satellite-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.
2
. Network design and engineering
. Receiving equipment and installation
. Network management
. 24/7 help desk services
. On-site maintenance and service
. Full-time or occasional transponder purchases (broadcast time)
. Uplink facilities or remote SNG uplink trucks
Streamed Video Hosting Services
Until the last few years, satellite was the only technology that could
deliver quality point to multi point video for business applications. Now,
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 a
major 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:
. Dedicated server space
. High-speed, redundant Internet connection
. Secure access
. Seamless links from client's website
. Customized link pages and media viewers
. Testing or self-checks
. Interactive discussion threads
. Participation/performance reports for managers/administrators
. Notification of participants via email
. Pay-per-view or other e-commerce applications
. Live events
. 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:
. In-studio or on-location video/audio production
3
. Editing/post-production
. Instructional design
. Video/audio encoding for Internet delivery
. Conversion of text or PowerPoint to HTML
. Alternative language conversion
. 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 one-time revenues from the sale and installation of satellite
receivers and antennas and 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. For delivery of content, we generally charge a fee every time a
person listens to or watches a streamed audio or video presentation.
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
2005, approximately 92% was derived from satellite based services and
approximately 8% was derived from product and content development servicesand
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. In September 2005, we
contracted with an independent master distributor to sell our recently
introduced video conferencing product. The master distributor is expected to
resell our product through a network of independent dealers throughout the
country.
4
CodecSys Technology
We own proprietary video compression technology that we call "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. Today, video compression is accomplished by using a single
technique or computer formula to create a particular data stream. Our
CodecSys technology uses multiple techniques or computer formulas 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 designed 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 and MPEG4. 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 that 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 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 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 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.
New Products and Services
We believe our CodecSys technology will offer significant efficiencies
and cost savings associated with video content transmission and storage. In
August 2005, we commenced marketing and selling the first application of our
CodecSys technology in a video conferencing product. We are still developing
and improving the CodecSys technology for a variety of other applications,
including Internet streaming, satellite encoding and transmitting video
content to cellular phones and other hand-held electronic devices. We believe
these applications may hold substantial licensing and other revenue
opportunities for our business. Commercialization and future applications of
the CodecSys technology are expected to require additional capital estimated
to be approximately $2.0 million annually. This estimate will increase or
decrease depending on funds available to us.
Following are examples with brief descriptions of various applications
of the CodecSys technology that have been identified by management.
Video Conferencing Product
Our first product utilizing the CodecSys technology is an Internet-based
video conferencing product. This product provides point-to-point and
multi-party video conferencing at significantly reduced bandwidth and
accompanying costs with video quality equal to or better than other
commercially available equipment. Because of the benefits associated with
this product, we believe there are revenue opportunities to sell this product
to enterprise customers desiring a competitively priced video conference
product that utilizes existing Internet connections.
5
Internet Streaming
Using CodecSys, customers are expected to be able to customize and
optimize different streams, platforms and channels, including broadband,
dial-up connections, landline, satellite and wireless. Commercial quality
video and stereo audio at low bandwidths is anticipated to provide a
compelling competitive advantage in applications such as video-on-demand,
distance learning and remote monitoring. We anticipate realizing licensing
fees and revenue from vendors of video-on-demand, distance learning and remote
monitoring products and services who desire to reduce their distribution costs
associated with such products and services while maintaining or improving the
quality of their transmissions.
Satellite Encoding
We are currently developing a satellite encoder product that utilize the
CodecSys technology. We expect to use the product in connection with
satellite transmissions over our private communication networks, thereby
providing customers with reduced satellite transmission time and corresponding
cost savings. We plan to generate additional revenue by selling our private
communication network satellite services to enterprise clients who are
particularly cost-sensitive to such services. We may also sell the satellite
encoder product to other satellite transmission vendors and service providers
who desire to reduce satellite transmission time and resulting costs.
Transmitting video content to cellular phones and other hand-held
electronic devices
Video content that is currently being transmitted to cellular phones,
PDAs and other hand-held electronic devices is currently limited by bandwidth
and quality constraints. We believe that our CodecSys technology will
mitigate some of these constraints and offer higher quality transmissions with
lower bandwidth requirements, thereby allowing enhanced video content,
including full motion music videos, advertisements, sporting highlights and
movie trailers. We intend to generate additional revenue by licensing our
technology to video content providers in these applications.
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. For the year ended December 31,
2005, we recorded research and development in process expenses of
approximately $383,000. Our ability to support future research and development
activities will depend on our ability to generate and/or obtain adequate
funding. Assuming such funding is obtained, management estimates we will
incur approximately $2.0 million annually in research and development expenses
as we pursue commercialization applications for our technology as described
above. This estimate will increase or decrease depending on funds available
to us. See "Management's Discussion and Analysis or Plan of Operation
Liquidity and Capital Resources."
6
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. We have filed for patent protection in the United States
and various foreign countries. As of March 15,2006, we had two issued patents
and 21 pending patent applications, of which five were U.S. applications and
16 were foreign counterpart applications.
We have identified additional applications of the technology, which
represent potential patents that further define the product specific
applications of the processes that are covered by the original patents. We
intend to continue building our intellectual property portfolio as funding
permits.
We have registered the "CodecSys" trademark with the U.S. Patent and
Trademark Office, and seek to protect our know-how, trade secrets and other
intellectual property through a variety of means, including confidentiality
agreements with our employees and customers.
Major Customers
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. In 2005, our three largest customers accounted for
approximately 62% of revenues. Our contracts with these customers expire in
December 2006, June 2007 and March 2008, with each contract subject to renewal
or extension. We have been increasing the amount of work done for one of our
three largest customers. We believe we will do more work for that customer in
2006 than in the past, which will extend our dependence on that customer.
Competition
The communications industry is extremely competitive. 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. With respect to
video conferencing, we compete with Sony, Polycom, Tandberg 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, that 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, 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.
7
Employees
We employ 44 full-time personnel at our executive offices and studio
facilities in Salt Lake City, Utah, three employees at the Staples, Inc.
studios in Framingham, Massachusetts, and three employees in Folsom,
California at IDI. In addition, we engage voice talent on an "as needed"
basis at our recording studios and employ the services of independent sales
representatives.
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.
Risk Factors
Readers should carefully consider the following in evaluating our
business and our securities. Investing in our securities involves a high
degree of risk. Any of the following risks could materially harm our business
and could result in a loss of your investment.
If we do not successfully commercialize our CodecSys technology, we may
never achieve profitability or be able to raise future capital.
It is imperative that we complete development of our CodecSys technology
and commence sales of products or licensing of the technology to other
parties. 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. This estimate will increase or decrease depending on
funds available to us. If we are unsuccessful in our CodecSys development and
commercialization efforts, it is highly doubtful we will achieve profitable
operations or be able to raise additional funding in the future.
There is substantial doubt about our ability to continue as a "going concern."
The accompanying consolidated financial statements have been prepared
on a going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. The Company has
incurred losses and has not demonstrated the ability to generate sufficient
cash flows from operations to satisfy their liabilities and sustain
operations. These factors raise substantial doubt about the Company's ability
to continue as a going concern.
The Company's continuation as a going concern is dependent on its
ability to generate sufficient income and cash flow to meet its obligations on
a timely basis and to obtain additional financing as may be required. The
Company is actively seeking options to obtain additional capital and
financing. There is no assurance the Company will be successful in its
efforts.
8
We need additional capital. If additional capital is not available, we may
have to curtail or cease operations, and we will be in default under our
senior secured convertible notes.
In order to continue our operations, we need additional funding. Our
monthly operating expenses currently exceed our monthly net sales by
approximately $250,000 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. We have no source of working capital except our
current operations and the prospect of obtaining new equity or debt financing.
We must continue to sell equity or find another source of operating capital
until our operations are profitable. If we do not raise sufficient additional
capital, we will be required to pursue one or a combination of the following
remedies: significantly reduce operating expenses, sell part or all of our
assets, or terminate operations.
Section 4(a)(xi) of the senior secured convertible notes specifies that
it is an event of default if we do not raise at least $3,000,000 by September
30, 2006. The remedies for default provide that if an event of default occurs
and is continuing, the holders may declare all of the then outstanding
principal amount of the notes and any accrued and unpaid interest thereon to
be immediately due and payable in cash. In the event of an acceleration, the
amount due and owing to the holders is 125% of the outstanding principal
amount of the notes and interest on such amount is calculated using the
default rate of 18% per annum if the full amount is not paid within one
business day after acceleration. An event of acceleration may require us to
seek bankruptcy protection or liquidation.
We have a limited operating history with our current business and have
sustained and may continue to sustain substantial losses.
Although we have been in existence for many years, our current business
has only been ongoing for six years. We have sustained operating losses in
each of the last four years. Through December 31, 2005, our accumulated
deficit was approximately $26,088,100. We may continue to sustain losses on a
quarterly and annual basis.
Covenant restrictions under our senior secured convertible notes may limit our
ability to operate our business.
Our senior secured convertible notes contain, 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. For
example, the notes contain anti-dilution provisions, and we may not pay any
dividends unless we obtain the prior written consent of the holders of at
least 85% of the principal amount of the outstanding notes. A breach of any
of the covenants contained in the senior secured 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.
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
9
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 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 experienced a significant deficiency and a material weakness in our
required disclosure controls and procedures regarding our accounting entries
and financial statements. As a result of these factors, we were required to
restate certain accounting periods in 2005. Any future deficiency, weakness,
malfunction or inadequacy related to internal operational or financial control
systems could produce inaccurate and unreliable information that may harm our
business.
We may be unable to respond adequately to rapid changes in technology
The market for private communication networks is 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 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. With respect to video conferencing, we compete with
Sony, Polycom, Tandberg and others. 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, that 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, 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.
10
If we fail to hire additional specialized personnel or retain our key
personnel in the future, we will not have the ability to successfully develop
our technology or manage our business.
We need to hire additional specialized personnel to successfully develop
and commercialize our CodecSys technology. If we are unable to hire or retain
qualified software engineers and project managers, our ability to complete
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.
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. In 2005, our three largest customers accounted for
approximately 62% of revenues and we expect that percentage to increase for
the coming year. Our contracts with these customers expire in December 2006,
June 2007, and March 2008 with each contract subject to renewal or extension.
Our largest customers may not continue to purchase our services and may
decrease their level of purchases. To the extent that a significant customer
reduces its reliance on us or terminates its relationship with us, revenues
would decline substantially, which would harm our business.
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. As of March
15,2006, we had two issued patents and 21 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.
11
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 there under
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 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.
12
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 March 15, 2006, we had 23,632,818 shares of common stock
outstanding. As of March 15, 2006, stock options, including options granted
to our employees, and warrants to purchase an aggregate of 5,485,237 shares of
our common stock were issued and outstanding, a substantial portion of which
were fully exercisable. As of March 15, 2006 , notes convertible into
2,000,000 shares of our common stock were issued and outstanding. 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.
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.
If you purchase shares of common stock, your ownership interest may be
substantially diluted by future issuances of securities.
We may issue additional shares of our common stock if we raise
additional equity or convertible debt financing. We may also issue additional
shares of our common stock to holders of outstanding convertible notes, stock
options and warrants. Moreover, if our institutional fund investors exercise
their additional investment rights, we will issue additional senior secured
convertible notes 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
2,651,000 shares of common stock available for future issuance under our
long-term incentive stock option plan. To the extent that additional
investment rights are exercised and/or future stock options are granted and
ultimately exercised, there will be further dilution to shareholders,
including investors in this offering.
We have never paid dividends and do not anticipate paying any dividends on our
common stock in the future, so any return on your investment will depend on
the market price of our common stock.
We currently intend to retain any future earnings to finance our
operations. The terms and conditions of our senior secured convertible notes
restrict and limit payment or distributions in respect of our common stock.
Any return or an investment in our common stock will depend on the future
market price of our common stock and not on any potential dividends.
13
ITEM 2. DESCRIPTION OF PROPERTY
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 an
18-month lease, the term of which ends October 31, 2007. The lease covers
approximately 13,880 square feet of office space leased at a rate of $24,108
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 multi-year contract at a rate of $8,797 per month.
The studio lease expires on November 30, 2008. We have also entered into a
cancelable lease for 1,630 square feet of office space located at 160 Blue
Ravine, in Folsom, California 95630.This space has been used for the
development of our CodecSys technology. This lease is for a one-year term and
expires on December 31, 2006, and is leased at a rate of $2,600 per month. To
the extent we continue the development program in California, we do not
anticipate any problem with locating suitable space. The Company has no other
properties.
ITEM 3. LEGAL PROCEEDINGS
There are no legal proceedings pending against us, and, to the knowledge of
management, no material litigation has been threatened.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
14
PART II
ITEM 5. MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
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:
Calendar Quarters High Bid Low Bid
----------------- --------- -------
Fiscal 2005
First Quarter $ 4.30 $ 3.25
Second Quarter 4.29 2.65
Third Quarter 4.30 3.00
Fourth Quarter 3.30 1.50
Fiscal 2004
First Quarter $ 5.95 $ 3.00
Second Quarter 6.30 5.75
Third Quarter 6.25 3.20
Fourth Quarter 6.15 2.20
As of March 15, 2006, we had 23,632,818 shares of our common stock
issued and outstanding, and there were approximately 1,300 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 senior secured convertible notes contain restrictive covenants
that prohibit us to declare or pay dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth, as of December 31, 2005, information
regarding our compensation plans under which shares of our common stock are
authorized for issuance.
Number of
securities
remaining
available for
future issuance
under equity
Number of securities Weighted-average compensation
to be issued upon exercise price of plans
exercise of out- outstanding (excluding
standing options, options, warrants outstanding
warrants and rights and rights securities)
---------------- ---------------------- ------------------- ---------------
Equity
compensation
plans by
approved
security holders 0 0 0
----------------------------------------------------------------------------
Equity
compensation
plans not
approved by
security
holders (1) 3,370,197 $1.13 2,400,343
----------------------------------------------------------------------------
Total 3,370,197 $1.13 2,400,343
----------------------------------------------------------------------------
15
(1) The Broadcast International, Inc. 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, 2005, options to purchase 229,460 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. Awards may be vested on such schedules determined by the
Board of Directors. Other than the long-term incentive plan, we do
not maintain any other equity compensation plan.
Recent Sales of Unregistered Securities
The following sets forth all securities issued by us during 2005 without
registration under the Securities Act. No underwriters were involved in any
of the stock issuances and, unless otherwise noted, no commissions were paid
in connection therewith. In each of the following transactions, we relied on
the exemption from registration under the Securities Act set forth in Section
4(2) thereof, except as indicated otherwise.
At various times from November 2004 to January 2005, we issued a total
of 41,666 shares of our common stock to two investors in exchange for an
aggregate consideration of $125,000. The investors were also issued warrants
to purchase 41,666 shares of our common stock at a purchase price of $3.50 per
share. These transactions were part of a private offering of up to 2,000,000
shares of our common stock at offering prices ranging from $3.00 to $4.50 per
share solely to accredited investors. Both investors in the transactions were
accredited investors and were fully informed regarding their 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.
On May 16, 2005, we issued senior secured convertible notes in the
principal amount of $3,000,000 to four institutional funds. The senior
secured convertible notes are convertible into shares of our common stock at
$2.50 per share. We also issued to the institutional funds warrants to
purchase a total of 600,000 shares of our common stock at $2.50 per share, and
warrants to purchase a total of 600,000 shares of our common stock at $4.00
per share. In connection with the foregoing transactions, we (i) issued
additional investment rights to these institutional funds to invest up to an
additional $3,000,000 on the same terms as the senior secured convertible
notes and warrants issued on May 16, 2005; (ii) paid an 8% commission of
$240,000 to Stonegate Securities, Inc., a registered broker-dealer who acted
as our placement agent with respect to the funding obtained from the
institutional funds; (iii) paid an additional commission to two affiliates of
Stonegate in the form of a total of 100,000 shares of our common stock (valued
at the then prevailing fair market price of the common stock ($3.51)
multiplied by the 100,000 shares issued) and warrants to purchase a total of
120,000 shares of our common stock at an exercise price of $2.50 per share;
and (iii) paid a 2% finder's fee of $60,000 to the party who introduced us to
Stonegate. In each of these transactions, we relied on the exemption from
registration under the Securities Act set forth in Section 4(2) pursuant to
Rule 506 of Regulation D and Section 4(6). On March 16, 2006 we entered into a
Waiver and Amendment Agreement with the institutional funds, which among other
things, adjusted the conversion rate of the senior secured notes from $2.50 to
$1.50 per share and the exercise of both the 600,000 warrants at $2.50 and the
600,000 warrants at $4.00 to $2.00 per share. The $1.50 conversion price of
the senior secured convertible notes and the $2.00 exercise price of the
warrants 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 $1.50 per share.
16
On June 1, 2005, we issued a total of 67,000 shares of our common stock
to two individuals as compensation for investor and public relations
consulting services performed for us. We valued the services received based
upon the then prevailing fair market price of the common stock ($3.51)
multiplied by the number of shares issued (67,000). The individuals were
accredited investors and were fully informed regarding their investment. In
the transaction, we relied on the exemptions from registration under the
Securities Act set forth in Section 4(2) and Section 4(6) thereof.
On August 3, 2005, the two affiliates of Stonegate described above
exercised their warrants in full on a net issuance basis pursuant to which we
issued a total of 47,272 shares of our common stock to them. Both affiliates
were accredited investors and were fully informed regarding their investment.
In the transaction, we relied on the exemptions from registration under the
Securities Act set forth in Section 4(2) and Section 4(6) thereof.
On August 29, 2005, we issued 40,000 shares of our common stock to one
entity in exchange for technology research, potential licensing and related
services performed for us. We valued the services received based upon the
then prevailing fair market price of the common stock ($3.65) multiplied by
the total number of shares issued (40,000). The entity was an accredited
investor and was fully informed regarding its investment. In the transaction,
we relied on the exemptions from registration under the Securities Act set
forth in Section 4(2) and Section 4(6) thereof.
On September 14, 2005, we issued 100,000 shares of our common stock to
one entity in exchange for management, financial and investor related
consulting services performed for us. We valued the services received based
upon the then prevailing fair market price of the common stock ($3.45)
multiplied by the number of shares issued (100,000). The entity was an
accredited investor and was fully informed regarding its investment. In the
transaction, we relied on the exemptions from registration under the
Securities Act set forth in Section 4(2) and Section 4(6) thereof.
On December 31, 2005, two foreign corporations elected to convert an
outstanding line of credit in the amount of $844,966 into 844,966 shares of
our common stock. These corporations were both accredited investors and were
fully informed regarding their investment. In the transaction, we relied on
the exemptions from registration under the Securities Act set forth in
Regulations S and Section 4(2).
17
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion and analysis should be read together with our
consolidated financial statements and related notes that are included
elsewhere in this report.
Forward-Looking Information, Cautionary Statements and Risk Factors
This report on Form 10-KSB includes "forward-looking statements" within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. Any statements about
our expectations, beliefs, plans, objectives, assumptions or future events or
performance are not historical facts and may be forward-looking. These
statements are often, but not always, made through the use of words or phrases
such as "anticipate," "estimate," "plan," "project," "continuing," "ongoing,"
"expect," "management believes," "we believe," "we intend" and similar words
or phrases. Accordingly, these statements involve estimates, assumptions and
uncertainties that could cause actual results to differ materially from those
expressed in them. Any forward-looking statements are qualified in their
entirety by reference to the factors discussed throughout this report. Among
the key factors that could cause actual results to differ materially from the
forward-looking statements are the following:
.. competitive factors;
.. general economic and market conditions;
.. rapid technological change;
.. dependence on commercialization of our CodecSys technology;
.. dependence on significant customers;
.. our ability to raise sufficient additional capital;
.. ineffective internal control systems;
.. restrictions under our senior secured convertible notes;
.. our ability to execute our business model;
.. our ability to hire and retain qualified software personnel;
.. uncertainty of intellectual property protection; and
.. one-time or non-recurring events.
Because the risk factors referred to above, as well as the risk factors
referenced in other sections of this report, could cause actual results or
outcomes to differ materially from those expressed in any forward-looking
statements made by us or on our behalf, you should not place undue reliance on
any forward-looking statements. Further, any forward-looking statement speaks
only as of the date on which it is made, and we undertake no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which the statement is made or to reflect the occurrence of
unanticipated events. New factors emerge from time to time, and it is not
possible for us to predict which factors will arise. In addition, we cannot
assess the impact of each factor on our business or the extent to which any
factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.
18
Critical Accounting Policies
We prepare our financial statements in conformity with accounting principles
generally accepted in the United States. As such, we are required to make
certain estimates, judgments and assumptions that we believe are reasonable
based upon the information available. These estimates and assumptions affect
the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
periods presented.
Our accounting policies that are the most important to the portrayal of
our financial condition and results, and which require the highest degree of
management judgment, relate to the reserves for doubtful accounts receivable
and the valuation of stock and options issued for services.
Reserves for Doubtful Accounts Receivable
Management estimates the amount of required reserves for the potential
non-collectibility of accounts receivable based upon past experience of
collection and consideration of other relevant factors. Past experience,
however, may not be indicative of future collections and therefore we could
incur additional charges in the future to reflect differences between
estimated and actual collections.
Valuation of stock and options
We value and account for the issuance of equity instruments to acquire
goods and services based on the fair value of the goods and services or the
fair value of the equity instrument at the time of issuance, whichever is more
reliably measurable.
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 collectibility 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 that has an
established network, to provide installation, network management, satellite
transponder and help desk, or a combination of these services, we recognize
this revenue 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. 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.
When we enter into a multi-year contract to provide equipment,
installation, network management, satellite transponder, help desk, or
combination of these services, to a customer for the establishment of a new
network (or major upgrade to an existing network) where substantial revenue is
earned for equipment sales and/or installation work performed at the beginning
of the contact, compared to expected on-going future revenue, we normalize
revenue recognition by deferring earned revenue over the contracted period.
These agreements typically provide for additional fees, once the initial
installations are completed, 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.
Additionally, as immaterial numbers of new sites are added to the network the
associated revenue and cost are recorded in the period in which the work is
completed.
19
When we enter into an agreement to perform equipment sales and/or
installation-only services the revenue and cost are recognized in the period
the work is completed.
Results of Operations
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Net Sales
We realized total revenues of $5,380,869 for the year ended December 31,
2005 compared to total revenues of $5,385,657 for the year ended December 31,
2004, which represents a decrease of less than 1% for the year. Although the
revenues were materially unchanged, we experienced a change in the mix of
services used by its customers from license fees and studio and production
fees to more equipment sales and installation, which includes the associated
costs of the equipment and installation and which have a lower margin than the
license fees and studio and production fees. In 2004, approximately 10% of our
revenue was derived from studio and production services compared to
approximately 2% in 2005.The net decrease in revenues of $4,788 is the result
of a decrease of $526,759 in license fees primarily from the loss of one
customer and a decrease of $307,778 in production fees, the majority of which
was also from another customer. These decreases were offset by an increase in
sales of equipment and installation revenues of $829,749. In 2005, our three
largest customers accounted for approximately 62% of revenues. Our contracts
with these customers expire in December 2006, June 2007 and March 2008, with
each contract subject to renewal or extension. We have been increasing the
amount of work done for one of our three largest customers. We believe we will
do more work for that customer in 2006 than in the past, which will extend our
dependence on that customer.
Cost of Sales
The cost of sales for the year ended December 31, 2005 aggregated $
6,381,431 as compared to cost of sales of $5,438,409 for the year ended
December 31, 2004, which represents an increase in cost of sales of 17.3%.
The increase in cost of sales of $943,022 was primarily a result of the
increase in sales and installation of equipment with its attendant costs and
the decrease in license fees and studio and production fees, which have
greater margins than are available for the sales and installation of
equipment. Cost of equipment sales increased $886,832, which accounted for
94% of the increase in costs. Cost of sales on equipment sales as a
percentage of revenue from equipment sales increased in 2005 compared to 2004
from 71% to 83%, respectively. The remainder of the increase in cost of sales
was the result of an increase of $73,789 in satellite distribution costs
resulting from greater satellite usage by customers and an increase in
operating departments of $12,879. Increases in cost of sales were offset by a
$30,478 decrease in depreciation.
Operating Expenses
We incurred total operating expenses of $3,544,656 for the year December
31, 2005, compared to total operating expenses of $15,366,481 for the year
ended December 31, 2004. The decrease of $11,821,825 is primarily due to an
decrease in research and development in process expenses of $12,276,042.
During 2004, we recorded total research and development in process expenses of
$12,659,094, which resulted from three transactions related to the acquisition
of IDI and the ongoing development of the CodecSys technology more fully
described as follows:
(1) Consolidation of IDI co-founders equity in IDI $ 1,219,573
(2) Issuance of Stock and Options to IDI co-founders 1,211,502
(3) Issuance of Stock and Options to Streamware AB 10,228,019
------------
$ 12,659,094
============
20
During the year ended December 31, 2005, none of the foregoing expenses
were repeated. We recorded research and development in process expenses of
$383,052 for the current year.
Our general and administrative expenses including production and
maintenance costs increased $466,335 from $1,974,428 for the year ended
December 31, 2004 to $2,440,763 for the year ended December 31, 2005. The
increase resulted principally from increases of $165,273 in legal expenses,
$59,444 in outside consulting expenses, $51,389 in accounting services,
$85,495 in increased travel expenses, $36,174 in directors and officers
insurance, and $68,560 in various other general expenses
Our sales and marketing expenses for the year ended December 31, 2005
were $720,841 compared to sales and marketing expenses of $732,959 for the
year ended December 31, 2004. The increase of $12,118 is due to minor
increases in most expense categories.
We recorded an increase in interest expense of $54,023 from interest of
$1,095,186 in 2004 to $1,149,209 in 2005. For the year ended December 31,
2005, the composition of the interest expense changed from 2004. We paid
interest expense of $330,500 on our 6% Senior Secured Convertible Notes
("Notes"), recorded interest expense of $624,998 related to accretion of the
Notes as the Notes are recorded on the Balance Sheet, $ 188,879 of
amortization of pre paid interest expense related to the cost of issuing the
Notes and recorded interest expense of $4,832 related to the beneficial
conversion feature of a convertible line of credit. The holders of the
convertible line of credit converted all of the line to common stock during
2005. During 2004 all of the interest expense related to the beneficial
conversion feature of the convertible line of credit.
Net Losses
We had a net loss in the amount of $5,581,679 for the year ended
December 31, 2005 compared to a net loss of $16,488,712 for the year ended
December 31, 2004. The net loss before taxes decreased by $10,907,033, which
was primarily the result of a decrease of $12,276,042 in research and
development in process, offset by an increase of $943,022 in the cost of
revenues, an increase of $466,335 in general and administrative expenses, and
an increase of $54,023 in interest expense, all as explained above. In
addition the net loss was decreased by $99,042 related to an increase in
interest and other income.
Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Liquidity and Capital Resources
At December 31, 2005, we had cash of $446,491, total current assets of
$2,457,774 total current liabilities of $5,568,255 and total stockholders'
deficit of $3,009,487. $3,012,000 of the current liabilities relates to the
value of the derivative for the senior secured notes and related warrants. We
experienced negative cash flow used in operations during the fiscal year ended
December 31, 2005 of $3,077,951 compared to negative cash flow used in
operations for the year ended December 31, 2004 of $1,500,720. The negative
cash flow was met by issuance of the senior secured notes, borrowings under
our convertible line of credit and sales of common stock to investors. We
expect to continue to experience negative operating cash flow as long as we
continue our technology development program or until we increase our sales by
adding new customers.
21
Our audited consolidated financial statements for the year ended
December 31, 2005 contain a "going concern" qualification. As discussed in
Note 3 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.
We entered into a convertible line of credit dated December 23, 2003, as
amended and restated June 30, 2004. The line of credit involved a loan to us,
the principal amount of which is convertible into shares of our common stock
at $1.00 per share. An aggregate total of $1,644,966 had been advanced to us
under the line of credit, all of which had been converted to shares of common
stock as of December 31, 2005.
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 used 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 and the first payment of $90,000 was made on
November 16, 2005. The notes were originally convertible into 1,200,000
shares of our common stock (at $2.50 per share), convertible any time during
the term of the notes.
We were in default under the terms of the securities purchase agreement
because we did not secure an effective registration statement by the deadline
required in the agreement. We have cured the default by securing the
effective registration statement and satisfied the liquidated damages arising
due to the default by entering into a waiver agreement. The securities
purchase agreement was amended by the waiver agreement dated March 16, 2006,
in which the notes are now convertible into 2,000,000 shares of our common
stock at $1.50 per share. In addition, we are required to raise $3,000,000
from the sales of our securities by September 30, 2006 or we will be in
default 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 waiver agreement changed the exercise price of the warrants to $2.00 per
share for both the A Warrants and the B Warrants. 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 warrants with the same terms as the warrants already
received by the funds. The additional investment rights must be exercised
within 90 days of February 3, 2006. We paid approximately $345,000 in cash
for commissions, finders fees and expenses in securing this financing,
$240,000 of which was included in prepaid expenses as of December 31, 2005 and
will be amortized over the term of the notes.
The $1.50 conversion price of the senior secured convertible notes and
the $2.00 exercise price of the warrants 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 $1.50 per share.
22
The securities purchase 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 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:
.. 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;
.. 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 puttable 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.
23
Section 4(a)(xi) of the senior secured convertible notes specifies that
it is an event of default if we do not raise at least $3,000,000 by September
30, 2006. The remedies for default provide that if an event of default occurs
and is continuing, the holders may declare all of the then outstanding
principal amount of the notes and any accrued and unpaid interest thereon to
be immediately due and payable in cash. In the event of an acceleration, the
amount due and owing to the holders is 125% of the outstanding principal
amount of the notes and interest on such amount is calculated using the
default rate of 18% per annum if the full amount is not paid within one
business day after acceleration. We have cured the default by securing an
effective registration statement and satisfied the liquidated damages arising
due to the default by entering into a waiver agreement as noted above.
On June 22, 2005, we secured a new customer contract, which has resulted
in revenues of approximately $1,400,000 for 2005. We anticipate that revenues
from this customer will be substantially more during 2006. We are continuing
to train 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 $250,000 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.
Notwithstanding any additional revenue that may be realized for these sources,
we will require additional capital in 2006.
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 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 contemplated,
among other things, that we would 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.
We paid a retainer of $200,000 to First Securities and have incurred
approximately $200,000 of additional expenses. We have determined to terminate
the proposed initial public offering but continue to consider private
financing opportunities through First Securities.
24
Recent Accounting Pronouncements
In December 2003, the FASB issued Interpretation No. 46 ("FIN 46R")
(revised December 2003), Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51 ("ARB 51"), which
addresses how a business enterprise should evaluate whether it has a
controlling interest in an entity though means other than voting rights and
accordingly should consolidate the entity. FIN 46R replaces FASB
Interpretation No. 46 ("FIN 46"), which was issued in January 2003. Before
concluding that it is appropriate to apply ARB 51 voting interest
consolidation model to an entity, an enterprise must first determine that the
entity is not a variable interest entity . As of the effective date of FIN
46R, an enterprise must evaluate its involvement with all entities or legal
structures created before February 1, 2003, to determine whether consolidation
requirements of FIN 46R apply to those entities. There is no grandfathering of
existing entities. Public companies must apply either FIN 46 or FIN 46R
immediately to entities created after January 31, 2003 and no later than the
end of the first reporting period that ends after March 15, 2004. The adoption
of FIN 46 had no effect on the Company's consolidated financial position,
results of operations or cash flows.
In December 2003, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 104, Revenue Recognition. SAB 104
revises or rescinds portions of the interpretive guidance included in Topic 13
of the codification of staff accounting bulletins in order to make this
interpretive guidance consistent with current authoritative accounting and
auditing guidance and SEC rules and regulations. The adoption of SAB 104 did
not have a material effect on the Company's results of operations or financial
condition.
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 financial position or
results of operations.
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
issuers 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. 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 2 of our Notes to Consolidated Financial Statements 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.
25
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 years beginning
after December 15, 2005.
In June 2005, the Emerging Issues Task Force 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. We do not expect the adoption of EITF 04-5 will have a
material impact on our consolidated financial position, results of operations
or cash flows.
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. We do not expect the adoption of EITF 05-2
will have a material impact on our 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. We do not expect the adoption of EITF
05-6 will have a material impact on our consolidated financial position,
results of operations or cash flows.
26
ITEM 7. FINANCIAL STATEMENTS
The following financial statements required by this Item 7 begin on
Page F-1 and are located following the signature page. All information which
has been omitted is either inapplicable or not required.
Report of Independent Registered Public Accounting Firm
for the year ended December 31, 2005................................F-1
Report of Independent Registered Public Accounting Firm
for the year ended December 31, 2004................................F-2
Consolidated Balance Sheets as of December 31, 2005 and
December 31, 2004....................................................F-3
Consolidated Statement of Operations for the years ended
December 31, 2005 and December 31, 2004..............................F-5
Consolidated Statement of Stockholders' Equity for the
years ended December 31, 2005 and 2004...............................F-6
Consolidated Statement of Cash Flows for the years ended
December 31, 2005 and December 31, 2004............................. F-8
Notes to Consolidated Financial Statements...........................F-9
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
We have no disagreements with our independent auditors with respect to
accounting and financial disclosure. Tanner LC, certified public accountants,
resigned as our independent certifying accountants, effective January 17,
2006. The termination of our relationship with Tanner was unanimously
accepted by our board of directors on January 17, 2006.
Also on January 17, 2006, our board of directors unanimously approved a
resolution to engage HJ and Associates, LC, certified public accountants, to
become our new independent certifying accountants.
ITEM 8A. 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 December 31, 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 December
31, 2005 in alerting them in a timely manner to material information required
to be included in our reports filed under the Exchange Act.
27
Our evaluation identified deficiencies that existed in the design or
operation of our internal control over financial reporting that it considered
to be a "significant deficiency" or a "material weakness." The material
weakness in our internal control consisted of a lack of accounting for
conversion features embedded in our senior secured convertible notes and
related warrants as embedded derivatives requiring liability classification.
Our management also disclosed the significant deficiency and material weakness
to our audit committee and board of directors.
Additional effort is needed to fully remedy the significant deficiency
and material weakness and we are continuing efforts to improve and strengthen
our system of internal control over accounting and financial reporting. Our
audit committee is working with our management and outside advisors to
implement internal controls over accounting and financial reporting that are
adequate and effective
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.
ITEM 8B. Other Information
None.
28
PART III
ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND
CONTROL PERSONS; COMPLIANCE WITH
SECTION 16(a) OF THE EXCHANGE ACT
The following table sets forth the names, ages and positions of our
executive officers and directors:
Name Age Position
--------------------- ----- ---------
William Davidson, Ph.D. 54 Chairman of the Board
Rodney M. Tiede 44 Chief Executive Officer, President and
Director
Randy Turner 50 Chief Financial Officer and Treasurer
Reed L. Benson 58 Vice President, Secretary, General
Counsel and Director
James E. Solomon 55 Director
Kirby D. Cochran 52 Director
William Davidson, Ph.D. has been our Chairman of the Board and a
director since March 2006. Since 1984, Dr. Davidson has been President of
MESA Research, a management consulting firm which he founded. From 1985 to
1998, he served as a tenured Professor of Management at the Marshall School of
Business, University of Southern California. Dr. Davidson held leadership
responsibilities in Deloitte & Touche LLP's telecom and media management
consulting practice from 1996 to 1998. Dr. Davidson earned an A.B. in
Economics, a Masters in Business Administration Degree and a Doctorate Degree
in Business Administration, all from Harvard University.
Rodney M. Tiede has been our Chief Executive Officer, President and a
director since the BI acquisition 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 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.
Randy Turner has been our Chief Financial Officer and Treasurer since
the BI acquisition in October 2003. He was also a director of ours from
October 2003 until February 2006. From August 2000 to the present, Mr. Turner
has been the Chief Financial Officer and Secretary of BI. From April 2003 to
the present, Mr. Turner has also been the Chief Financial Officer and
Secretary of IDI. From January 1990 to August 2000, Mr. Turner was Chief
Accounting Officer of Broadcast International, Inc., the predecessor of BI,
and Treasurer of Data Broadcasting Corporation, the former parent company of
BI. He received a Bachelor of Science Degree in Accounting from Weber State
University in 1985.
Reed L. Benson has been our Vice President, Secretary, General Counsel
and a director since the BI acquisition in October 2003. He has been in the
private practice of law from April 2000 to the present and consulted directly
with BI during that period. From August 1987 to April 2000, he was Vice
President, Secretary and General Counsel of Broadcast International, Inc., the
predecessor of BI, and from June 1995 to April 2000, he served as Vice
President, Secretary and General Counsel of Data Broadcasting Corporation, the
former parent company of BI. From April 2003 to the present, Mr. Benson has
also been the General Counsel and a director of IDI. Mr. Benson is President
and a director of Xvariant, Inc., a public company. Mr. Benson received a
Bachelor of Science Degree in Accounting from the University of Utah in 1971
and a Juris Doctor Degree from the University of Utah College of Law in 1976.
Mr. Benson became a certified public accountant in 1974 and is currently an
attorney licensed to practice in Utah.
29
James E. Solomon has been a director of ours since September 2005. 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 serves on the Board of Directors of Nevada Chemicals, Inc., a public
company, 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.
Kirby D. Cochran has been a director of ours since February 2006. For
the past five years, Mr. Cochran has been an angel investor and business
consultant, assisting growth stage companies with their strategy and
operations. From May 1999 to May 2005, he taught graduate school as an
adjunct professor in the Business and Finance Departments at the University of
Utah. Mr. Cochran holds a Masters in Business Administration Degree from
North Dakota State University.
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 are employees who serve as officers of Broadcast International. The
service of these two officers and an additional officer is governed by the
terms of their respective employment contracts. See "Employment Contracts and
Change in Control Arrangements" below.
As noted above, several of our executive officers and directors have
served as officers and directors of BI since August 2000 and as officers and
directors of IDI since April 2003. During 2001 and 2002, BI entered into
various licensing agreements with IDI and purchased shares of convertible
preferred stock of IDI. Management of BI determined that the CodecSys
technology being developed by IDI represented a significant opportunity for BI
and its future business prospects. By April 2003, the financial condition of
IDI had deteriorated significantly and BI provided a line of credit to IDI to
sustain its operations. At such time, BI also assumed operational control of
IDI. By October 2003, management of BI realized that IDI could not survive on
its own notwithstanding the financial support provided by BI. Accordingly,
IDI filed for bankruptcy protection under chapter 11 of the federal bankruptcy
code on October 23, 2003. Over the next seven months, IDI continued its
limited operations and designed a bankruptcy plan of reorganization which was
confirmed on May 18, 2004. Under the plan of reorganization, Broadcast
International issued shares of our common stock to creditors of IDI and
assumed certain liabilities of IDI in exchange for shares of the common stock
of IDI representing majority ownership of IDI. Since confirmation of the plan
of reorganization, the operations of IDI have been consolidated with ours.
For additional information regarding the IDI bankruptcy, see Note 5 of the
Notes to Consolidated Financial Statements included elsewhere in this report.
Section 16 (a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our executive officers,
directors and persons who own more than ten percent of our Common Stock to
file initial reports of beneficial ownership on Form 3, changes in beneficial
ownership on Form 4 and an annual statement of beneficial ownership on Form 5,
with the SEC. Such executive officers, directors and greater than ten percent
shareholders are required by SEC rules to furnish us with copies of all such
forms that they have filed.
Based solely on its review of the copies of such forms received by us
and representations from certain reporting persons, we believes that all
Section 16(a) filing requirements applicable to its executive officers,
directors and ten-percent shareholders for 2005 were timely met.
30
Code of Ethics
We have adopted a Code of Ethics for its principal executive officer,
principal financial officer, controller, or persons performing similar
functions. A copy of the Code of Ethics was filed with the Securities and
Exchange Commission as an exhibit to our Annual Report on Form 10-KSB for the
year ended December 31, 2003.
Audit Committee and Financial Expert
Our Audit Committee was established in September 2005 and currently
includes Messrs. Solomon and Cochran. Mr. Solomon serves as Chairman of the
Audit Committee. The functions of the Audit Committee include recommending an
independent registered public accounting firm to audit our annual financial
statements, reviewing the independence of our auditors, the financial
statements and the auditors' report, and reviewing management's administration
of our system of internal control over financial reporting and disclosure
controls and procedures. The Board of Directors has not yet adopted a written
Audit Committee charter or similar document. Each of the members of the Audit
Committee is "independent" under the definition of independence in Rule
4200(a)(15) of the NASD's listing standards.
Our Board of Directors has determined that James E. Solomon meets the
requirements of an "Audit Committee Financial Expert" as defined in Item
401(e) of Regulation S-B adopted by the Securities and Exchange Commission.
ITEM 10. EXECUTIVE COMPENSATION
Summary of Cash and Certain Other Compensation
The following sets forth the compensation of the Company's Chief Executive
Officer and the other executive officers as of December 31, 2005 for the three
fiscal years ended December 31, 2005.
Summary Compensation Table
Annual Compensation
--------------------
Fiscal Year
Ended All Other(2)
Name and Principal Position December 31 Salary($) Bonus($) Compensation($)
---------------------------- ------------ --------- -------- ---------------
Rodney M. Tiede 2005 120,000 25,000 6,682
Chief Executive Officer (1) 2004 120,000 0 5,824
2003 20,000 0 1,245
----------------------------------------------------------------------------
Randy Turner 2005 100,000 20,000 5,536
Chief Financial Officer (1) 2004 100,000 0 4,895
2003 25,000 0 1,068
----------------------------------------------------------------------------
Reed L. Benson 2005 84,000 20,000 3,410
Secretary, General Counsel 2004 81,700(3) 0 1,252
Vice President (1) 2003 15,000(3) 0 0
----------------------------------------------------------------------------
31
(1) Became an executive officer October 1, 2003. Compensation listed dates
from such date.
(2) Includes amounts paid by the Company for 401(k) matching, and employee
life insurance.
(3) Mr. Benson was paid by way of consulting fees until April 2004, which
fees are included in the table above. Subsequent to April 2004, Mr.
Benson was paid as an employee of the Company.
Aggregated Options/SAR Exercises in Last Fiscal Year
And FY-End Options/SAR Values
The following table summarizes for the executive officers the number of
stock options exercised during fiscal 2005, the aggregate dollar value
realized upon exercise, the total number of unexercised options held at
December 31, 2005 and the aggregate dollar value of in-the-money unexercised
options held at December 31, 2005. Value realized upon exercise is the
difference between the fair market value of the underlying stock on the
exercise date (based upon the average of the high and low prices of common
stock as reported by the OTC Bulletin Board, and the exercise price of the
option. Options are in-the-money if the fair market value of the underlying
securities exceed the exercise price of the option. The value of unexercised,
in-the-money options at December 31, 2005 is the aggregate amount of the
difference between their exercise price and $2.25 per share, the fair market
value of the underlying stock on December 31, 2005, based on the closing price
of the common stock on that date.
The underlying options have not been and may never be exercised. The
actual gains, if any, on exercise will depend on the value of the Common Stock
on the actual date of exercise. There can be no assurance that these values
will be realized.
Number of
Securities Value of
Underlying Unexercised
Unexercised In-the-Money
Options/SAR's Options/SAR's
At FY-End(#) At FY-End($)
-------------- --------------
Shares Acquired Value Exercisable/ Exercisable/
Name on Exercise (#) Realized($) Unexercisable Unexercisable
------------------- ---------------- ----------- -------------- --------------
Rod M.Tiede - - 16,667/33,333 0/0
Randy Turner - - 524,723/33,333 1,132,965/0
Reed L. Benson - - 33,333/91,667 0/0
-----------------------------------------------------------------------------
32
Options/SAR Grants in Last Fiscal Year
Number of % of Total
Securities Options/SAR's
Underlying Granted to Exercise or
Options/SAR's Employees in Base Price Expiration
Name Granted(#)(1) Fiscal Year(2) ($/Sh)(3) Date
---------------------- --------------- ---------------- ----------- ----------
Reed L. Benson 25,000 7% 2.55 10/2015
---------------------- --------------- ---------------- ----------- ----------
(1) All of the options granted in 2005 vest ratably over three years,
beginning on October 3, 2006.
(2) The percentage reflected in the table above was computed based on the
total number of shares (375,000) issuable under options granted to
employees and directors in 2005.
(3) The exercise prices shown above equals the fair market values on the
dates of grant, which fair market value was determined by the closing
price of the Common Stock as reported by the OTC Bulletin Board.
Compensation of Directors
Our non-employee directors receive fees of $20,000 per year, paid
quarterly, and an initial grant of stock options to purchase 75,000 shares
(thereafter annual grants of 25,000 options) of the our common stock with an
exercise price equal to the fair market value of the stock on the date of
grant. In addition, the Chairman of the Board receives an additional grant of
25,000 options and an annual fee of $5,000. In addition to the standard
director compensation mentioned above, the Chairman of both the Audit and
Compensation Committees receive an annual fee of $5,000 for serving in such
capacity. Directors who are employees of Broadcast International receive no
additional compensation for serving as directors. Options granted to outside
Directors are immediately exercisable and expire ten years from the date of
grant.
Employment Contracts and Termination of Employment and Change in Control
Arrangements
In April 2004, the Company 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 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 the Company's stock option
plan, the payment of severance pay, and other standard benefits such as
vacation, participation in the Company's 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 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 shall have
the right to terminate the employment agreement and receive
33
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 the shareholders of the
Company exchanging their shares for stock or other consideration, Mr. Tiede
shall receive an amount equal to the per share price paid to the shareholders
of the Company less the pre-announcement price multiplied by 50,000.
In April 2004, the Company and Mr. Turner entered into an employment
agreement covering Mr. Turner's employment for a term commencing upon the
execution thereof and continuing until December 31, 2006. The agreement calls
for payment of a gross annual salary of not less than $100,000, 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. Turner 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. Turner during the previous fiscal year.
The agreement also provides for participation in the Company's stock option
plan, the payment of severance pay, and other standard benefits such as
vacation, participation in the Company's 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 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. Turner 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 the shareholders of the
Company exchanging their shares for stock or other consideration, Mr. Turner
shall receive an amount equal to the per share price paid to the shareholders
of the Company less the pre-announcement price multiplied by 50,000.
In April, 2004 the Company and Mr. Benson entered into an employment
agreement covering Mr. Benson employment for a term commencing upon the
execution thereof and continuing until December 31, 2006. The agreement calls
for payment of a gross annual salary of not less than $84,000, 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. Benson 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 Compensation Committee thereof) based upon an
evaluation of the performance of Mr. Benson during the previous fiscal year.
The agreement also provides for participation in the Company's stock option
plan, the payment of severance pay, and other standard benefits such as
vacation, participation in the Company's 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 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. Benson 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 the shareholders of the
Company exchanging their shares for stock or other consideration, Mr. Benson
shall receive an amount equal to the per share price paid to the shareholders
of the Company less the pre-announcement price multiplied by 50,000.
Compensation Committee Interlocks and Insider Participation
Our Compensation Committee was established in October 2005 and currently
includes Messrs. Solomon, Davidson and Cochran. Mr. Cochran serves as Chairman
of the Compensation Committee.
34
Board Meetings
During the year ended December 31, 2005, the Board held five formal
meetings and took two separate actions by unanimous written consent
resolution.
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table sets forth the beneficial ownership of the common
stock of the Company, at March 15, 2006, by each director, executive officer,
and each person who, to the knowledge of the Company, owned beneficially more
than 5% of the Company's common stock.
Amount & Nature
Name & Address of Beneficial Percent
of Beneficial Owner Ownership of Class
------------------------------ ---------------------- --------
Rodney M. Tiede (1) (2) 3,998,174 17.5%
Renae Hambly (1) (3) 1,732,292 7.4%
Kenneth Moore (1) (4) 1,732,090 7.4%
Randy L. Turner (1) (5) 1,534,674 6.6%
Reed L. Benson (6) 719,422 3.1%
William H. Davidson (7) 100,000 *
James E. Solomon (7) 75,000 *
Kirby D. Cochran (7) 75,000 *
All directors and executive
officers as a group
(6 persons) (8) 6,502,270 27.4%
* Represents less than 1% of the Company's common stock.
(1) The address for each named individual is the Company's address at 7050
Union Park Avenue, #600, Salt Lake City, Utah 84047, and all named
individuals are employees of the Company.
(2) Includes 328,440 shares held by Mr. Tiede as Custodian under the Uniform
Gift to Minors Act for the benefit of his children. Includes presently
exercisable options to acquire a total of 16,666 shares of common stock
(3) Includes presently exercisable options to acquire a total of 513,258
shares of common stock held by Ms. Hambly and her spouse.
(4) Includes presently exercisable options to acquire 508,056 shares of
common stock.
(5) Includes 57,477 shares held by Mr. Turner as Custodian under Uniform
Gift to Minors Act for the benefit of his child and presently
exercisable options to acquire a total of 524,722 shares of common
stock.
(6) Includes 686,089 shares held by a limited liability company of which Mr.
Benson and his spouse own a 40% equity interest. Mr. Benson is the
manager of the limited liability company and, as such, has voting and
investment power with respect to all such shares. Mr. Benson disclaims
beneficial ownership of all such shares except to the extent of his
equity interest therein. Also includes presently exercisable options to
acquire 33,333 shares
25
(7) Represents presently exercisable options granted to Independent
Directors.
(8) Includes presently exercisable options to acquire a total of 824,721
shares of common stock held by all directors and executive officers.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Since April 2003, BI (and since October 2003, Broadcast International)
advanced money to IDI, pursuant to the terms of a secured, revolving line of
credit, which allowed IDI to continue operations. At December 31, 2003, the
outstanding principal amount advanced under the line of credit was $82,200,
included in other long-term assets. From January 2004 until the consolidation
of IDI in May 2004, Broadcast International advanced an additional $182,808 to
IDI. The entire advanced amount of $265,008 was expensed upon consolidation
when the IDI bankruptcy plan of reorganization was confirmed. See Note 5 of
the Notes to Consolidated Financial Statements included elsewhere in this
report.
ITEM 13. 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-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, filed under cover of From S-3,
pre-effective Amendment No.3 filed with the SEC on October 11, 2005.)
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, filed under cover of From S-3,
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, filed under cover
of From S-3, pre-effective Amendment No.3 filed with the SEC on
October 11, 2005.)
36
Exhibit
Number Description of Document
------- -----------------------
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, filed under cover
of From 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 Randy L.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, filed under cover of From S-3, 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, filed under cover
of From S-3, pre-effective Amendment No.3 filed with the SEC on
October 11, 2005.)
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, filed under cover of From S-3, 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, filed under cover of From S-3,
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, filed under
cover of From S-3, pre-effective Amendment No.3 filed with the SEC on
October 11, 2005.)
37
Exhibit
Number Description of Document
------- -----------------------
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,filed under cover of From
S-3,pre-effective Amendment No.3 filed with the SEC on October 11,
2005.)
10.11 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.)
10.12 Forbearance Agreement dated November 30, 2005, between Broadcast
International, Inc. and the Institutional Funds. (Incorporated by
reference to Exhibit No. 10.13 of the Company's Current Report on Form
8-K filed with the SEC on December 6, 2005.)
10.13 Waiver and Amendment Agreement dated March 16, 2006, between Broadcast
International, Inc. and the Institutional Funds. (Incorporated by
reference to Exhibit No. 10.14 of the Company's Current Report on Form
8-K filed with the SEC on March 20, 2006.)
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 on Form
10-KSB of the Company's annual Report filed with the SEC on April 1,
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 of2002
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
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
38
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
Fees for professional services provided by our independent auditors for
each of the last two fiscal years, in each of the following categories, are as
follows:
2005 2004
-------- --------
Audit fees $ 70,500 $ 44,400
Audit-related fees - 5,275
Tax fees 3,500 3,500
All other fees - -
-------- --------
Total $ 74,000 $ 53,175
========= ========
Fees for audit services include fees associated with the annual audit, the
reviews of our quarterly reports on Form 10-QSB, assistance with and review of
documents filed with the SEC and comfort letters. Audit-related fees
principally consisted of audit related consultation. Tax fees included tax
compliance and tax consultations.
The board of directors has adopted a policy that requires advance approval of
all audit, audit -related, tax services, and other services performed by our
independent auditor. The policy provides for pre -approval by the board of
directors of specifically defined audit and non-audit services. Unless the
specific service has been previously pre-approved with respect to that year,
the board of directors must approve the permitted service before the
independent auditor is engaged to perform it.
39
SIGNATURES
In accordance with Section 13 or 15(d) 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: March 31, 2006 /s/ Rodney M. Tiede
By: Rodney M. Tiede
Its: President and Chief Executive Officer
In accordance with the Exchange Act, 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, 2006 /s/ Rodney M. Tiede
By: Rodney M. Tiede
Its: President, Chief Executive Officer and
Director
(Principal Executive Officer)
Date: March 31, 2006 /s/ Randy L. Turner
By: Randy L. Turner
Its: Chief Financial Officer
(Principal Financial and Accounting
Officer)
Date: March 31, 2006 /s/ Reed L. Benson
By: Reed L. Benson
Its: Director
Date: March 31, 2006 /s/ James E. Solomon
By: James E. Solomon
Its: Director
40
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 sheet of Broadcast
International, Inc. as of December 31, 2005, and the related consolidated
statements of operations, stockholders' deficit and cash flows for the year
then ended. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of Broadcast International, Inc. as of December 31, 2005, and the results of
their operations and their cash flows for the year then ended in conformity
with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to
the consolidated financial statements, the Company's operating losses and lack
of working capital raise substantial doubt about its ability to continue as a
going concern. Management's plans concerning these matters are also described
in Note 3. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ HJ & Associates, LLC
Salt Lake City, Utah
March 27, 2006
F-1
41
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Stockholders and Board of Directors of
Broadcast International, Inc.
We have audited the accompanying consolidated balance sheet of Broadcast
International, Inc. and subsidiaries, as of December 31, 2004, and the related
consolidated statements of operations, stockholders' deficit and cash flows
for the year then ended. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on these consolidated financial statements based on our audit.
We conducted our audit 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
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audit provides 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, 2004 and the results
of their operations and their cash flows for the year then ended in conformity
with U.S. generally accepted accounting principles.
The accompanying consolidated financial statements have been prepared assuming
that the Company will continue as a going concern. As discussed in Note 3 to
the consolidated financial statements, the Company has incurred significant
losses and used cash from operations during the year ended December 31, 2004.
These conditions raise substantial doubt about its ability to continue as a
going concern. Management's plans regarding these matters also are described
in Note 3. The consolidated financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
/s/ Tanner LC
Salt Lake City, UT
February 18, 2005
F-2
42
Broadcast International, Inc.
CONSOLIDATED BALANCE SHEETS
December 31
---------------------------
2004 2005
------------- -------------
ASSETS:
Current assets
Cash and cash equivalents $ 173,536 $ 446,491
Trade accounts receivable, net 479,382 1,186,634
Inventory 20,066 235,279
Prepaid expense 192,881 589,370
------------- -------------
Total current assets 865,865 2,457,774
Property and equipment
Furniture and fixtures 77,939 77,803
Leasehold improvements 237,108 237,108
Machinery and equipment 1,748,049 1,693,433
Accumulated depreciation and amortization (1,298,325) (1,504,182)
------------- -------------
Property and equipment, net 764,771 504,162
Other assets
Patents, at cost 179,084 201,565
Debt offering costs - 717,121
Deposits and other assets 7,824 7,824
------------- -------------
Total other assets 186,908 927,110
------------- -------------
Total assets $ 1,817,544 $ 3,889,046
============= =============
(see the accompanying notes to consolidated financial statements)
F-3
43
Broadcast International, Inc.
CONSOLIDATED BALANCE SHEETS (continued)
December 31
---------------------------
2004 2005
------------- -------------
LIABILITIES:
Current liabilities
Accounts payable $ 139,768 $ 1,176,100
Payroll and related expenses 165,592 185,627
Other accrued expenses 81,189 347,400
Unearned revenues 205,078 776,941
Current portion of long-term obligations 70,187 70,187
Derivative valuation - 3,012,000
------------- -------------
Total current liabilities 661,814 5,568,255
Senior convertible debt (net of
$2,375,002 discount) - 624,998
Other long-term obligations 570,557 105,280
Deferred bonus payable 600,000 600,000
------------- -------------
Total liabilities 1,832,371 6,898,533
Commitments and contingencies - -
STOCKHOLDERS DEFICIT:
Preferred stock, no par value; 10,000,000
shares authorized, none issued - -
Common stock, $.05 par value; 40,000,000
shares authorized, 21,872,089 and
20,653,986 shares issued as of
December 31, 2005 and 2004, respectively 1,032,699 1,093,604
Additional paid-in capital 19,458,897 21,985,011
Accumulated deficit (20,506,423) (26,088,102)
------------- -------------
Total stockholders' deficit (14,827) (3,009,487)
------------- -------------
Total liabilities and stockholders' deficit $ 1,817,544 $ 3,889,046
============= =============
(see the accompanying notes to consolidated financial statements)
F-4
44
Broadcast International, Inc.
Consolidated Statement of Operations
For the years ended December 31
-------------------------------
2004 2005
------------- ------------
Net sales $ 5,385,657 $ 5,380,869
Cost of sales 5,438,409 6,381,431
------------ -----------
Gross profit (loss) (52,752) (1,000,562)
Operating expenses:
Administrative and general 1,939,319 2,440,763
Selling and marketing 732,959 720,841
Production and maintenance 35,109 -
Research and development in process 12,659,094 383,052
------------ -----------
Total operating expenses 15,366,481 3,544,656
------------ -----------
Total operating loss (15,419,233) (4,545,218)
Other income (expense)
Interest income 2,570 29,745
Interest expense (1,095,186) (1,149,209)
Derivative valuation gain - (12,000)
Other income 23,137 95,003
------------ -----------
Total other income (loss) (1,069,479) (1,036,461)
------------ -----------
Loss before income taxes (16,488,712) (5,581,679)
Provision for income taxes
Current tax expense (benefit) - -
Deferred tax expense (benefit) - -
------------ -----------
Total provision for income taxes - -
------------ -----------
Net loss $(16,488,712) $(5,581,679)
============ ===========
Loss per share basic and diluted $ (.85) $ (.26)
============= ============
Weighted average shares basic and diluted 19,365,000 20,844,000
============= ============
(see the accompanying notes to consolidated financial statements)
F-5
45
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Broadcast International, Inc.
Consolidated Statement of Stockholders Equity (Deficit)
Years ended December 31, 2005 and 2004
Common Stock Additional Retained
--------------------------- Paid-in Earnings Equity
Shares Amount Capital (Deficit) (Deficit)
------------- ------------- ------------- ------------- -------------
Balance, January 1, 2004 18,185,736 $ 909,287 $ 3,870,179 $ (4,017,711) $ 761,755
Common stock issued for cash 343,307 17,165 847,755 - 864,920
Common stock issued for services 209,444 10,472 906,524 - 916,996
Common stock issued to IDI
debt holders 111,842 5,592 676,630 - 682,222
Common stock issued on
exercise of options 3,657 183 3,179 - 3,362
Common stock issued from
long-term debt conversion 800,000 40,000 760,000 - 800,000
Common stock and warrants
issued pursuant to contract
settlement agreement 1,000,000 50,000 11,299,520 - 11,349,520
Beneficial conversion feature - - 1,095,110 - 1,095,110
Net loss - - - (16,488,712) (16,488,712)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2004 20,653,986 1,032,699 19,458,897 (20,506,423) (14,827)
Common stock issued for cash 41,666 2,083 122,897 - 124,980
Common stock issued for services 307,000 15,350 1,061,820 - 1,077,170
Common stock returned by IDI
debt holders (22,801) (1,140) 1,140 - -
Common stock issued from
debt conversion 844,966 42,248 802,718 - 844,966
Common stock issued on
exercise of warrants 47,272 2,364 (2,364) - -
------------- ------------- ------------- ------------- -------------
Balance forward 21,872,089 $ 1,093,604 $ 21,445,108 $(20,506,423) $ (2,032,289)
F-6
46
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Broadcast International, Inc.
Consolidated Statement of Stockholders Equity (Deficit)
Years ended December 31, 2005 and 2004
Common Stock Additional Retained
--------------------------- Paid-in Earnings Equity
Shares Amount Capital (Deficit) (Deficit)
------------- ------------- ------------- ------------- -------------
Balance forward 21,872,089 $ 1,093,604 $ 21,445,108 $(20,506,423) $ (2,032,289)
Warrants issued for services - - 315,600 - 315,600
Warrants issued for
technology R & D - - 288,018 - 288,018
Beneficial conversion feature - - 4,832 - 4,832
Extinguishment of Debt - - (68,547) - (68,547)
Net loss - - - (5,581,679) (5,581,679)
------------- ------------- ------------- ------------- -------------
Balance, December 31, 2005 21,872,089 $ 1,093,604 $ 21,985,011 $(26,088,102) $ (3,009,487)
============= ============= ============= ============= =============
(see the accompanying notes to consolidated financial statements)
F-7
47
[Enlarge/Download Table]
Broadcast International, Inc.
Consolidated Statement of Cash Flows
For the years ended December 31
-------------------------------
2004 2005
---------------- -------------
Cash flows from operating activities:
Net loss $ (16,488,712) $ (5,581,679)
Adjustments to reconcile net loss to net cash
used by operating activities:
Depreciation and amortization 398,319 367,841
Loss on retirement of assets - 24,050
Deferred income tax expense (benefit) - -
Common stock issued for services 916,996 235,170
Common stock and options issued for research and
development in process 11,439,520 288,018
Liability assumed for research and development in process 1,219,573 -
Beneficial conversion expense 1,095,110 4,832
Extinguishment of debt - (68,547)
Accretion of senior convertible note - 624,998
Derivative liability valuation - 12,000
Allowance for doubtful accounts 36,404 62,660
Changes in assets and liabilities:
Accounts receivable (73,225) (769,911)
Inventories 58,102 (215,213)
Prepaids and debt offering costs (31,127) 43,390
Accounts payable (42,960) 1,036,332
Accrued liabilities 23,165 286,245
Deferred revenues (51,885) 571,863
---------------- -------------
Net cash used in operating activities (1,500,720) (3,077,951)
Cash flows from investing activities:
Purchase of equipment (80,965) (131,003)
Related party note receivable (net) (182,799) -
Patents (179,084) (22,760)
---------------- -------------
Net cash used in investing activities (442,848) (153,763)
Cash flows from financing activities:
Principal payments - debt (160,955) (70,187)
Stock issued for cash 864,920 124,980
Proceeds from exercise of stock options 3,362 -
Loan financing 1,095,110 3,449,876
---------------- -------------
Net cash provided by financing activities 1,802,437 3,504,669
---------------- -------------
Net (decrease) increase in cash and equivalents (141,131) 272,955
Cash and equivalents, beginning of year 314,667 173,536
---------------- -------------
Cash and equivalents, end of year $ 173,536 $ 446,491
================ =============
Supplemental disclosures of cash flow information:
Interest paid $ 76 $ 90,000
Income taxes paid - -
(see the accompanying notes to consolidated financial statements)
F-8
48
Broadcast International, Inc.
Notes to Consolidated Financial Statements
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), an 86% 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 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, the Company issued to the creditors of IDI approximately 111,842
shares of the common stock of the Company. In exchange, the Company received
approximately 50,127,218 shares of the common stock of IDI. Additionally, the
Company had previously acquired convertible preferred stock which, if
converted, equated to approximately 1,050,000 shares of the common stock of
IDI. The transaction with IDI was accounted for as a purchase of IDI by the
Company. At December 31, 2005, the Company owned, on a fully diluted basis,
approximately 51,177,218 common share equivalents, representing approximately
86%, of the equity of IDI.
The consolidated financial statements herein include the operations of BI from
January 1, 2004 to December 31, 2005, and the operations of IDI from May 18,
2004 to December 31, 2005. IDI produced losses from operations during the
period May 18, 2004 to December 31, 2005; therefore, 100% of the results from
operations have been included in the Company's consolidated statements. All
intercompany transactions and balances have been eliminated in consolidation.
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,
2005 and 2004 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 believes it is not exposed to any significant credit risk
on cash and cash equivalents.
F-9
49
Trade 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
-------
Patents represent initial legal costs incurred to apply for US 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, 2005, only Singapore had granted patent rights. We are in the
final stages of patent registration with other foreign countries and expect to
soon receive registration status. 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 those 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 $279 for the year ended
December 31, 2005.
Estimated amortization expense, if all patents were issued at the beginning of
2006, for each of the next five years is as follows:
Year ending December 31:
2006 $ 10,110
2007 10,110
2008 10,110
2009 10,110
2010 10,110
F-10
50
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.
Stock Compensation
------------------
We have adopted the disclosure-only provisions of Statement of Financial
Accounting Standards (SFAS) No. 123, Accounting for Stock-Based Compensation.
Accordingly, no compensation cost has been recognized in the financial
statements for employees, except when the exercise price is below the market
price of the stock on the date of grant. Had compensation cost for our stock
option plans been determined based on the fair value at the grant date for
awards in fiscal year 2005 and 2004 consistent with the provisions of SFAS No.
123, our approximate net loss and loss per share would have been the pro forma
amounts indicated below:
Years Ended December 31,
2004 2005
------------- -------------
Net loss, as reported $(16,488,712) $ (5,581,679)
Addback:
Stock-based employee compensation 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 (366,740) (815,548)
------------- -------------
Pro forma net loss $(16,855,452) $ (6,397,227)
============= =============
(Loss) earnings per share:
Basic and diluted - as reported $ (0.85) $ (0.26)
============= =============
Basic and diluted - pro forma $ (0.87) $ (0.31)
============= =============
The weighted average fair value of options granted during year ended December
31, 2005 was $2.37 per share. The fair value for the options granted in 2005
were estimated at the date of grant using a Black Scholes option pricing
model.
Income Taxes
-------------
We account for income taxes in accordance with the asset and liability method
of accounting for income taxes prescribed by Statement of Financial Accounting
Standards No. 109, 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
Company's selling price to its customers is fixed and determinable with
required documentation, and collectibility is reasonably assured. We recognize
as deferred revenue, payments made in advance by customers for services not
yet provided.
F-11
51
When we enter into a multi-year contract with a customer that has an
established network, to provide installation, network management, satellite
transponder and help desk, or combination of these services, we recognize this
revenue 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. 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.
When we enter into a multi-year contract to provide equipment, installation,
network management, satellite transponder, help desk, or combination of these
services, to a customer for the establishment of a new network (or major
upgrade to an existing network) where substantial revenue is earned for
equipment sales and/or installation work performed at the beginning of the
contact, compared to expected on-going future revenue, we normalize revenue
recognition by deferring earned revenue over the contracted period. These
agreements typically provide for additional fees, once the initial
installations are completed, 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.
Additionally, as immaterial numbers of new sites are added to the network the
associated revenue and cost are recorded in the period in which the work is
completed.
When we enter into an agreement to perform equipment sales and/or
installation-only services the revenue and cost are recognized in the period
the work is completed.
Research and Development
------------------------
Research and development costs are expensed when incurred.
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.
Our accounts receivable include three customers whose combined balances
represent approximately 68% and 50% of trade receivables as of December 31,
2005 and 2004, respectively and whose related sales revenues account for
approximately 62% and 53% of total revenues for the years ended December 31,
2005 and 2004,respectively.
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 and
warrants outstanding during the year, using the treasury stock method and the
average market price per share during the year. Options to purchase 8,122,747
and 6,415,650 shares of common stock at prices ranging from $.02 to $45.90 per
share were outstanding at December 31, 2005 and 2004, respectively. As we
experienced a net loss during the years ended December 31, 2005 and 2004, no
common stock equivalents have been included in the diluted earnings per common
share calculation as the effect of such options would be anti-dilutive.
F-12
52
Common Stock Reverse Split
--------------------------
On January 13, 2004, we effected a 10:1 reverse stock split of its common
stock. The financial statements reflect the reverse stock split as if it had
occurred on January 1, 2004.
Fair Value of Financial Instruments
-----------------------------------
Our financial instruments consist of cash, receivables, notes receivables,
payables, and notes payable. The carrying amount of cash, receivables and
payables approximates fair value because of the short-term nature of these
items. The aggregate carrying amount of the notes receivable and notes
payable approximates fair value as the individual notes bear interest at
market interest rates.
Advertising Expenses
--------------------
We follow the policy of charging the costs of advertising to expense as
incurred. Advertising expense for the years ended December 31, 2005 and 2004
was $48,339 and $70,890, respectively.
Off-Balance Sheet Arrangements
------------------------------
We have no off-balance sheet arrangements.
Reclassifications
-----------------
Certain reclassifications have been made to the 2004 financial statements in
order for them to conform to the classifications used for the current year.
Note 3 - Going Concern
-----------------------
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. We have incurred
losses and have not demonstrated the ability to generate sufficient cash flows
from operations to satisfy our liabilities and sustain operations. These
factors raise substantial doubt about our ability to continue as a going
concern.
Our continuation as a going concern is dependent on our ability to generate
sufficient income and cash flow to meet our obligations on a timely basis and
to obtain additional financing as may be required. We are actively seeking
options to obtain additional capital and financing. We have commenced a
private placement of up to $4,500,000 of our commons stock and as of March 23,
2006 we have raised $456,185 (see Note 15). There is no assurance we will be
successful in our efforts.The accompanying statements do not include any
adjustments that might be necessary if the Company is unable to continue as a
going concern.
Note 4 - Trade Accounts Receivable
----------------------------------
Our trade accounts receivable are shown in the accompanying balance sheet net
of its allowance for uncollectible accounts of $82,402 and $39,574 as of
December 31, 2005 and 2004, respectively.
Our largest customer for the year ending December 31, 2005 represented 52% of
the year-end accounts receivable balance; this customer was new in 2005. Our
accounts receivable aggregate balances for the three largest customers
represent approximately 68% and 50% of trade receivables as of December 31,
2005 and 2004, respectively.
F-13
53
Note 5 - Investment in Interact Devices, Inc (IDI)
--------------------------------------------------
We began investing in and advancing monies to IDI in 2001. IDI was developing
technology which CodecSys is being developed from. The following describes
the various transactions and accounting treatment for its investment in IDI
for the years ending December 31, 2005 and 2004.
During 2001 and 2002, we entered into various licensing agreements with IDI to
license its technology. In addition to these license agreementswe purchased
convertible preferred stock of IDI. On April 1, 2003, we entered into a stock
purchase agreement ("Agreement") with three of the co-founders of IDI to
purchase shares of IDI owned by such co-founders. Amounts paid by us for such
shares were capitalized as part of the Company's investment in IDI.
Coincident to the Agreement, our President was granted the right to vote the
remaining shares owned by the founders for a one year period, which resulted
in us having the right to vote in excess of 60% of the voting stock of IDI.
Pursuant to the Agreement, the founders resigned as officers and members of
the Board of Directors of IDI. Our management assumed operational control of
IDI and were appointed to the IDI Board. To date, members of our management
occupy 3 of the 5 IDI Board seats.
On April 1, 2003, we also entered into a revolving line of credit promissory
note with IDI. The note was at our sole discretion and allowed IDI to draw up
to $1,000,000. All principal and interest at 10% per annum was due and payable
on December 31, 2003. 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 obtain
certain licensing rights, which had previously been sold to Streamware
Solutions, AB by IDI.
Streamware Solutions AB
-----------------------
On February 6, 2004, IDI entered into a license agreement with Streamware
Solutions AB (Streamware), a Swedish corporation, which dissolved a previous
partner agreement dated April 26, 2002. The license agreement provides
Streamware certain rights to the IDI technology, including a 2-year
exclusivity for certain companies located in Europe. Use of the technology by
Streamware will result in fees being received by the Company.
In association with the license agreement mentioned above, Streamware, or it's
shareholders, had the right pursuant to a stock purchase and option grant
agreement to purchase up to 250,000 shares of our common stock at a per share
price of $2.00, on or before March 4, 2004. Of the 250,000 shares available,
187,500 shares were purchased at approximately 50% below market value,
resulting in proceeds for us of $375,000 and a research and development in
process expense of $375,000. We granted Streamware the right to purchase these
shares in association with the rights to market the IDI technology to the
non-exclusive customers located in Europe, which were previously unavailable
due to the partner agreement. Additionally, we had granted Streamware
shareholders a 2-year option to purchase an additional 1,312,500 shares of our
common stock at a per share price of $4.50, at an expense of $2,054,944, which
expired on February 6, 2006 and was not exercised.
Additionally, Streamware was issued 1,000,000 shares of common stock pursuant
to a stock issuance and option grant agreement also dated February 6, 2004,
which were valued at $6,000,000. We also issued to Streamware or its
principals an additional 1,500,000 options to purchase our common shares at an
exercise price of $4.50 per share, which expired on February 6, 2006 and was
not exercised, associated with the agreements mentioned above at an expense of
$1,798,075. These agreements were entered concurrently with IDI entering into
the license agreement with Streamware. All expenses associated with Streamware
and the IDI bankruptcy above were recorded as research and development in
process, as part of the on-going development costs of the CodecSys technology.
F-14
The Company recorded the following related to the transactions with
Streamware:
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
expense from Streamware $ 10,228,019
=============
Assumption and Consolidation of IDI
-----------------------------------
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 111,842 shares
of common stock of the Company, valued at approximately $682,222, and assumed
cash liabilities of approximately $312,768 to be paid over a 4-year period in
exchange for approximately 50,127,218 shares of the common stock of IDI.
For the years ended December 31, 2005 and 2004, we have paid approximately
$70,187 and $67,114, respectively of the $312,768 original obligation. The a
balance remaining as of December 31, 2005 and 2004 was approximately,
$175,467 and $245,654, of which $70,187 has been recorded as the current
portion with $105,280 and $175,467, respectively as long-term debt.
During the year ended December 31, 2004, we recorded the following net 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)
Trade receivables, net 13,506
Inventory 6,997
Prepaid expenses 2,166
Equipment 46,450
Accounts payable and accrued liabilities (28,696)
------------
Total research and development in process $ 1,219,573
============
During the year ended December 31, 2005 six former debt holders of IDI retuned
to us approximately 22,801 shares of our common stock which they had received
as part of the debtor-in-possession's plan of reorganization. We accounted for
this as a reduction in the number of outstanding shares of our common stock
with a corresponding increase in additional paid in capital
IDI Co-Founders Settlement
--------------------------
On September 1, 2004, we entered into a settlement agreement with the
co-founders of IDI related to a prior agreement entered into in 2003, in which
we agreed to pay a total of $90,000, in cash, to the co-founders in four
monthly payments of $22,500, beginning September 2004. In exchange for such
payment, the IDI co-founders agreed to terminate the prior agreement and
return shares of IDI stock to IDI to satisfy certain obligations owed to IDI
F-15
55
by such co-founders. The $90,000 expense is recorded in research and
development in process. Additionally, we granted the co-founders warrants to
purchase 450,000 shares of our common stock at a purchase price of $6.25 per
share, immediately exercisable. We recognized an expense in research and
development in process, of $1,121,502 using a Black-Scholes option-pricing
model which brings the total expense to $1,211,502 for the co-founders
settlement.
Summary
-------
We have taken the position that the payment of cash, assumption of
liabilities, issuance of stock and stock options in order to modify or
terminate liability agreements, license rights and continued development of
the CodecSys technology should be recorded as an expense because these
transactions represent costs to terminate or alter license rights, acquire or
continue development of an unproven technology. Also, we believe that to
record the transaction otherwise could be misleading to a reader of the
financial statements through recording an intangible asset for an unproven
technology. The current status of the CodecSys technology is that there have
been only few sales of the products embodying the technology. There is a
great deal of development that needs to be completed before any sales of the
product can commence in a commercially sustainable fashion. With that in mind,
we have taken the position that it is most proper to expense the above
transactions as a research and development in process expense. The summary of
expenses related to IDI and Streamware recorded in the year ending December
31, 2004 follows:
2004
-------------
Streamware stock and options $ 10,228,019
Assumption and consolidation of IDI 1,219,573
IDI Co-founders settlement (cash and options) 1,211,502
-------------
$ 12,659,094
Note 6 - Long-term Obligations
------------------------------
Senior Convertible Promissory Note
-----------------------------------
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 are due May 16,
2008 and were originally convertible into 1,200,000 shares of common stock of
the Company at a conversion price of $2.50 per share. On March 16, 2006 we
entered into a Waiver and Amendment Agreement (discussed below), which
adjusted the conversion rate to $1.50 per share. The private placement
transaction may ultimately result in gross proceeds to us of up to $13,800,000
if the additional investment rights and warrants to purchase common stock are
exercised in full. The warrants and the embedded conversion feature of the
senior secured convertible notes have been accounted for as derivatives
pursuant to EITF 00-19 and SFAS No. 133.
We 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. On March 16, 2006 we entered into a Waiver and Amendment
Agreement (discussed below), which adjusted the exercise price of both the A
and B warrants to $2.00 per share. These rights include (i) equitable
adjustments in the event the Company effects 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 the common stock; and (iii) "full ratchet" price
F-16
56
protection adjustments in the event we issue new shares of common stock or
common stock equivalents in certain transactions at a price less than $1.50
per share. In no event, however, will the conversion price or exercise price
be adjusted below $0.50 per share for the reset provision.
The conversion feature and the prepayment provision of the notes were
accounted for as embedded derivatives and valued on the transaction date using
a Black-Scholes pricing model. The warrants were accounted for as derivatives
and were valued on the transaction date using a Black-Scholes pricing model as
well. At the end of each quarterly reporting date, the values of the
derivatives are evaluated and adjusted to current fair value. The note
conversion feature and the warrants may be exercised at any time and,
therefore, have been reported as current liabilities. The prepayment
provision may not be exercised by us until May 16, 2007, and then only in
certain limited circumstances. For all periods since the issuance of the
senior secured convertible notes, the derivative value of the prepayment
provision has been nominal and has not had any offsetting effect on the
valuation of the conversion feature of the notes.
As of December 31, 2005, we recorded an aggregate derivative liability of
$3,012,000 and a derivative valuation loss of $12,000 to reflect the change in
value of the aggregate derivate liability since May 16, 2005. The aggregate
derivative liability of $3,012,000 included $1,356,000 for the conversion
feature and $1,656,000 for the warrants. These values were calculated using
the Black-Scholes pricing model with the following assumptions: (i) risk free
interest rate of 4.33%; (ii) expected life (in years) of 2.50 for the
conversion feature and 4.50 for the warrants; (iii) expected volatility of
86.46%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of
$2.25.
The principal value of $3,000,000 of the senior secured convertible notes are
being accreted over the term of the obligations, for which $624,998 was
included in interest expense for the year ended December 31, 2005. The notes
bear a 6% annual interest rate payable semi annually, and for the year ended
December 31,2005, $112,500 was included in interest expense.
The senior secured convertible notes required that we secure an effective
registration statement with the Securities and Exchange Commission within 120
days from May 16, 2005 (September 13, 2005). Section 4(a) of the senior
secured convertible notes enumerates circumstances that are considered an
event of default. The remedies for default provide that if an event of default
occurs and is continuing, the holders may declare all of the then outstanding
principal amount of the notes and any accrued and unpaid interest thereon to
be immediately due and payable in cash. In the event of an acceleration, the
amount due and owing to the holders is 125% of the outstanding principal
amount of the notes and interest on such amount is calculated using the
default rate of 18% per annum if the full amount is not paid within one
business day after acceleration. We were in default under Section 4(a)(viii),
related to the effective date of our registration statement, beginning October
13, 2005 until February 3, 2006, at which time the event of default was cured
and is no longer continuing. For the year ended December 31, 2005, we accrued
$218,000 as additional interest expense for this default.
On March 16, 2006 we entered into a Waiver and Amendment Agreement with the
four instructional investors in which the then aggregate default amount of
$284,000 was satisfied by adjusting the conversion rate on the notes from
$2.50 to $1.50. If the total sum of the $3,000,000 notes were converted it
would, result in the issuance of 2,000,000 shares of common stock of the
Company. Additionally, the exercise price of both the A and B Warrants was
lowered to $2.00 per share. As a condition of this agreement we must raise
$3,000,000 of cash financing from the sale of our securities by September 30,
2006 or we will be in default.
F-17
57
Convertible Line of Credit Promissory Note
------------------------------------------
On December 23, 2003, we entered into a convertible line of credit for up to
$1,000,000 with Meridel LTD and Pascoe Holdings LTD, both foreign
corporations. We could 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 year ended
December 31, 2004, the Company borrowed $1,095,110, making the aggregate
amount borrowed at December 31, 2004, $1,195,090. On September 30, 2004, the
lenders exercised their conversion rights and converted a total of $800,000
($400,000 each) of the $1,195,090 into 800,000 shares of common stock. The
remaining balance of the note at December 31, 2004 was $395,090.
During the year ended December 31, 2005 we borrowed $449,876 and on December
30, 2005 the lenders exercised their conversion rights and converted the
aggregate total of the note of $844,966 ($422,483 each) into 844,966 shares of
common stock of the Company. As of December 31, 2005 all amounts borrowed
pursuant to the convertible line of credit have been converted to common
stock.
The note bore an annual interest rate of 6%, however, accrued interest was
forgiven upon conversion pursuant to the terms of the line of credit. During
the year ending December 31, 2005 we recorded $68,547 as gain on early
extinguishment of debt in other income and $4,832 for the beneficial
conversion feature as an increase in interest expense. For year ended December
31, 2004, we recorded $1,095,110, as a convertible beneficial conversion
feature associated with the advances made under the line of credit. This
amount is included in interest expense.
IDI Bankruptcy Settlement
-------------------------
On May 18, 2004, the plan of reorganization for IDI was confirmed by the
United States Bankruptcy Court. As a part of this confirmation, we assumed
liabilities to be paid in cash of approximately $312,768. The approximately
$682,222 of liabilities to be paid in stock was paid prior to December 31,
2004. For the years ended December 31, 2005 and 2004, we had paid
approximately $70,187 and $67,114, respectively of the $312,768 original
obligation. The a balance remaining as of December 31, 2005 and 2004 was
approximately, $175,467 and $245,654, of which $70,187 has been recorded as
the current portion with $105,280 and $175,467, respectively as long-term
debt. See Notes to Consolidated Financial Statements, Note 5 Investment in
Interact Devices, Inc.
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 an
18-month lease, the term of which ends October 31, 2007. The lease covers
approximately 13,880 square feet of office space leased at a rate of $24,108
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 multi-year contract at a rate of $8,797 per month.
The studio lease expires on November 30, 2008. We have also entered into a
cancelable lease for 1,630 square feet of office space located at 160 Blue
Ravine, in Folsom, California 95630.This space has been used for the
development of our CodecSys technology. This lease is for a one-year term and
expires on December 31, 2006, and is leased at a rate of $2,600.00 per month.
To the extent we continue the development program in California, we do not
anticipate any problem with locating suitable space. The Company has no other
properties. The Company recognized rent expense of approximately $446,600 and
$414,400 in 2005 and 2004, respectively.
F-18
58
The Company also leases copy machines on a multi-year lease that expires on
February 25, 2007 at a minimum rate of $1,037 per month.
Future minimum payments under non-cancelable operating leases at December 31,
2005 are as follow:
2006 $433,100
2007 351,400
2008 99,600
--------
$884,100
Note 8 - Income Taxes
---------------------
The (expense) benefit for income taxes differs from the amount computed at the
federal statutory rates as follows:
Years Ended
December 31,
2004 2005
--------------- -------------
Federal income tax (expense)
benefit at statutory rates $ 5,326,000 $ 1,869,500
State income tax (expense)
benefit at statutory rates 824,000 98,395
Options issued in contract terminations (1,855,000) -
Other 81,000 -
Change in valuation allowance (4,376,000) (1,967,895)
--------------- -------------
$ - $ -
=============== =============
Deferred tax assets (liabilities) consist of the following:
December 31,
-----------------------------
2004 2005
--------------- -------------
Assets:
Net operating loss carryforwards $ 6,795,000 $ 7,897,996
General business and AMT
credit carryforwards 226,000 226,000
Deferred compensation 224,000 309,900
Impairment of investment 804,000 -
Depreciation 58,000 42,585
--------------- -------------
Total deferred tax assets $ 8,107,000 $ 8,476,481
=============== =============
Liabilities
Depreciation (24,000) -
--------------- -------------
Total deferred tax liabilities $ (24,000) $ -
=============== =============
Net deferred tax assets and liabilities 8,083,000 8,476,481
Valuation allowance (8,083,000) (8,476,481)
--------------- -------------
Total, net deferred tax assets $ - $ -
=============== =============
F-19
59
We have net operating loss carryforwards for tax purposes of approximately
$20,000,000 at December 31, 2005 available to offset future taxable income
which begin to expire in 2006. Should a change of more than 50 percent in the
our ownership occur, any future benefits from such carryforwards may be
substantially lost. During the year ended December 31, 2003, we had a change
of over 50% ownership due to the reverse acquisition of Laser Corporation.
Therefore, net operating losses of approximately $2,253,000 were excluded from
future use and are excluded from the $20,000,000 noted above. At December 31,
2005, a valuation allowance has been established for the net deferred tax
asset due to the unce rtainty of realization.
Note 9 - Preferred and Common Stock
------------------------------------
We have authorized two classes of stock, preferred stock with no par value and
common stock with a $.05 par value. No preferred stock has been issued, while
21,872,089 shares of common stock were issued and outstanding at December 31,
2005. 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.
Private Placements Memorandums
------------------------------
At different times during the years ended December 31, 2005 and 2004, we
entered into various private placement transactions with qualified investors
pursuant to which we sold 41,666 and 155,807 shares of common stock resulting
in $124,980 and $489,920 in proceeds, respectively. Included in the sales
during 2005 and 2004 were 33,333 and 99,974 shares sold to Broadcast
International, LTD representing $99,980 and $299,920 in proceeds,
respectively. In each of the transactions, each purchased share included an
attached warrant to acquire one share of our common stock within one year at a
purchase price of $.50 per share greater than the subscription price of the
share purchased. We intend to seek additional funding on similar or even
unrelated terms and conditions.
Note 10 - Stock Option Plan
---------------------------
We have adopted a stock option plan available to its employees. Options to
purchase shares of common stock of the Company are granted at a price not less
than 100% of the estimated market price on the date granted. Options generally
may not be exercised until twelve months after the date granted and expire ten
years after being granted except to stockholders who own greater than 10% of
the outstanding shares of the Company, for whom options expire 5 years after
being granted. Options granted generally vest on a three-year vesting
schedule, after the first year vesting at the rate of one-third each year.
Should an employee terminate before the vesting period is completed, the
unvested portion of each grant is forfeit. The information presented is shown
as though the 10:1 reverse split of January 13, 2004 had been completed at
January 1, 2004. The following table summarizes option and warrant activity
during the years ended December 31, 2004 and 2005.
F-20
60
Options
and Warrants Options or Warrants
Outstanding Price Per Share
------------- -------------------
Outstanding at January 1, 2004 2,969,024
Options granted 258,000 4.00 - 6.05
Warrants issued 3,395,807 3.50 - 6.25
Expired (600) 16.88 - 45.90
Forfeited (202,924) .33 - 4.00
Exercised (3,657) .55 - 1.00
-------------
Outstanding at December, 31, 2004 6,415,650 $ 0.02 - 45.90
Options granted 605,000 2.25 - 3.30
Warrants issued 1,361,667 2.50 - 4.00
Expired (134,107) 3.50 - 45.90
Forfeited (5,463) .33 - 4.00
Exercised (120,000) 2.50 - 2.50
-------------
Outstanding at December, 31, 2005 8,122,747 $ 0.02 - 45.90
=============
The following table summarizes information about stock options and warrants
outstanding at December 31, 2005.
Outstanding Exercisable
---------------------------------------------------------------
Weighted
Average Weighted Weighted
Range of Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Prices Outstanding Life(years) Price Exercisable Price
------------- ------------- ------------ ----------- ------------- ----------
$ 0.02 1,524,168 4.25 $ 0.02 1,524,168 $ 0.02
0.04 248,383 4.58 0.04 248,383 0.04
0.33-0.55 989,229 6.86 0.53 756,981 0.52
3.50-6.25 5,356,167 2.72 4.23 4,891,500 4.28
9.50-11.50 2,800 4.28 10.61 2,800 10.61
36.25-45.90 2,000 3.82 40.11 2,000 40.11
------------- ------------- ------------ ----------- ------------- ----------
$.02 - 45.90 8,122,747 3.57 $ 2.87 7,425,832 $ 2.89
=============================================================================
Note 11 - 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. We match contributions up to 100% of the
first 3% of 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 31,2005 and
2004, we made matching contributions totaling $65,209 and $68,543,
respectively.
Note 12 - First Securities ASA
-------------------------------
We 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
common stock of the Company on the Oslo Stock Exchange. The agreement
contemplated, among other things, that we would 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
F-21
61
listing by the Oslo Stock Exchange and the interest for our shares in the
capital markets. We paid a retainer of $200,000 to First Securities and have
incurred $222,951 of additional expenses. All expenses have been included in
general and administrative expense. We have decided to terminate the proposed
initial public offering but continue to consider private financing
opportunities through First Securities.
Note 13 - Supplemental cash flow information
--------------------------------------------
2005
----
.. 354,272 shares of common stock valued at $1,392,770 were issued as
compensation for services rendered by consultants. Of the 354,272
shares issued, 47,272 resulted from a cashless exercise options made
available from 120,000 warrants issued to purchase common stock of the
company at an exercise price of $2.50 per share. Of the $1,392,770,
$235,170 was for services rendered immediately while $1,157,600 was for
services rendered over a period of time or were the result of costs
associated with our senior convertible debt, therefore they have been
recorded as prepaid expense to be recognized over the length of each
individual contract. As of December 31, 2005 the following indicates the
expected pre-paid consulting expense to be recognized and included in
general and administrative expense:
Year Amount
---- ----------
2005 $ 288,167
2006 563,908
2007 222,197
2008 83,328
----------
Total $1,157,600
.. A non-cash research and development in process expense of $288,018 was
recorded for warrants to purchase 1) 130,000 shares of common stock of
the Company at an exercise price of $2.95 per share, issued to a
consultant for the rights to use their patent pending technology and 2)
100,000 shares of common stock of the Company, vesting over a 3-year
period, at an exercise price of $2.55 per share, issued to two
individuals serving on our Technology Committee for work performed in
enhancing and evaluating the CodecSys technology. A total value
$227,000 for these warrants was determined using a Black-Scholes pricing
model with the Company recording an $18,918 expense in research and
development in process for the year ending 2005.
.. $4,832 of beneficial conversion feature expense was recognized on the
convertible line of credit, which was recorded as an increase to
additional paid-in capital and interest expense. Additionally, we
recognized $68,547 of gain on extinguishment of debt as other income and
a reduction in additional paid-in capital. See Note 6.
.. A non-cash expense of $624,998 was recorded for the accretion of the
senior convertible debt as interest expense. See Note 6.
.. A non-cash loss of $18,000 was recorded in other income expenses part
of the valuation of the embedded derivative associated with the senior
convertible debt. See Note 6.
.. 844,966 shares were issued to satisfy $844,966 of debt on the
convertible line of credit. See Note 6.
.. 22,801 shares of common stock of were returned by former debt holders of
IDI. See Note 5.
F-22
62
2004
-----
.. A non-cash expense of $916,996 was recorded in administrative and
general expense for 1) $792,563 of services rendered by consultants and
compensated by the issuance of 165,000 shares of common stock, and 2)
$124,433 for 44,444 shares of common stock issued to a licensor to
terminate an existing license agreement and initiate a distributor
agreement with a foreign corporation for exclusive distributor rights in
certain Central American areas and non-exclusive distributor rights
elsewhere.
.. A non-cash research and development in process expense of $11,439,520
was recorded for 1) $90,000 liability assumed and $1,121,502 fair value
of options issued pursuant to a settlement agreement with the
co-founders of IDI, 2) $10,228,019 in stock and options issued to
Streamware, and 3) $1,219,573 assumption and consolidation of IDI. See
Note 5.
.. 800,000 shares were issued to satisfy $800,000 of debt on the
convertible line of credit. See Note 6.
.. $1,095,110 of beneficial conversion feature expense was recognized on
the convertible line of credit, which was recorded as an increase to
additional paid-in capital and interest expense. See Note 6.
.. The Company paid $682,222 of the bankruptcy liability assumed from IDI
by issuing 111,842 shares of common stock. See Note 6.
Note 14 - Recent Accounting Pronouncements
------------------------------------------
In December 2003, the FASB issued Interpretation No. 46 ("FIN 46R") (revised
December 2003), Consolidation of Variable Interest Entities, an Interpretation
of Accounting Research Bulletin No. 51 ("ARB 51"), which addresses how a
business enterprise should evaluate whether it has a controlling interest in
an entity though means other than voting rights and accordingly should
consolidate the entity. FIN 46R replaces FASB Interpretation No. 46 ("FIN
46"), which was issued in January 2003. Before concluding that it is
appropriate to apply ARB 51 voting interest consolidation model to an entity,
an enterprise must first determine that the entity is not a variable interest
entity . As of the effective date of FIN 46R, an enterprise must evaluate its
involvement with all entities or legal structures created before February 1,
2003, to determine whether consolidation requirements of FIN 46R apply to
those entities. There is no grandfathering of existing entities. Public
companies must apply either FIN 46 or FIN 46R immediately to entities created
after January 31, 2003 and no later than the end of the first reporting period
that ends after March 15, 2004. The adoption of FIN 46 had no effect on the
Company's consolidated financial position, results of operations or cash
flows.
In December 2003, the Securities and Exchange Commission ("SEC") issued Staff
Accounting Bulletin ("SAB") No. 104, Revenue Recognition. SAB 104 revises or
rescinds portions of the interpretive guidance included in Topic 13 of the
codification of staff accounting bulletins in order to make this interpretive
guidance consistent with current authoritative accounting and auditing
guidance and SEC rules and regulations. The adoption of SAB 104 did not have a
material effect on the Company's results of operations or financial condition
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 financial position or
results of operations.
F-23
63
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
issuers 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. 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 2 of our Notes to Consolidated Financial Statements 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 years beginning
after December 15, 2005.
In June 2005, the Emerging Issues Task Force 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. We do not expect the adoption of EITF 04-5 will have a
material impact on our consolidated financial position, results of operations
or cash flows.
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. We do not expect the adoption of EITF 05-2 will
have a material impact on our consolidated financial position, results of
operations or cash flows.
F-24
64
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. We do not expect the adoption of EITF 05-6
will have a material impact on our consolidated financial position, results of
operations or cash flows.
Note 15 -Subsequent Events
---------------------------
Video Processing Technologies Inc. Acquisition
-----------------------------------------------
On January 27, 2006 we acquired 100% of the common stock of Video Processing
Technologies Inc. (VPTI) in exchange for an aggregate of 944,063 shares of
common stock of the company. VPTI had no revenues in 2005 or 2006 prior to the
acquisition. Prior to this acquisition VPTI had entered into a license
agreement with the University of California, San Diego, related to certain
patent pending technology which management of Company anticipates
incorporating into the CODECSYS technology.
Private Placements Memorandum
-----------------------------
On February 27, 2006 the Board of Directors approved a Private Placement
Offering in anticipation of raising up to $4,500,000 by selling 3,000,000
shares of common stock of the Company at a price of $1.50 per share.
Additionally, the holder of each share shall receive a warrant to acquire one
share of common stock of the Company. The warrants have a three-year exercise
period and are exercisable at a $2.00 exercise price. As of March 23, 2006 we
have raised proceeds of $456,185 from the sale of 304,123 shares of stock.
Waiver and Amendment Agreement
-------------------------------
On March 16, 2006, we entered into a waiver and amendment agreement with the
four institutional funds regarding our default under the forbearance
agreement. Under the terms of the waiver, the institutional funds terminated
the forbearance agreement and waived any and all defaults under the senior
secured convertible notes and related transaction agreements. In
consideration of the waiver, we and the funds agreed to amend the transaction
agreements as follows: (i) Section 3.12 of the securities purchase agreement
was deleted, which provision gave the funds a preemptive right to acquire any
new securities issued by us; (ii) Section 3.15(c) of the securities purchase
agreement was deleted, which provision prohibited us from completing a private
equity or equity-linked financing; (iii) the conversion price, at which the
notes are convertible into common shares of the Company, was amended to be
$1.50 instead of $2.50; (iv) the exercise price, at which all warrants (A
warrants and B warrants) held by the funds are exercisable, was changed to
$2.00; and (v) the notes were amended by adding a new event of default, which
is that if we fail to raise and receive at least $3,000,000 in cash net
proceeds through one or more private or public placements of its securities by
September 30, 2006, we are in default under the notes.
F-25
65
Dates Referenced Herein and Documents Incorporated by Reference
| Referenced-On Page |
|---|
| This ‘10KSB’ Filing | | Date | | First | | Last | | | Other Filings |
|---|
| |  |
| | 11/30/08 | | 16 | | 60 |
| | 5/16/08 | | 24 | | 58 |
| | 10/31/07 | | 16 | | 60 |
| | 5/16/07 | | 59 |
| | 2/25/07 | | 61 |
| | 12/31/06 | | 16 | | 60 | | | 10-K, 10-K/A, NT 10-K |
| | 10/3/06 | | 35 |
| | 9/30/06 | | 11 | | 67 | | | 10-Q |
| Filed as of: | | 4/3/06 | | | | | | | NT 10-K |
| | 4/1/06 | | 60 |
| Filed on: | | 3/31/06 | | 42 | | | | | 10-Q, NT 10-K |
| | 3/27/06 | | 43 |
| | 3/23/06 | | 55 | | 67 | | | 424B3 |
| | 3/20/06 | | 40 | | | | | 8-K |
| | 3/16/06 | | 18 | | 67 | | | 8-K |
| | 3/15/06 | | 1 | | 37 |
| | 3/2/06 | | 1 |
| | 2/27/06 | | 67 | | | | | 4 |
| | 2/6/06 | | 56 |
| | 2/3/06 | | 24 | | 59 |
| | 1/27/06 | | 67 |
| | 1/17/06 | | 29 |
| For Period End: | | 12/31/05 | | 1 | | 64 | | | NT 10-K |
| | 12/30/05 | | 60 |
| | 12/15/05 | | 27 | | 66 |
| | 12/6/05 | | 40 | | | | | 8-K |
| | 11/30/05 | | 40 | | | | | 8-K |
| | 11/16/05 | | 24 |
| | 10/17/05 | | 40 | | | | | 8-K |
| | 10/13/05 | | 59 | | | | | 4 |
| | 10/11/05 | | 26 | | 63 | | | S-3/A |
| | 9/14/05 | | 19 |
| | 9/13/05 | | 59 | | | | | 4 |
| | 8/29/05 | | 19 |
| | 8/12/05 | | 38 | | | | | 10QSB |
| | 8/3/05 | | 19 |
| | 6/30/05 | | 38 | | | | | 10QSB, 10QSB/A |
| | 6/29/05 | | 28 | | 67 |
| | 6/22/05 | | 26 |
| | 6/15/05 | | 27 | | 65 |
| | 6/1/05 | | 19 |
| | 5/16/05 | | 18 | | 59 | | | 10QSB, 8-K |
| | 4/1/05 | | 40 | | | | | 10KSB |
| | 3/31/05 | | 60 | | | | | 10QSB, NT 10-K |
| | 2/18/05 | | 44 |
| | 12/31/04 | | 22 | | 62 | | | 10KSB, 10KSB/A, NT 10-K |
| | 9/30/04 | | 60 | | | | | 10QSB |
| | 9/1/04 | | 57 |
| | 6/30/04 | | 24 | | 60 | | | 10QSB, NT 10-Q |
| | 5/18/04 | | 3 | | 60 |
| | 5/12/04 | | 39 | | | | | 10QSB |
| | 4/28/04 | | 39 | | | | | 4 |
| | 3/31/04 | | 39 | | | | | 10QSB |
| | 3/30/04 | | 39 | | 40 | | | 10KSB |
| | 3/15/04 | | 27 | | 65 |
| | 3/4/04 | | 56 |
| | 2/26/04 | | 40 |
| | 2/6/04 | | 39 | | 56 |
| | 1/13/04 | | 3 | | 62 | | | DEF 14C |
| | 1/1/04 | | 51 | | 62 |
| | 12/31/03 | | 33 | | 62 | | | 10KSB |
| | 12/23/03 | | 24 | | 60 |
| | 10/23/03 | | 32 | | 56 |
| | 10/1/03 | | 3 | | 51 | | | 3, 8-K, 8-K/A |
| | 4/1/03 | | 56 |
| | 2/1/03 | | 27 | | 65 |
| | 1/31/03 | | 27 | | 65 |
| | 4/26/02 | | 56 |
| | 9/30/01 | | 9 | | | | | 10QSB |
| List all Filings |
1 Subsequent Filing that References this Filing
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