UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, DC 20549  FORM 10-Q  S Quarterly report
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  For the quarterly period
ended September 30, 2008  OR  £ Transition report
pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934  For the transition
period from ________ to ________  Commission File
No.0-13316  BROADCAST INTERNATIONAL, INC. (Exact name of
registrant as specified in its charter)  Utah

87-0395567(State or other
jurisdiction of

(IRS
Employerincorporation or
organization)

Identification
No.)  7050 Union Park Ave.
#600, Salt Lake City, Utah 84047 (Address of principal
executive offices and zip code)  (801)
562-2252 (Registrants telephone
number, including area code)  Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements
for the past 90 days. Yes  S
    No £  Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See definitions of  large
accelerated filer,  accelerated filer, and smaller reporting company
in Rule 12b-2 of the Exchange Act.  £Large accelerated filer£Accelerated filer£Non-accelerated filerSSmaller
reporting company  Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)
 Yes   £
   No   S  Indicate the number of shares
outstanding of each of the registrants classes of common stock, as of the
latest practicable date:  Class
Outstanding as
of October  31, 2008Common Stock, $.05
par value
38,671,252
shares  1


Broadcast International, Inc. Form 10-Q  Table of Contents  Part
I - Financial Information Page Item
1.   Financial Statements 3 Item
2.   Managements Discussion and Analysis of Financial Condition and
Results of Operations 22 Item
3.   Quantitative and Qualitative Disclosures about Market Risk 29 Item
4T. Controls and Procedures 29 Part
II -Other Information Item
1.   Legal Proceedings 30 Item
1A. Risk Factors 30 Item
2.   Unregistered Sales of Equity Securities and Use of Proceeds 30 Item
3.   Defaults Upon Senior Securities 30 Item
4.   Submission of Matters to a Vote of Security Holders 30 Item
5.   Other Information 31 Item
6.   Exhibits 32 Signatures 34        2    Item
1. Financial Information    BROADCAST
INTERNATIONAL, INC. CONDENSED
CONSOLIDATED BALANCE SHEETS  December
31,

September
30,2007

2008(Unaudited)ASSETS:Current assetsCash
and cash equivalents
$
16,598,300
$
6,714,626Trade
accounts receivable, net

220,834

432,539Inventory

57,218

21,811Prepaid
expenses

2,449,236

913,717Total current assets

19,325,588

8,082,693Property and equipment,
net

641,314

1,959,183Other assetsDebt
offering Costs

1,367,583

1,021,275Patents,
net

197,346

194,302Available-for-sale
securities (note 7)

--

2,554,597Deposits
and other assets

8,795

9,058Total other assets

1,573,724

3,779,232Total assets
$
21,540,626
$
13,821,108 See accompanying notes to consolidated financial statements.      3    BROADCAST
INTERNATIONAL, INC. CONDENSED
CONSOLIDATED BALANCE SHEETS (Continued)  December
31,

September
30,2007

2008LIABILITIES:



(Unaudited)Current liabilitiesAccounts
payable
$
640,292
$
654,818Payroll
and related expenses

460,236

514,596Other
accrued expenses

55,356

181,136Unearned
revenue

169,359

9,626Current
debt obligations

47,692

--Derivative
valuation

14,267,600

11,871,400Total current
liabilities

15,640,535

13,231,576Long-term liabilitiesConvertible
debt (net of $13,068,755 and $9,675,278discount,
respectively)

2,931,245

6,324,722Total liabilities

18,571,780

19,556,298Commitments and contingenciesSTOCKHOLDERS EQUITY:Preferred
stock, no par value, 20,000,000 sharesauthorized;
none issued

-

-Common stock,
$.05 par value, 180,000,000 sharesauthorized;
37,775,034 and 38,662,585 shares issuedas
of December 31, 2007 and September 30, 2008,respectively

1,888,752

1,933,129Additional paid-in
capital

69,078,449

72,983,036Accumulated other comprehensive
loss

-

(245,403)Subscriptions receivable

(25,000)

-Accumulated deficit

(67,973,355)

(80,405,952)Total stockholders equity
(deficit)

2,968,846

(5,735,190)Total liabilities and
stockholders equity (deficit)
$
21,540,626
$
13,821,108 See accompanying notes to consolidated financial statements.     4    BROADCAST
INTERNATIONAL, INC. CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)  For the three months ended

For the nine months endedSeptember 30,

September 302007

2008

2007

2008Net
sales
$
834,320
$
761,572
$
3,197,170
$
2,759,767Cost
of sales

819,821

913,295

3,215,431

3,018,600Gross
profit (loss)

14,499

(151,723)

(18,261)

(258,833)Operating
expenses:Administrative
and general

1,542,058

1,755,844

4,291,635

4,744,585Selling
and marketing

103,135

359,904

412,570

962,405Research
and development

301,216

1,410,308

814,920

3,239,094Impairment
of license rights

-

-

1,142,400

-Total
operating expenses

1,946,409

3,526,056

6,661,525

8,946,084Total
operating loss

(1,931,910)

(3,677,779)

(6,679,786)

(9,204,917)Other
income (expense):Interest
income

3,303

53,714

15,881

318,003Interest
expense

(365,354)

(1,492,785)

(1,492,193)

(4,487,362)Derivative
valuation gain (loss)

(4,679,000)

(3,929,100)

(4,350,910)

934,723Other
income (expense), net

(8,205)

11,290

(8,555)

6,956Total
other income (expense)

(5,049,256)

(5,356,881)

(5,835,777)

(3,227,680)Loss
before income taxes

(6,981,166)

(9,034,660)

(12,515,563)

(12,432,597)Provision
for income taxes

--

--

--

--Net
loss
$
(6,981,166)
$
(9,034,660)
$
(12,515,563)
$
(12,432,597)Net
loss per share  basic & diluted
$
(0.23)
$
(0.23)
$
(0.42)
$
(0.32)Weighted
average shares  basic & diluted

30,584,600

38,641.500

29,531,300

38,452,800    See accompanying notes
to consolidated financial statements.       5    BROADCAST
INTERNATIONAL, INC. CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)  Nine Months
EndedSeptember
30,2007

2008Cash flows from operating
activities:Net loss
$
(12,515,563)
$
(12,432,597)Adjustments to reconcile net
loss to
net cash used in operating
activities:Depreciation
and amortization

163,560

351,332Common
stock issued for services

--

192,990Common
stock issued for in process research and development

--

75,501Accretion
of discount on convertible notes payable

733,335

3,394,234Stock-based
compensation

1,683,127

742,701Gain on
sale of assets

(5,100)

(363)Derivative
liability valuation

4,350,910

(934,723)Impairment
of license rights

1,142,400

--Extinguishment
of debt

365,624

6,056Allowance
for doubtful accounts

29,128

197,922Changes in assets and
liabilities:Accounts
receivable

601,566

(409,627)Inventories

(32,406)

35,407Debt
offering costs

256,554

346,308Prepaid
and other assets

1,672,203

2,023,256Accounts
payable and accrued expenses

6,075

106,613Deferred
revenues

(334,318)

(159,733)Net
cash used in operating activities

(1,882,905)

(6,464,723)Cash flows from investing
activities:Purchase of equipment

(57,092)

(1,589,623)Purchase of available-for-sale
securities

--

(11,600,000)Proceeds from sale of
available-for-sale securities

--

8,800,000Proceeds from sale of
assets

5,100

11,882Net
cash used in investing activities

(51,992)

(4,377,741)Cash flows from financing
activities:Proceeds from the exercise of
warrants

--

933,040Principal payments on
debt

(630,477)

--Proceeds from subscription
receivable

--

25,000Proceeds from the exercise of
options

--

750Proceeds for the sale of stock

1,802,999

--Loan proceeds

299,948

--Net
cash provided by financing activities

1,472,470

958,790Net decrease in cash and cash
equivalents

(462,427)

(9,883,674)Cash and cash equivalents,
beginning of period

807,741

16,598,300Cash and cash equivalents, end
of period
$
345,314
$
6,714,626  See accompanying notes
to consolidated financial statements.    6    BROADCAST
INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) September 30,
2008  NOTE 1 - BASIS OF
PRESENTATION  In the opinion of management, the
accompanying unaudited condensed consolidated financial statements of Broadcast
International, Inc. (we or the Company) contain the adjustments, all of
which are of a normal recurring nature, necessary to present fairly our
financial position at December 31, 2007 and September 30, 2008 and the results
of operations for the three and nine months ended September 30, 2007 and 2008,
respectively, with the cash flows for each of the nine month periods ended
September 30, 2007 and 2008, in conformity with U.S. generally accepted
accounting principles.  These condensed consolidated
financial statements should be read in conjunction with the audited consolidated
financial statements and related notes included in our Annual Report on Form
10-K for the year ended December 31, 2007.  Operating results for the three
and nine months ended September 30, 2008 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2008.  NOTE 2 - RECLASSIFICATIONS  Certain 2007 financial statement
amounts have been reclassified to conform to 2008 presentations.  NOTE 3 - WEIGHTED AVERAGE
SHARES  The computation of basic earnings
(loss) per common share is based on the weighted average number of shares
outstanding during each period.  The computation of diluted earnings per
common share is based on the weighted average number of common shares
outstanding during the period, plus the common stock equivalents that would
arise from the exercise of stock options and warrants outstanding, using the
treasury stock method and the average market price per share during the period,
plus the effect of assuming conversion of the convertible debt.  Options and warrants to purchase
16,064,057 and 15,819,837 shares of common stock at prices ranging from $.02 to
$45.90 per share were outstanding at September 30, 2008 and 2007, respectively,
but were excluded from the calculation of diluted earnings per share because the
effect of the stock options and warrants was anti-dilutive. Furthermore, the
Company had convertible debt that was convertible into 3,418,961 shares of
common stock at September 30, 2008, that was excluded from the calculation of
diluted earnings per share because the effect was anti-dilutive.  NOTE 4 - STOCK COMPENSATION  Beginning on January 1, 2006, we
began accounting for stock-based compensation   under the provisions
of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment
(FAS 123R), which requires the recognition of the fair value of stock-based
compensation. We have used the modified prospective application. Under the fair
value recognition provisions for FAS 123R, stock-based compensation cost is
estimated at the grant date based on the fair value of the awards expected to
vest and recognized as expense ratably over the requisite service period of the
award.  We have used the Black-Scholes valuation model to estimate fair
value of our stock-based awards, which requires various judgmental assumptions
including estimated stock price volatility, forfeiture rates, and expected life.
 Our computation of expected volatility is based on a combination of
historical and market-based implied volatility.  We calculated the fair market value
of each option and warrant awarded on the date of grant using the Black-Scholes
option-pricing model. The following assumptions were used for the grants awarded
for nine months ended September 30, 2008.  Risk-free interest rate
2.17% - 3.99%Expected lives in years
1.40 - 10.0Dividend yield
0Expected volatility
76.73% -
86.96%     7    Net loss for the nine months ended
September 30, 2008 and 2007 includes $742,701 and $1,683,127, respectively, of
non-cash stock-based compensation expense. Options issued to directors vest
immediately and all other options and warrants are subject to applicable vesting
schedules. Expense is recognized proportionally as each grant vests.  Included in the $742,701 of non-cash
stock based compensation expense for the nine months ended September 30, 2008 is
(i) $173,105 for the vested portion of 496,500 options granted to seventeen
employees, (ii) $217,532 for the vested portion of 400,000 warrants granted to
three consultants, (iii) $370,193 resulting from the vesting of unexpired
options and warrants issued prior to January 1, 2008, and (iv) $18,129 credit
for recovery of previously recorded expense of unvested options forfeited during
the period.  Included in the $1,683,127 of
non-cash stock based compensation expense for the nine months ended September
30, 2007 is (i) $959,000 resulting from 1,100,000 options granted to three
directors, (ii) $349,805 resulting from the vesting of unexpired options and
warrants issued prior to January 1, 2007, (iii) $293,550 resulting from
1,090,000 warrants issued to five consultants, of which 500,000 warrants were
issued to a current member of our board of directors prior to him becoming a
member of the board, (iv) 1,000,000 warrants were issued to an additional
consultant, however, no services were rendered and the warrants were forfeited
by the consultant, (v) $70,412 resulting from the issuance of 366,500 options
issued to non-executive management employees, and (vi) $10,360 for repriced
options previously granted to executive management. Warrants to acquire
1,202,003 shares of our common stock were also granted to certain equity
investors.  The impact on our results of
operations for recording stock-based compensation under FAS 123R for the three
and nine months ended September 30, 2007 and 2008 are as follows:  For the three months ended

For the nine months endedSeptember 30,

September 30,2007

2008

2007

2008General
and administrative
$
20,529
$
271,551
$
1,503,986
$
445,720Research
and development

63,168

120,382

179,141

296,981Total
$
683,697
$
391,933
$
1,683,127
$
742,701  Due to unexercised options and
warrants outstanding at September 30, 2008, we will recognize an aggregate total
of $2,551,910 of compensation expense over the next four years for employees and
consultants as a result of the adoption of FAS 123R based upon option and
warrant award vesting parameters as shown below:  2008
$
         
 1,138,8252009
773,7532010
509,6642011
129,668Total
$
      
    2,551,910     8   The
following unaudited tables summarize option and warrant activity during the nine
months ended September 30, 2008.  Options and
Warrants
Outstanding

Options or
Warrants
Price Per
ShareOutstanding at December 31,
2007
16,034,019

$     
 0.02

$   45.90Options
granted
496,500

2.50

3.45Warrants
issued
400,000

2.94

3.35Expired
--

--

--Forfeited
(259,804)

0.33

4.00Exercised
(606,658)

0.33

2.00Outstanding at September 30,
2008
16,064,057

$  
    0.02

$   45.90  The
following table summarizes information about stock options and warrants
outstanding at September 30, 2008.  Outstanding
ExercisableWeighted
Average
Remaining

Weighted
Average


Weighted
AverageRange of
Exercise
Prices
Number
Outstanding
Contractual
Life
(years)

Exercise
Price
Number
Exercisable

Exercise
Price$
0.02-0.04
1,264,495
1.56
$
0.03
1,264,495
$
0.030.33-0.95
1,667,481
6.09

0.72
1,500,814

0.701.06-6.25
13,128,481
3.04

2.51
12,356,314

2.549.50-11.50
2,000
2.77

10.65
2,000

10.6536.25-45.90
1,600
1.92

41.08
1,600

41.08$
0.02-45.90
16,064,057
3.24
$
2.13
15,125,223
$
2.15   NOTE 5- 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 September 30, 2008 and 2007, we
had bank balances in the excess of amounts insured by the Federal Deposit
Insurance Corporation. We have not experienced any losses in such accounts, and
believe we are not exposed to any significant credit risk on cash and cash
equivalents. Current
financial market conditions have had the effect of restricting liquidity of cash
management investments and have increased the risk of even the most liquid
investments and the viability of some financial institutions.  We do not
believe, however, that these conditions will materially affect our business or
our ability to meet our obligations or pursue our business plans.    9    Account
Receivables Included in
our $432,539 and $220,834 net accounts receivable for the nine months ended
September 30, 2008 and year ended December 31, 2007, respectively, were (i)
$12,626 and $35,106 of unbilled trade receivables and (ii) $213 and $5,421 for
employee travel advances and other receivables, respectively.  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 United States and
international patents on the CodecSys technology, and are amortized on a
straight-line basis over their useful life of approximately 20 years.
 We have filed several patents in the United States and foreign countries.
As of September 30, 2008, the United States Patent and Trademark Office had
approved 2 patents.  Additionally, seven foreign countries had approved
patent rights.  While we are unsure whether we can develop the technology
in order to obtain the full benefits, the patents themselves hold value and
could be sold to companies with more resources to complete the development.
On-going legal expenses incurred for patent follow-up have been expensed from
July 2005 forward. Amortization
expense recognized on all patents totaled $1,054 and $3,044 for the three and
nine months ended September 30, 2008, respectively. Amortization expense
recognized on all patents totaled $673 and $2,084 for the three and nine months
ended September 30, 2007, respectively. Estimated
amortization expense for each of the next five years is as follows: Year ending December 31:2008
$    10,4862009
10,4862010
10,4862011
10,4862012
10,486 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.    10   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 selling price
to our customers is fixed and determinable with required documentation, and
collectability is reasonably assured. We recognize as deferred revenue, payments
made in advance by customers for services not yet provided. When we
enter into a multi-year contract with a customer to provide installation,
network management, satellite transponder and help desk, or combination of these
services, we recognize this revenue as services are performed and as equipment
is sold.  These agreements typically provide for additional fees, as
needed, to be charged if on-site visits are required by the customer in order to
ensure that each customer location is able to receive network communication. As
these on-site visits are performed the associated revenue and cost are
recognized in the period the work is completed. If we install, for an additional
fee, new or replacement equipment to an immaterial number of new customer
locations, and the equipment immediately becomes the property of the customer,
the associated revenue and cost are recorded in the period in which the work is
completed. Research
and Development Research and
development costs are expensed when incurred.  We expensed $1,410,308, and
$3,239,094 of research and development costs for the three and nine months ended
September 30, 2008 and $301,216 and $814,920 for the three and nine months ended
September 30, 2007, respectively. Concentration
of Credit Risk Financial
instruments, which potentially subject us to concentration of credit risk,
consist primarily of trade accounts receivable. In the normal course of
business, we provide credit terms to our customers. Accordingly, we perform
ongoing credit evaluations of our customers and maintain allowances for possible
losses which, when realized, have been within the range of managements
expectations. For the nine
months ended September 30, 2008, we had 4 customers that individually
constituted greater than 10% of our total revenues, which represented 26%, 12%,
12% and 10% of our revenues, respectively.  For the nine months ended
September 30, 2007, we had 3 customers that individually constituted greater
than 10% of our total revenues, which represented 21%, 21% and 20% of our
revenues, respectively. Only one of these customers in 2008 was the same
customer as in 2007. 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. Off-Balance
Sheet Arrangements We have no
off-balance sheet arrangements.    11   NOTE
6 - LONG TERM OBLIGATIONS Senior
Secured 6.25% Convertible Note On December
24, 2007, we entered into a securities purchase agreement in which we raised
$15,000,000 (less $937,000 of prepaid interest).  We are using the proceeds
from this financing to support our CodecSys commercialization and development
and for general working capital purposes.  Pursuant to the financing, we
issued a senior secured convertible note in the principal amount of $15,000,000,
which is due December 21, 2010 and bears interest at 6.25% per annum.
 Interest for the first year was prepaid at closing.  Interest-only
payments thereafter in the amount of $234,375 are due quarterly and commence in
April 2009.  Interest payments may be made through issuance of common stock
in certain circumstances.  The note is convertible into 2,752,294 shares of
our common stock, at a conversion price of $5.45 per share, convertible any time
during the term of the note.  We have granted a first priority security
interest in all of our property and assets and of our subsidiaries to secure our
obligations under the note and related transaction agreements. In
connection with the financing, the senior secured convertible note holder
received warrants to acquire 1,875,000 shares of our common stock exercisable at
$5.00 per share.  The warrants are exercisable any time for a five-year
period beginning on the date of grant.  We also issued to the convertible
note holder 1,000,000 shares of our common stock valued at $3,750,000 and
incurred an additional $1,377,000 for commissions, finders fees and other
transaction expenses, including the grant of a three-year warrant to purchase
112,500 shares of our common stock to a third party at an exercise price of
$3.75 per share, valued at $252,000.  A total of $1,377,000 was included in
debt offering costs and is being amortized over the term of the note.  The
warrants and the embedded conversion feature and prepayment provision of the
senior secured convertible notes have been accounted for as derivatives pursuant
to EITF 00-19 and SFAS No. 133. The $5.45
conversion price of the senior secured convertible note and the $5.00 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 $5.45 per share. 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 calculated using a Black-Scholes pricing model 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 senior
secured convertible note contains a prepayment provision allowing us to prepay,
in certain limited circumstances, all or a portion of the note.  The
portion of the note subject to prepayment must be purchased at a price equal to
the greater of (i) 135% of the amount to be purchased and (ii) the company
option redemption price, as defined in the note.  Even if we elect to
prepay the note, the note holder may still convert any portion of the note being
prepaid pursuant to the conversion feature thereof. We also
entered into a registration rights agreement with the holder of the senior
secured convertible note pursuant to which we agreed to provide certain
registration rights with respect to the shares of common stock, the shares of
common stock issuable upon conversion of the note, the shares of common stock
issuable as interest shares under the note and shares of common stock issuable
upon exercise of the warrant under the Securities Act of 1933, as amended (the
Securities Act).  The holder is entitled to demand registration of the
above-mentioned shares of common stock after six months from the closing of the
securities purchase agreement in certain circumstances. The
securities purchase agreement under which the senior secured convertible note
and related securities were issued contains, among other things, covenants that
may restrict our ability to obtain additional capital, to declare or pay a
dividend or to engage in other business activities.  A breach of any of
these covenants could result in a default under our senior secured convertible
note, in which event the holder of the note could elect to declare all amounts
outstanding to be immediately due and payable, which would require us to secure
additional debt or    12   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 holder: · directly
or indirectly, redeem, or declare or pay any cash dividend or distribution on,
our common stock; · issue
any additional notes or issue any other securities that would cause a breach or
default under the senior secured convertible note; · issue
or sell any rights, warrants or options to subscribe for or purchase common
stock or directly or indirectly convertible into or exchangeable or exercisable
for common stock at a price which varies or may vary with the market price of
the common stock, including by way of one or more reset(s) to any fixed price
unless the conversion, exchange or exercise price of any such security cannot be
less than the then applicable conversion price with respect to the common stock
into which any note is convertible or the then applicable exercise price with
respect to the common stock into which any warrant is exercisable; · enter
into or affect any dilutive issuance (as defined in the note) if the effect of
such dilutive issuance is to cause us to be required to issue upon conversion of
any note or exercise of any warrant any shares of common stock in excess of that
number of shares of common stock which we may issue upon conversion of the note
and exercise of the warrants without breaching our obligations under the rules
or regulations of the principal market or any applicable eligible market; · 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; or · cause,
permit or suffer, directly or indirectly, any change in control transaction as
defined in the senior secured convertible note.  As of
September 30, 2008, we recorded an aggregate derivative liability of $8,111,000,
and a derivative valuation gain of $509,100 to reflect the change in value of
the aggregate derivate liability since December 31, 2007.  The aggregate
derivative liability of $8,111,000 included $4,211,000 for the conversion
feature and $3,900,000 for the warrants.  These values were calculated
using the Black-Scholes pricing model with the following assumptions: (i)
risk-free interest rate between 2.00% and 2.63%, (ii) expected life (in years)
of 2.2 for the conversion feature and 4.2 for the warrants; (iii) expected
volatility of 87.93% for the conversion feature and 79.47% for the warrants;
(iv) expected dividend yield of 0.00%; and (v) stock trading price of $3.79. The
principal value of $15,000,000 of the 6.25% senior secured convertible note is
being accreted over the term of the obligation, for which $1,047,825 and
$3,143,475 was included in interest expense for the three and nine months ended
September 30, 2008, respectively. The note bears a 6.25% annual interest rate
payable quarterly, and for the three and nine months ended September 30, 2008,
$234,375 and $703,125, respectively, was included in interest expense. On
December 21, 2007, we paid $937,500 as interest for the first year of the note
and at September 30, 2008 have recorded $210,937 as prepaid interest. Unsecured
Convertible Note On September
29, 2006, we entered into a letter of understanding with Triage Capital
Management, or Triage, dated September 25, 2006.  The letter of
understanding provided that Triage loan $1,000,000 to us in exchange for us
entering into, on or prior to October 30, 2006, a convertible note securities
agreement.  It was intended that the funding provided by Triage be replaced
by a convertible note and accompanying warrants, as described below.
 Effective November 2, 2006, we entered into securities purchase agreement,
a 5% convertible note, a registration rights agreement, and four classes of
warrants to purchase our common stock, all of which were with an individual note
holder, the controlling owner of Triage, who caused our agreement with Triage to
be assigned to him, which satisfied our agreement with Triage. Pursuant to
the securities purchase agreement, (i) we sold to the convertible note holder a
three-year convertible note in the principal amount of $1,000,000 representing
the funding received by us on September 29, 2006; (ii) the convertible note
bears an annual interest rate of 5%, payable semi-annually in cash or shares of
our common    13   stock;
(iii) the convertible note is convertible into shares of our common stock at a
conversion price of $1.50 per share; and (iv) we issued to the convertible note
holder four classes of warrants (A Warrants, B Warrants, C Warrants and D
Warrants), which gave the convertible note holder the right to purchase a total
of 5,500,000 shares of our common stock as described below.  The A and B
Warrants originally expired one year after the effective date of a registration
statement filed under the Securities Act to register the subsequent sale of
shares received from exercise of the A and B Warrants. The C Warrants and D
Warrants originally expired eighteen months and twenty four months,
respectively, after the effective date of a registration statement to be filed
under the Securities Act.  The A Warrants grant the convertible note holder
the right to purchase up to 750,000 shares of common stock at an exercise price
of $1.60 per share, the B Warrants grant the convertible note holder the right
to purchase up to 750,000 shares of common stock at an exercise price of $1.75
per share, the C Warrants grant the convertible note holder the right to
purchase up to 2,000,000 shares of common stock at an exercise price of $2.10
per share, and the D Warrants grant the convertible note holder the right to
purchase up to 2,000,000 shares of common stock at an exercise price of $3.00
per share. During the
fourth quarter of the year ended December 31, 2007, the convertible note holder
exercised 454,000 A Warrants at an exercise price of $1.60 per share providing
$726,400 in funding to us. Additionally, we entered into an exchange agreement
dated October 31, 2007 in which the convertible note holder received 650,000
shares of our common stock in exchange for cancellation of the C and the D
Warrants.  The expiration date of the A Warrants and the B Warrants was
extended from January 11, 2008 to December 3, 2008. During the
three months ended June 30, 2008, the convertible note holder exercised 64,400 A
Warrants at an exercise price of $1.60 per share providing $103,040 in funding
to us. As of September 30, 2008, there remain 231,600 A warrants and 750,000 B
Warrants available. As of
September 30, 2008 and 2007, we recorded an aggregate derivative liability of
$3,673,700 and $6,310,000, and derivative valuation gain of $313,860 and
derivative valuation loss of $3,039,200, respectively, to reflect the change in
value of the aggregate derivate liability since December 31, 2007 and 2006,
respectively.  The aggregate derivative liability of $3,673,700 included
$1,626,700 for the conversion feature and $2,047,000 for the warrants.
 These values were calculated using the Black-Scholes pricing model with
the following assumptions: (i) risk-free interest rate of 1.78% for the
conversion feature and 0.92% for the warrants, (ii) expected life (in years) of
1.00 for the conversion feature and 0.20 for the warrants; (iii) expected
volatility of 85.25% for the conversion feature and 90.18% for the warrants;
(iv) expected dividend yield of 0.00%; and (v) stock trading price of $3.79. The
principal value of $1,000,000 of the unsecured convertible note is being
accreted over the term of the obligation, for which $83,334 and $250,002 was
included in interest expense for the three and nine months ended September 30,
2008 and 2007, respectively.  The note bears a 5% annual interest rate
payable semi-annually, and for both the three and nine months ended September
30, 2008 and 2007, $12,501 and $37,503, respectively, was included in interest
expense. Senior
Secured 6% Convertible Notes On May 16,
2005, we consummated a private placement of $3,000,000 principal amount of 6%
senior secured convertible notes and related securities, including common stock
warrants and additional investment rights, to four institutional funds.
 The senior secured convertible notes were originally due May 16, 2008 and
were originally convertible into 1,200,000 shares of our common stock at a
conversion price of $2.50 per share.  On March 16, 2006, we entered into a
waiver and amendment agreement (discussed below), which adjusted the conversion
rate to $1.50 per share.  The warrants and the embedded conversion feature
of the senior secured convertible notes have been accounted for as derivatives
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 anti-dilution 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 the 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    14   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 was not
exercisable 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. 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 enumerated 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 years ended December 31, 2006 and 2005, we recorded $66,000 and
$218,000, respectively, as additional interest expense for this default. On March 16,
2006, we entered into a waiver and amendment agreement with the four
institutional funds regarding our default discussed above.  Under the terms
of the waiver, the institutional funds terminated a 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 shares of our
common stock, 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 (which exercise price was subsequently reduced
to $1.50 due to applicable antidilution provisions); 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 would have been in
default under the notes. On April 21,
2006, two of the institutional funds converted an aggregate of $500,000 of their
convertible notes into 333,334 shares of our common stock. Upon completion of
this conversion, the principal amount of the senior secured convertible notes
was reduced from $3,000,000 to $2,500,000. On March 18,
2007, two of the institutional funds converted an aggregate of $750,000 of their
convertible notes into 500,000 shares of our common stock. Upon completion of
this conversion, the principal amount of the senior secured convertible notes
was reduced from $2,500,000 to $1,750,000. On April 4,
2007, one of the institutional funds converted an aggregate of $100,000 of its
convertible notes into 66,667 shares of our common stock. Upon completion of
this conversion, the principal amount of the senior secured convertible notes
was reduced to $1,650,000. On September
13, 2007, one of the institutional funds assigned $54,505 of its convertible
note and certain associated warrants to a third party. On September 25, 2007,
two of the institutional funds converted an aggregate of $225,000 of their
convertible notes into 150,000 shares of our common stock. Upon completion of
this conversion, the principal amount of the senior secured convertible notes
was reduced to $1,425,000. During
October 2007, four of the institutional funds converted an aggregate of
$1,091,944 of their convertible notes into 727,963 shares of our common stock.
During November 2007, one of the institutional funds converted an    15   aggregate
of $278,551 of its convertible notes into 185,701 shares of our common stock.
Upon completion of this conversion, the principal amount of the senior secured
convertible notes was reduced to $54,505. During the
three months ended December 31, 2007, four of the institutional funds exercised
an aggregate of 667,298 of their A and B warrants at an exercise price of $1.50
providing $1,000,947 in funding to us.  As of December 31, 2007, there were
532,702 remaining warrants outstanding. During the
three months ended March 31, 2008, three of the institutional funds exercised an
aggregate of 500,000 of their A and B warrants at an exercise price of $1.50
providing $750,000 in funding to us.  As of September 30, 2008, there were
32,702 remaining warrants available. As of
September 30, 2008 and 2007, we recorded an aggregate derivative liability of
$86,700 and $2,161,000 and a derivative valuation gain of $111,763 and a
derivative valuation loss of $1,639,800 to reflect the change in value of the
aggregate derivate liability since December 31, 2007 and 2006, respectively.
 The aggregate derivative liability of $86,700 was for the 32,702 remaining
warrants.  The value was calculated using the Black-Scholes pricing model
with the following assumptions: (i) risk-free interest rate of 1.89%; (ii)
expected life (in years) of 1.6; (iii) expected volatility of 96.66%; (iv)
expected dividend yield of 0.00%; and (v) stock trading price of $3.79. The $54,505
principal value of the senior secured convertible notes at December 31, 2007 was
converted during the three months ended March 31, 2008. Prior to conversion, the
outstanding principal value was being accreted over the term of the obligations,
for which $757 and $483,333 was included in interest expense for the nine months
ended September 30, 2008 and 2007, respectively.  The accretion included in
interest expense for the three months ended September 30, 2007 was $ 137,499.
 The notes bore a 6% annual interest rate payable semi annually for which
(i) $0 and $136 for the three and nine months ended September 30, 2008,
respectively, and (ii) $24,525 and $85,467 for the three and nine months ended
September 30, 2007, respectively, were included in interest expense. IDI
Bankruptcy Settlement On May 18,
2004, the debtor-in-possessions plan of reorganization for Interact Devices,
Inc., or 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 our common stock, 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
representing approximately 86% of the equity of IDI. During the
year ended December 31, 2007, we satisfied our obligation to the creditors of
IDI. For the three and nine months ended September 30, 2007, we paid
approximately $17,547 and $52,640, respectively of the $312,768 original
obligation. The balance remaining as of September 30, 2007 was approximately
$52,640 and had been recorded as a current liability (for that year). NOTE 7  FAIR VALUE
MEASUREMENTS  The Company
adopted SFAS No. 157, Fair Value Measurements, (SFAS 157) as of January 1,
2008 for financial instruments measured at fair value on a recurring basis.
 SFAS 157 defines fair value, establishes a framework for measuring fair
value in accordance with accounting principles generally accepted in the United
States and expands disclosures about fair value measurements. SFAS 157
establishes a three-tier fair value hierarchy which prioritizes the inputs used
in measuring fair value.  The hierarchy gives the highest priority to
unadjusted quoted prices in active markets for identical assets or liabilities
(level 1 measurements) and the lowest priority to unobservable inputs (level 3
measurements).  These tiers include: · Level
1, defined as observable inputs such as quoted prices in active markets; · Level
2, defined as inputs other than quoted prices in active markets that are either
directly or indirectly observable; and · Level
3, defined as unobservable inputs in which little or no market data exists,
therefore requiring an entity to develop its own assumptions.    16   We
measure certain financial instruments at fair value on a recurring basis. Assets
and liabilities measured at fair value on a recurring basis are as follows at
September 30, 2008: Quoted Prices
in

Significant
Other

SignificantActive Markets
for

Observable

UnobservableIdentical
Assets

Inputs

InputsTotal

(Level 1)

(Level 2)

(Level
3)AssetsMoney market funds

$
895,026
$
895,026
$
-
$
-Treasury cash reserve
securities

5,964,600

5,964,600

-

-Auction rate preferred
securities

2,554,597

-

-

2,554,597Total assets measured at fair
value
$
9,414,223
$
6,859,626
$
-
$
2,554,597LiabilitiesDerivative valuation (1)

$
11,871,400
$
-
$
-
$
11,871,400Total liabilities measured at
fair value
$
11,871,400
$
-
$
-
$
11,871,400(1) See Note 6 of the Company's
Condensed Consolidated Financial Statements for additional
discussion.
  The table
below presents the Companys assets measured at fair value on a recurring basis
using significant unobservable inputs (Level 3) as defined in SFAS 157 at
September 30, 2008. The Company classifies financial instruments in Level 3 of
the fair value hierarchy when there is reliance on at least one significant
unobservable input to the valuation model. Derivative

Auction
RateValuation
Liability

Preferred
Securities

TotalBalance at December 31,
2007
$
(14,267,600)
$
-
$
(14,267,600)Total gains or losses (realized
and unrealized)Included in net loss

934,723

-

934,723Included in other comprehensive
loss
-

(245,403)

(245,403)Purchases, issuances, and
settlements, net
1,461,477

2,800,000

4,261,477Transfers to Level 3

-

-

-Balance at September 30,
2008
$
(11,871,400)
$
2,554,597
$
(9,316,803)
  Money Market Funds and Treasury
Securities  The money market funds and treasury
cash reserve securities balances are classified as cash and cash equivalents on
the Companys Condensed Consolidated Balance Sheet.  Auction Rate Preferred
Securities  As of September 30, 2008, the Company
had investments in auction rate preferred securities (ARPS), which are
classified as available-for-sale securities on the Companys Condensed
Consolidated Balance Sheet and reflected at fair value.  Due to events in
credit markets, the auction events for these instruments held by the Company
failed during first quarter 2008.  Therefore, the fair values of these
securities were estimated utilizing a discounted cash flow analysis of the
estimated future cash flows for the ARPS as of September 30,
2008.  This analysis considers, among other items, the
collateralization of the underlying security investments, the creditworthiness
of the counterparty, the timing of expected future cash flows and the
expectation of the next time the security is expected to have a successful
auction or the security has been called by the issuer.  As a result of the temporary decline
in fair value for the Companys ARPS, which it attributes to liquidity issues
rather than credit issues, the Company has recorded an unrealized loss of
$245,403 to accumulated other comprehensive loss.  The ARPS held by
the Company at September 30, 2008, totaling $2,800,000 were in AAA    17   rated
funds.  Due to the Companys belief that the market for these
instruments may take in excess of twelve months to fully recover, the Company
has classified these investments as non-current.  During second quarter
2008, $8,800,000 of the Companys ARPS, held at March 31, 2008, were redeemed at
100% of their par value.  As of September 30, 2008, the Company continues
to earn interest on its ARPS under the default interest rate features of the
ARPS. Any future fluctuation in fair value related to these instruments
that the Company deems to be temporary, including any recoveries of previous
write-downs, would be recorded to accumulated other comprehensive
loss.  If the Company determines that any future valuation adjustment
is other than temporary, it would record a charge to earnings as
appropriate.  NOTE 8  COMPREHENSIVE
LOSS  Comprehensive loss equaled net loss
of $6,981,166 and $12,515,563 for the three and nine months ended September 30,
2007, respectively. Net loss totaled $9,034,660 and $12,432,597 for the three
and nine months ended September 30, 2008, respectively, and included unrealized
losses on auction rate preferred securities.  The difference between net
loss and comprehensive loss for the three and nine months ended September 30,
2008 was as follows:  Three Months
Ended

Nine Months
EndedSeptember 30,
2008

September 30,
2008Net Loss
$
               (9,034,660)

$
            (12,432,597)Unrealized gain (loss) on
Available-for-sale Securities
(51,077)

(245,403)Comprehensive Loss
$
               (9,085,737)

$
            (12,678,000)
  Accumulated other comprehensive loss
per the Companys Condensed Consolidated Balance Sheet consists of the Companys
unrealized loss of $245,403 on its available-for-sale securities.  NOTE 9 - SUPPLEMENTAL CASH FLOW
INFORMATION  During the nine months ended
September 30, 2008, we issued 160,000 shares of our common stock to a
corporation, to provide investor relations services for the Company. The value
of these shares of $488,000 was recorded as a prepaid expense and will be
recognized over the service periods as follows:  2008
$   
    427,0032009
60,997$  
     488,000  During the nine months ended
September 30, 2008, we issued 63,000 shares of our common stock pursuant to an
existing consulting agreement to a corporation, to provide investor relations
services for the Company. The value of these shares of $192,990 was recorded in
general and administrative expense.  On March 18, 2007, one of the
institutional funds converted an aggregate of $54,505 of their convertible notes
into 36,337 shares of our common stock resulting in an extinguishment of debt
non-cash expense of $6,056 included as interest expense for the nine months
ended September 30, 2008. See Note 6.  During the nine months ended
September 30, 2008, an aggregate of 2,258 options and 40,000 warrants were
exercised by one and three individuals providing $750 and $80,000, respectively,
in funding to the Company.  For the nine months ended September
30, 2008 and 2007, an aggregate non-cash expense of $3,394,234 and $733,335 was
recorded for the accretion of (i) the senior 6% convertible notes of $757 and
483,333, respectively, (ii) the unsecured convertible note of $250,002 in each
of the periods, and (iii) $3,143,475 for the senior secured 6.25% convertible
notes in 2008, as interest expense. See Note 6.  For the nine months ended September
30, 2007, we received $1,802,999 from the sale of 1,202,016 shares of common
stock pursuant to a private placement offering at a price of $1.50 per share.
Additionally, the holders of 1,202,013 of these shares received a warrant to
acquire one share of our common stock for each share purchased.  The
warrants have a three-year exercise period and are exercisable at a $2.00
exercise price.     18   During the
nine months ended September 30, 2007, we issued 2,160,000 shares of our common
stock to three corporations, which provide investor relations services for us.
The value of these shares of $2,124,000 was recorded as a prepaid expense and
will be recognized over the service periods as follows:  2007
$   
     996,9972008
1,066,0062009
60,997$
     2,124,000  During the nine
months ended September 30 2007, three of the institutional funds converted an
aggregate of $1,075,000 of their senior secured convertible notes into 716,667
shares of our common stock resulting in an extinguishment of debt non-cash
expense in the amount of $365,264 included as interest expense for the nine
months ended September 30, 2007. See Note 6.  On February 28, March 30, and May 11,
2007, we entered into three unsecured promissory 6% notes with a Utah
corporation, in the aggregate of $299,948 included at September 30, 2007 as
current debt obligations.  The Company paid no cash for income
taxes during the nine months ended September 30, 2008 and 2007.  The Company paid $26,108 and $94,863
for interest expense during the nine months ended September 30, 2008 and 2007,
respectively.  NOTE 10 - RECENT ACCOUNTING
PRONOUNCEMENTS  In September
2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157),
which establishes specific criteria for the fair value measurements of financial
and nonfinancial assets and liabilities that are already subject to fair value
under current accounting rules. SFAS 157 also requires expanded disclosures
related to fair value measurements. In February 2008, the FASB approved FASB
Staff Position (FSP) FAS 157-2, Effective Date of FASB Statement No. 157
(FSP 157-2) which allows companies to elect a one-year delay in applying SFAS
157 to certain fair value measurements of non-financial instruments, except for
those recognized or disclosed at fair value on at least an annual basis. We
elected the delayed adoption date for the portions of SFAS 157 impacted by FSP
157-2 and, as a result, we partially adopted SFAS 157 on January 1, 2008.
The partial adoption of SFAS 157 was prospective and did not have a significant
effect on our Condensed Consolidated Financial Statements. See Note 7 for
information about fair value measurements. We are currently evaluating the
impact of applying the deferred portion of SFAS 157 to the nonrecurring fair
value measurements of our nonfinancial assets and nonfinancial liabilities. In
accordance with FSP 157-2, the fair value measurements for these items will be
adopted effective January 1, 2009. In October
2008, the FASB issued Staff Position 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active, (FSP SFAS
157-3). FSP SFAS 157-3 provides guidance on how management's internal cash flow
and discount rate assumptions should be considered when measuring fair value
when relevant observable data does not exist, how observable market information
in a market that is not active should be considered when measuring fair value
and how the use of market quotes should be considered when assessing the
relevance of observable and unobservable data available to measure fair value.
The Company has incorporated the considerations of FSP SFAS 157-3 in its
assessment of the fair value of its ARPS as of September 30, 2008. In February
2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial LiabilitiesIncluding an amendment of SFAS 115 (SFAS
159). SFAS 159 permits a company to voluntarily elect to use fair value,
instead of historic or original cost, to account for certain financial assets
and liabilities. The fair value option is designated on an item-by-item basis,
is irrevocable and requires that changes in fair value in subsequent periods be
recognized in earnings in the period of change. We adopted SFAS 159 on
January 1, 2008. The adoption had no impact on our consolidated financial
statements as we did not make a fair value election for any of our existing
financial assets and liabilities. Any election to use the fair value method for
future eligible transactions will be made on a case-by-case and
instrument-by-instrument basis. In December
2007, the FASB issued SFAS No. 141 (revised 2007), Business
Combinations (SFAS 141R). Under SFAS 141R, an entity is required to
recognize the assets acquired, liabilities assumed, contractual contingencies,
and contingent consideration at their fair value on the acquisition date. It
further requires that    19   acquisition-related
costs be recognized separately from the acquisition and expensed as incurred,
restructuring costs generally be expensed in periods subsequent to the
acquisition date, and changes in accounting for deferred tax asset valuation
allowances and acquired income tax uncertainties after the measurement period
impact income tax expense. In addition, acquired in-process research and
development is capitalized as an intangible asset and amortized over its
estimated useful life. The adoption of SFAS 141R will change our accounting
treatment for business combinations on a prospective basis beginning in the
first quarter of fiscal year 2009. In December
2007, the FASB issued SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statementsan amendment of Accounting Research Bulletin
No. 51 (SFAS 160), which establishes accounting and reporting
standards for ownership interests in subsidiaries held by parties other than the
parent, the amount of consolidated net income attributable to the parent and to
the noncontrolling interest, changes in a parents ownership interest, and the
valuation of retained noncontrolling equity investments when a subsidiary is
deconsolidated. SFAS 160 also establishes disclosure requirements that
clearly identify and distinguish between the interests of the parent and the
interests of the noncontrolling owners. SFAS 160 is effective for fiscal
years beginning after December 15, 2008. We do not expect that the adoption
of SFAS 160 will have a significant impact on our consolidated financial
statements. In March
2008, the FASB issued SFAS No. 161, Disclosures about Derivative
Instruments and Hedging Activitiesan amendment of FASB Statement No. 133
(SFAS 161), which requires enhanced disclosures about an entitys
derivative and hedging activities and thereby improves the transparency of
financial reporting. SFAS 161 is effective for fiscal years beginning after
November 15, 2008. We are currently evaluating the impact of SFAS 161 on
our consolidated financial statements. In May 2008, the FASB issued SFAS No.
162, The Hierarchy of Generally Accepted Accounting Principles(SFAS
162).  SFAS 162 is intended to improve financial reporting by identifying
a consistent framework, or hierarchy, for selecting accounting principles to be
used in preparing financial statements in conformity with U.S. generally
accepted accounting principles (GAAP) for nongovernmental entities.  The
statement establishes that the GAAP hierarchy should be directed to entities
because it is the entity (not its auditor) that is responsible for selecting
accounting principles for financial statements that are presented in conformity
with GAAP.  This statement is effective 60 days following the SECs
approval of the Public Company Accounting Oversight Board Auditing amendments to
AU Section 411, The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles.  The Company does not believe
implementation of SFAS 162 will have a material impact on its consolidated
financial statements.  In May 2008, the FASB issued SFAS No.
163, Accounting for Financial Guarantee Insurance Contracts - an interpretation
of FASB Statement No. 60 (SFAS 163).  SFAS 163 clarifies how Statement
60 applies to financial guarantee insurance contracts, including the recognition
and measurement of premium revenue and claim liabilities. This Statement also
requires expanded disclosures about financial guarantee insurance contracts.
 SFAS 163 is effective for fiscal years beginning on or after December 15,
2008, and interim periods within those fiscal years. The Company does not expect
that the adoption of SFAS 163 will have a material impact on its consolidated
financial statements.  In June 2008, the
FASB issued FASB Staff Position Emerging Issues Task Force
(EITF) No. 03-6-1, Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities (FSP EITF No.
03-6-1).  Under FSP EITF No. 03-6-1, unvested share-based payment awards
that contain rights to receive nonforfeitable dividends (whether paid or unpaid)
are participating securities, and should be included in the two-class method of
computing EPS. FSP EITF No. 03-6-1 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those years, and is not
expected to have a significant impact on the Companys consolidated financial
statements.  In May 2008, the FASB issued
FASB Staff Position APB 14-1, Accounting for Convertible Debt Instruments That
May Be Settled in Cash Upon Conversion (including Partial Cash Settlement (FSP
APB 14-1). FSP APB 14-1 clarifies that convertible debt instruments that may be
settled in cash upon conversion are not addressed by APB Opinion No. 14 and
specifies that issuers of such instruments should separately for the liability
and equity components in a matter that will reflect the entitys nonconvertible
debt borrowing rate when interest cost is recognized in subsequent periods.
 FSP APB 14-1 is effective for fiscal years beginning after
December 15, 2008, and interim periods within those years. The Company is
currently assessing the impact of the adoption of FSP APB 14-1 on its
consolidated financial statements.     20   In
April 2008, the FASB issued FASB Staff Position No. 142-3,
Determination of the Useful Life of Intangible Assets (FSP No. 142-3)
to improve the consistency between the useful life of a recognized intangible
asset (under SFAS No. 142) and the period of expected cash flows used to
measure the fair value of the intangible asset (under SFAS No. 141(R)). FSP
No. 142-3 amends the factors to be considered when developing renewal or
extension assumptions that are used to estimate an intangible assets useful
life under SFAS No. 142. The guidance in the new staff position is to be
applied prospectively to intangible assets acquired after December 31,
2008. In addition, FSP No. 142-3 increases the disclosure requirements
related to renewal or extension assumptions. The Company is currently assessing
the impact of the adoption of FSP No. 142-3 on its consolidated financial
statements.  The Company has reviewed all other
recently issued, but not yet adopted, accounting standards in order to determine
their effects, if any, on its condensed consolidated financial statements. 
Based on that review, the Company believes that none of these pronouncements
will have a significant effect on its current or future consolidated financial
statements.  NOTE 11  SUBSEQUENT
EVENTS  On August 4, 2008, an aggregate of
200,000 restricted stock units were awarded to five members of our board as
follows: (i) 100,00 (25,000 each) to four members of our board and (ii) 100,000
to one member of the board for extraordinary services performed. All awards
issued were subject to the approval of the 2008 Equity Incentive Plan by our
shareholders.  On October 8, 2008, one member of the
board was awarded 200,000 restricted stock units for extraordinary services
performed and for assuming additional operational responsibilities for the
Company. This award was issued subject to the approval of the 2008 Equity
Incentive Plan by our shareholders.  On October 15, 2008, we issued 8,667
shares of our common stock to an individual in exchange for 130,000 share
equivalents of IDI (a majority owned subsidiary of the Company).  On November 4, 2008, we issued 60,000
shares of our common stock to an individual in exchange for 900,000 share
equivalents of IDI.    21    Item 2.
    MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS  Cautionary
Note Regarding Forward-Looking Statements This report
contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and
Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6
promulgated thereunder, that involve inherent risk and uncertainties.  Any
statements about our expectations, beliefs, plans, objectives, strategies or
future events or performance constitute forward-looking statements.  These
statements are often, but not always, made through the use of words or phrases
such as anticipate, estimate, plan, project, continuing, ongoing,
expect, believe, intend and similar words or phrases.  Accordingly,
these statements involve estimates, assumptions and uncertainties that could
cause actual results to differ materially from those expressed or implied
therein.  All forward-looking statements are qualified in their entirety by
reference to the factors discussed in this report and to the risk factors
discussed in Item 1A of our Annual Report on Form 10-K for the year ended
December 31, 2007, as follows: · dependence
on commercialization of our CodecSys technology; · our
need and ability to raise sufficient additional capital; · our
continued losses; · restrictions
contained in our outstanding convertible notes; · general
economic and market conditions; · ineffective
internal operational and financial control systems; · rapid
technological change; · intense
competitive factors; · our
ability to hire and retain specialized and key personnel; · dependence
on the sales efforts of others; · dependence
on significant customers; · uncertainty
of intellectual property protection; · potential
infringement on the intellectual property rights of others; · factors
affecting our common stock as a penny stock; · extreme
price fluctuations in our common stock; · price
decreases due to future sales of our common stock; · future
shareholder dilution; and · absence
of dividends. Because the
risk factors referred to above could cause actual results or outcomes to differ
materially from those expressed or implied in any forward-looking statements
made by us or on our behalf, you should not place undue reliance on any
forward-looking statement.  Further, any forward-looking statement speaks
only as of the date on which it is made, and we undertake no obligation to
update any forward-looking statement to reflect events or circumstances after
the date on which the statement is made or to reflect the occurrence of future
events or developments.  New factors emerge from time to time, and it is
not possible for us to predict which factors will arise.  In addition, we
cannot assess the impact of each factor on our business or the extent to which
any factor, or combination of factors, may cause actual results to differ
materially from those contained in any forward-looking statements.      22   Critical
Accounting Policies The
preparation of financial statements in conformity with U.S. GAAP requires that
we make estimates and judgments that affect the reported amounts of assets,
liabilities, revenues and expenses and the related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our assumptions and
estimates, including those related to recognition of revenue, valuation of
investments, valuation of inventory, valuation of intangible assets, valuation
of derivatives, measurement of stock-based compensation expense and litigation.
We base our estimates on historical experience and on various assumptions that
are believed to be reasonable under the circumstances, the results of which form
the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions. We
discuss our critical accounting policies in Managements Discussion and Analysis
of Financial Condition and Results of Operations in our Annual Report on Form
10-K for the year ended December 31, 2007. Except for the critical
accounting policy set forth below entitled Valuation of Investments, there
have been no other significant changes in our critical accounting policies or
estimates since those reported in our Annual Report. Valuation
of Investments As discussed
in Note 7 to the unaudited condensed consolidated financial statements, we
adopted the provisions of SFAS 157 effective January 1, 2008.  In
valuing our investments, we predominantly use market data or data derived from
market sources. When market data is not available, such as when the investment
is illiquid, we utilize a discounted cash flow analysis to arrive at the
recorded fair value. This process involves incorporating our assumptions about
the anticipated term and the yield that a market participant would require to
purchase the security in the marketplace. We utilized unobservable (Level 3)
inputs in determining the fair value of our auction rate preferred securities,
which totaled $2,554,597 at September 30, 2008. Our auction
rate preferred securities are classified as available-for-sale securities and
reflected at fair value.  In prior periods, due to the auction process
which took place every 7-30 days for most securities, quoted market prices were
readily available, which would qualify as Level 1 under SFAS
157.  However, due to events in credit markets during 2008, the
auction events for most of these instruments failed, and, therefore, we have
determined the estimated fair values of these securities utilizing a discounted
cash flow analysis as of September 30, 2008.  This analysis considers,
among other items, the collateralization of the underlying securities, the
expected future cash flows and the expectation of the next time the security is
expected to have a successful auction.  These securities were also
compared, when possible, to other observable market data with similar
characteristics to the securities held by us.  Due to these events, we
reclassified these instruments as Level 3 during first quarter 2008 and recorded
a temporary unrealized decline in fair value of $560,187, with an offsetting
entry to accumulated other comprehensive loss at March 31, 2008. During the
quarter ended June 30, 2008, we liquidated at par approximately 80% of our
auction rate securities held at March 31, 2008 resulting in the temporary
unrealized decline in fair value being adjusted to $194,326 at June 30, 2008,
which we have increased by $51,077 to $245,403 at September 30, 2008 to further
reflect current market conditions.  We currently believe that this
temporary decline in fair value is due entirely to liquidity issues and not
credit issues, because they are in AAA closed-end bond mutual funds that are
over-collateralized by at least 200% and are backed by the underlying marketable
securities. We believe we have sufficient cash and cash equivalents
available at September 30, 2008 to allow us sufficient time for the securities
to return to full value.  We will re-evaluate each of these factors as
market conditions change in subsequent periods. Executive
Overview The current economic downturn and
uncertainty in the financial markets in the U.S. and internationally may
adversely affect our business, financial results and our liquidity. If economies
remain unstable or weaken, or if businesses or consumers perceive that these
economic conditions may continue or weaken, we may experience declines in the
sales or renewals as customers delay or defer buying or reduce their level of
 spending activity. Moreover, these economic conditions and uncertain
financial markets have caused companies across many of the industries we serve,
particularly in the financial services and retail sectors, to experience
downturns in their businesses, which may cause our customers in these industries
to reduce the level of services they purchase from us. Additionally, we may
experience increased difficulty in obtaining financing in the future, which
could negatively impact our ability to pursue our business and development of
CodecSys products. As a result, we cannot predict what impact the current
economic downturn and uncertainty of the financial markets will have on our
business, but    23   expect
that such events may have an adverse effect on our business, financial results
and liquidity in the current quarter and future periods, including 2009.  On November
15, 2007, we entered into a two-year license agreement with IBM pursuant to
which we will license our patented CodecSys technology for use by IBM in video
encoders that IBM intends to manufacture and sell. The IBM video encoder is not
completed in a commercially deployable form.  The IBM agreement is our
first significant license of the CodecSys technology for use in a commercial
application.  We believe this agreement may hold substantial revenue
opportunities for our business.  Although IBM has commenced marketing and
sales activities with respect to products incorporating our CodecSys technology,
no sales of products have been made, and we have not derived any material
revenue from our CodecSys technology to date. During the quarter ended September
30, 2008, our revenues decreased by 14% compared to the same quarter in 2007.
For the nine months ended September 30, 2008, our revenues decreased by 10%
compared to the same period in 2007. These decreases resulted primarily from
customer contracts that were either not renewed or were completed, as discussed
below. Net cash used for operations in the nine months ended September 30, 2008
increased compared to the nine months ended September 30, 2007 by 243%.
 Until cash from operations is sufficient to cover all corporate expenses,
we will continue to deplete our available cash and increase our need for future
equity and debt financing.  Results of Operations for the Nine
Months ended September 30, 2008 and September 30, 2007  Revenues  We generated $2,759,767 in revenue
during the nine months ended September 30, 2008.  During the same
nine-month period in 2007, we generated revenue of $3,197,170.  The
decrease in revenue of $437,403 was due primarily to: (i) a $414,661 decrease in
satellite fees charged, due to the expiration of a customer contract that was
not renewed, resulting in a decrease in satellite revenue of $441,600 from that
customer and,  (ii) the Company completing installation services for two
customers in 2007 that were not repeated in 2008, which was offset by increased
services provided to other customers, resulting in a decrease in installation
related revenues of $94,430.  (iii)  studio and production fees
decreased by $96,739 due mainly to a decrease of production jobs,  (iv)
increased web and development fees of $98,280 from increased activity primarily
for a single customer, and (v) increased license fees of $70,146 from the
addition of a new customer, as well as increased installation and satellite
usage revenues from other new and existing customers.  Sales revenues from our three largest
customers accounted for approximately 49% and 62% of total revenues for the nine
months ended September 30, 2008 and 2007, respectively. Any material reduction
in revenues generated from any one of our largest customers could harm our
results of operations, financial condition and liquidity. The three largest
customers in 2008 are not the same three largest customers in 2007. One of our
three largest customers in 2008, accounting for $328,811 in revenues for the
nine months ended September 30, 2008, will not generate significant revenues for
us in the future and will need to be replaced by new business or we will suffer
a further  reduction in revenues.  Cost of Revenues  Cost of revenues decreased by
approximately $196,832 to $3,018,600 for the nine months ended September 30,
2008 from $3,215,431 for the nine months ended September 30, 2007.  The
decrease was due primarily to decreased satellite distribution costs of
$217,113, which resulted from the expiration of a customer contract referenced
above. In addition, costs of installation services decreased by $149,367 due to
decreased activity in installation of equipment primarily for one customer.
These decreases were partially offset by an increase in depreciation and
amortization of approximately $190,005, which resulted from large equipment
purchases and improvements related primarily to our development activities.  Expenses  General and administrative expenses
for the nine months ended September 30, 2008 were $4,744,585 compared to
$4,291,635 for the nine months ended September 30, 2007.  The increase in
general and administrative expenses of approximately $452,950 resulted primarily
from an increase in employee salary and related expenses of $205,711, an
increase of $171,263 in bad debt expense and an increase in legal services
expenses of $98,470.     24   Research
and development in process increased by $2,424,174 for the nine months ended
September 30, 2008 to $3,239,094 from $814,920 for the nine months ended
September 30, 2007, not including a one-time expense for impairment of license
rights of $1,142,400 recorded in 2007.  The increase resulted primarily
from an increase of $1,294,931 in employee related expenses, an increase of
$365,249 in professional services, an increase of $108,278 in developmental
services incurred by IDI, an increase of $117,839 in option and warrant expense,
an increase of $27,345 in patent related expenses, an increase in general
operating expenses of $264,704 related to the increased number of employees and
an increase of $157,210 in materials and supplies expense also related to
increased developmental activities.  In addition, we recorded an expense of
$76,047 for the purchase of a portion of the minority interests of IDI, our
development subsidiary..  Sales and marketing expenses
increased $549,835 to $962,405 for the nine months ending September 30, 2008
from $412,570 for the nine months ending September 30, 2007.  The increase
reflects an increase in consulting and other professional services of $259,881,
an increase in advertising and promotion expenses of $118,557, and $93,990 for
additional sales personnel hired to begin marketing of our CodecSys products and
related overhead expenses.  Interest Expense  For the nine months ended September
30, 2008, we incurred interest expense of $4,487,362 compared to interest
expense for the nine months ended September 30, 2007 of $1,492,193.  The
increase of $2,995,168 resulted primarily from the Company recording more non
cash interest expense related to the accretion of note liability on our 6.25%
senior secured convertible note and related amortization of debt offering costs,
which was not outstanding in 2007 and on our unsecured convertible note. In
addition, interest expense paid or accrued on the 6.25% senior secured
convertible note is likewise greater due to the increased principal balance
outstanding.  Net Loss  We realized a net loss for the nine
months ended September 30, 2008 of $12,432,597 compared with a net loss for the
nine months ended September 30, 2007 of $12,515,563. The decrease in the net
loss of $82,966 is primarily due to the difference of $5,285,633 between a loss
of $4,350,910 recorded in 2007 related to our derivative valuation calculation
and the gain of $934,723 recorded as of September 30, 2008 relative to the
derivative valuation calculation, which was offset by (i) the increase of
$2,995,168 in interest expense, (ii) an increase in operating expenses of
$2,284,559 as explained above, and (iii) a $240,572 decrease in gross margin as
a result of decreased revenues.  Results of Operations for the
Three Months ended September 30, 2008 and September 30, 2007  Revenues  The Company generated $761,572 in
revenue during the three months ended September 30, 2008.  During the same
three-month period in 2007, the Company generated revenue of $834,320.  The
decrease in revenue of $72,748 was due primarily to a decrease of $242,306 in
satellite fees resulting from the expiration of a customer contract, partially
offset by the Company realizing an increase of $175,014 from installation and
service work in the three months ended September 30, 2008.  The Company's three largest
customers sales revenues accounted for approximately 58% and 60% of total
revenues for the quarters ended September 30, 2008 and 2007, respectively.
 The three customers with the greatest revenues in 2007 were not the same
three customers in 2008. Any material reduction in revenues generated from any
one of its largest customers could harm the Companys results of operations,
financial condition and liquidity unless we could replace the lost revenues with
new customers.  Cost of Revenues  Costs of revenues increased by
approximately $93,474 to $913,295 for the three months ended September 30, 2008,
from $819,821 for the three months ended September 30, 2007.  The increase
was due primarily to increased depreciation of $100,752 due to purchases of
equipment and upgrades of our internal network primarily for our development
activities and increased activity in installation of equipment, which resulted
in an increase in the costs related to such installation services for all the
Companys customers of $90,183 and an increase in    25   salaries
and attendant expense in the operations department. The increases were partially
offset by a decrease in satellite distribution costs of $159,035 due to the loss
of a satellite customer.  Expenses  General and administrative expenses
for the three months ended September 30, 2008 were $1,755,844 compared to
$1,542,058 for the three months ended September 30, 2007.  The increase of
approximately $213,786 resulted primarily from increases in expenses incurred
for bad debt expense of $88,111, outside director fees of $70,000 and payroll
and related expenses of $38,994.  Consulting fees for the quarter ended
September 30, 2008 increased by $339,716, but were offset by a decrease in
option and warrant expense of $348,978.  Research and development in process
increased by $1,109,092 for the three months ended September 30, 2008 to
$1,410,308 from $301,216 for the three months ended September 30, 2007.
 This increase resulted primarily from increased employee and related costs
of $620,890, increased consulting and other professional services of $305,821
and increased expenses in IDI of $141,421, all of which expenses were increased
as a result of increasing our development activity.  Sales and marketing expenses
increased $256,769 for the three months ended September 30, 2008 to $359,904
from $103,135 for the three months September 30, 2007.  The increase was
due primarily to increased consulting and other professional fees of $132,826,
increased payroll and related expenses of $57,257 resulting from hiring of
additional personnel devoted to sales, and an increase of $50,008 in advertising
and promotion expenses.  Interest Expense  For the three months ended September
30, 2008, the Company incurred interest expense of $1,492,785 compared to
interest expense for the three months ended September 30, 2007 of $365,355.
 The increase of $1,127,430 resulted primarily from the Company recording
interest expense  related to note accretion and accrual of interest payable
related to our 6.25% senior secured convertible note, which was not outstanding
during the third quarter of 2007, partially offset by note accretion of our 6.0%
senior secured convertible notes in 2007, which have since been converted and
are no longer outstanding. The $1,492,785 interest expense recorded primarily
consisted of $1,131,159 recorded to account for the accretion of note liability
on our balance sheet, interest payable on all notes of $246,876 and amortization
of debt offering costs of $114,750.  Net Loss  We realized a net loss for the three
months ended September 30, 2008 of $9,034,660 compared with a net loss for the
three months ended September 30, 2007 of $6,981,166. The increase in net loss of
$2,053,494 was primarily the result of the increase of $1,127,430 in interest
expense, the increase of operating expenses of $1,579,647 as described above,
and a decrease in gross margin of $166,222. These factors which increased net
loss were offset by a decrease in derivative valuation loss of $749,900, which
resulted primarily from the valuation of our 6.25% senior secured convertible
note.  Liquidity and Capital
Resources  At September 30, 2008, we had cash of
$ 6,714,626, total current assets of $8,082,693, total current liabilities of
$13,231,576 and total stockholders' deficit of $5,735,190.  Included in
current liabilities is $11,871,400, which relates to the value of the embedded
derivatives for the 6.25% senior secured convertible note and related warrants
and the unsecured convertible note and warrants. Our current liabilities,
without considering the derivative liability, were $1,360,176.  As of September 30, 2008, we held
approximately $2,800,000 of auction rate preferred securities, valued at
$2,554,597 and classified as long-term investments. Beginning in February 2008,
many of these auction rate preferred securities became illiquid because their
scheduled auctions failed to settle. During the second quarter 2008, $8,800,000
of the $11,600,000 auction rate preferred securities held at March 31, 2008 were
liquidated at par, with the Company not sustaining any losses. However, we may
have limited or no opportunities to liquidate the remaining auction rate
investments and fully recover their stated value in the near term. An auction
failure occurs when the parties wishing to sell securities at auction cannot
effect a sale. When an auction fails, the affected securities begin to pay
interest under their default interest rate terms. As a result of this
illiquidity caused by the lack of an active market, these investments were
classified as non-current.   Although approximately 80% of    26   our
investments have been redeemed by the issuers, none of the issuers of the
auction rate preferred securities still held by us have announced a definitive
plan for redemption of the remainder of the securities in the near term.  A
temporary unrealized loss of $560,187 was recorded in the first quarter of 2008,
which was decreased to $194,326 at June 30, 2008 to reflect the redemptions
which occurred in the second quarter, but was increased to $245,403 in the third
quarter to reflect changed market conditions. We utilized a discounted cash flow
analysis in determining the fair value of these securities, which used
significant unobservable inputs at September 30, 2008.  We believe the impairment of these
securities is temporary because they are backed by more than 200% collateral and
approximately 80% have already been redeemed. All of our remaining auction rate
preferred securities are currently rated AAA, the highest rating by a rating
agency. We believe we will ultimately be able to liquidate these investments
without significant loss through successful auctions or redemptions of
securities by the issuers. However, it could take a long period of time to
realize the investments full value for a portion of the investments. Based on
our expected operating cash flows, and our other sources of cash, we do not
anticipate that the current illiquidity of $2,800,000 of these investments will
adversely affect our operations.  We experienced negative cash flow
used in operations during the nine months ended September 30, 2008 of $6,464,723
compared to negative cash flow used in operations for the nine months ended
September 30, 2007 of $1,882,905.  The negative cash flow was met by cash
reserves.  We expect to continue to experience negative operating cash flow
as long as we continue our technology development program or until we begin to
receive licensing revenue from licenses of our CodecSys technology or increase
sales in our network division to new or existing customers.  On December
24, 2007, we entered into a securities purchase agreement in which we raised
$15,000,000 (less $937,000 of prepaid interest and $1,377,000 of related costs
including commissions).  We are using the proceeds from this financing to
support our CodecSys commercialization and development and for general working
capital purposes.  The senior secured convertible note is due December 21,
2010 and bears interest at 6.25% per annum.  Interest for the first year
was prepaid at closing.  Interest-only payments thereafter in the amount of
$234,375 are due quarterly and commence in April 2009.  Interest payments
may be made through issuance of common stock in certain circumstances.  The
note is convertible into 2,752,294 shares of our common stock at a conversion
price of $5.45 per share, convertible any time during the term of the note.
 We have granted a first priority security interest in all of our property
and assets and of our subsidiaries to secure our obligations under the note and
related transaction agreements. In
connection with the financing, the senior secured convertible note holder
received warrants to acquire 1,875,000 shares of our common stock exercisable at
$5.00 per share.  The warrants are exercisable any time for a five-year
period beginning on the date of grant.  We also issued to the convertible
note holder 1,000,000 shares of our common stock valued at $3,750,000 and
incurred an additional $1,377,000 for commissions, finders fees and other
transaction expenses, including the grant of a three-year warrant to purchase
112,500 shares of our common stock to a third party at an exercise price of
$3.75 per share, valued at $252,000.  A total of $1,377,000 was included in
debt offering costs and is being amortized over the term of the note. See note 6
of our consensed consolidated financial statements included elsewhere in this
report. The $5.45
conversion price of the senior secured convertible note and the $5.00 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 $5.45 per share. The senior
secured convertible note contains a prepayment provision allowing us to prepay,
in certain limited circumstances, all or a portion of the note.  The
portion of the note subject to prepayment must be purchased at a price equal to
the greater of (i) 135% of the amount to be purchased and (ii) the company
option redemption price, as defined in the note.  Even if we elect to
prepay the note, the note holder may still convert any portion of the note being
prepaid pursuant to the conversion feature thereof. We also
entered into a registration rights agreement with the holder of the senior
secured convertible note pursuant to which we agreed to provide certain
registration rights with respect to the shares of common stock, the shares of
common stock issuable upon conversion of the note, the shares of common stock
issuable as interest    27   shares
under the note and shares of common stock issuable upon exercise of the warrant
under the Securities Act of 1933, as amended (the Securities Act).  The
holder is entitled to demand registration of the above-mentioned shares of
common stock after six months from the closing of the securities purchase
agreement in certain circumstances. The
securities purchase agreement under which the senior secured convertible note
and related securities were issued contains, among other things, covenants that
may restrict our ability to obtain additional capital, to declare or pay a
dividend or to engage in other business activities.  A breach of any of
these covenants could result in a default under our senior secured convertible
note, in which event the holder of the note could elect to declare all amounts
outstanding to be immediately due and payable, which would require us to secure
additional debt or equity financing to repay the indebtedness or to seek
bankruptcy protection or liquidation.  The securities purchase agreement
provides that we cannot do any of the following without the prior written
consent of the holder: · directly
or indirectly, redeem, or declare or pay any cash dividend or distribution on,
our common stock; · issue
any additional notes or issue any other securities that would cause a breach or
default under the senior secured convertible note; · issue
or sell any rights, warrants or options to subscribe for or purchase common
stock or directly or indirectly convertible into or exchangeable or exercisable
for common stock at a price which varies or may vary with the market price of
the common stock, including by way of one or more reset(s) to any fixed price
unless the conversion, exchange or exercise price of any such security cannot be
less than the then applicable conversion price with respect to the common stock
into which any note is convertible or the then applicable exercise price with
respect to the common stock into which any warrant is exercisable; · enter
into or affect any dilutive issuance (as defined in the note) if the effect of
such dilutive issuance is to cause us to be required to issue upon conversion of
any note or exercise of any warrant any shares of common stock in excess of that
number of shares of common stock which we may issue upon conversion of the note
and exercise of the warrants without breaching our obligations under the rules
or regulations of the principal market or any applicable eligible market; · 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; or · cause,
permit or suffer, directly or indirectly, any change in control transaction as
defined in the senior secured convertible note.  On November 2, 2006, we closed on a
convertible note securities agreement dated October 28, 2006 with an individual
that provided we issue to the convertible note holder (i) an unsecured
convertible note in the principal amount of $1,000,000 representing the funding
received by us from an affiliate of the convertible note holder on September 29,
2006, and (ii) four classes of warrants (A warrants, B warrants, C warrants and
D warrants) which gave the convertible note holder the right to purchase a total
of 5,500,000 shares of our common stock as described below.  The unsecured
convertible note is due October 16, 2009 and bears an annual interest rate of
5%, payable semi-annually in cash or in shares of our common stock if certain
conditions are satisfied.  The unsecured convertible note is convertible
into shares of our common stock at a conversion price of $1.50 per share,
convertible any time during the term of the note, and is subject to standard
anti-dilution rights. The A
warrants and B warrants expire December 3, 2008.  The original expiration
date was to be one year after the effective date of a registration statement
filed under the Securities Act registering the subsequent sale of shares
received from exercise of the A warrants and B warrants, but was extended in
connection with the exchange agreement described below.  The A warrants
grant the convertible note holder the right to purchase up to 750,000 shares of
common stock at an exercise price of $1.60 per share and the B warrants grant
the convertible note holder the right to purchase up to 750,000 shares of common
stock at an exercise price of $1.75 per share.  The convertible note holder
also received C warrants to purchase 2,000,000 shares of common stock and D
warrants to purchase 2,000,000 shares of common stock, all of which have been
cancelled as discussed below.  The A warrants and B warrants are
exercisable at any time until their expiration date and are subject to    28   adjustment
pursuant to standard anti-dilution rights.  As of September 30, 2008, the
convertible note holder had exercised 518,400 A warrants and no B warrants. In October
2007, we entered into an exchange agreement with the convertible note holder.
 Pursuant to the exchange agreement, we cancelled the C warrants to acquire
up to 2,000,000 shares of our common stock at $2.10 per share and the D warrants
to acquire up to 2,000,000 shares of our common stock at $3.00 per share in
exchange for the issuance of 650,000 shares of our common stock. Our monthly
operating expenses currently exceed our monthly net sales by approximately
$650,000 per month.  This amount could increase significantly.  We
expect our operating expenses will continue to outpace our net sales until we
are able to generate additional revenue.  Our business model contemplates
that sources of additional revenue include (i) sales from our private
communication network services, (ii) sales resulting from new customer
contracts, and (iii) sales, licensing fees and/or royalties related to
commercial applications of our CodecSys technology, including from our IBM
license agreement. Our
long-term liquidity is dependent upon execution of our business model and the
realization of additional revenue and working capital as described above, and
upon capital needed for continued commercialization and development of the
CodecSys technology.  Commercialization and future applications of the
CodecSys technology are expected to require additional capital. We have
increased our expenditures for research and development in anticipation of
bringing products to market. We currently estimate our research and development
expenditures to be approximately $4.0 million annually for the foreseeable
future.  This estimate will increase or decrease depending on specific
opportunities and available funding. To date, we have met our working
capital needs primarily through funds received from sales of our common stock
and from convertible debt financings.  Until our operations become
profitable, we must continue to rely on external funding. Given the current
state of the financial markets, there is significant uncertainty and we may not
be able to raise the necessary capital on terms favorable to us and our
shareholders, if at all.  Off-Balance Sheet
Arrangements  We have no off-balance sheet
arrangements.  Item 3.
 Quantitative and Qualitative Disclosures about Market Risk Market risk represents the risk of
loss that may impact our financial position due to adverse changes in financial
market prices and rates.  We do not issue financial instruments for trading
purposes or have any derivative financial instruments.  As discussed above,
however, the embedded conversion features and prepayment options of our
convertible notes and our related warrants are deemed to be derivatives and are
subject to quarterly mark-to-market valuations.  We have investments in auction rate
preferred securities, which are classified as available-for-sale securities and
reflected at fair value.  Approximately 80% of our auction rate
preferred securities have been redeemed by the issuers at par.  The
remaining amount of these securities, which are approximately $2,800,000, we
have classified as non-current assets in the unaudited Condensed Consolidated
Balance Sheet as of September 30, 2008 and valued them at $2,554,597. For a
complete discussion on auction rate preferred securities, including our
methodology for estimating their fair value, see Note 7 to the unaudited
condensed consolidated financial statements.  Our cash and cash equivalents are
also exposed to market risk.  However, because of the short-term maturities
of our cash and cash equivalents, we do not believe that an increase in market
rates would have any significant impact on the realized value of our cash and
cash equivalent investments.  We currently do not hedge interest rate
exposure and are not exposed to the impact of foreign currency fluctuations.  Item 4T.  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.  Our disclosure controls and procedures include controls and
procedures designed to ensure    29   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 September
30, 2008.  Based on this evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were not
effective as of September 30, 2008 because of a filing error with respect to our
definitive proxy materials related to our annual meeting of shareholders. See
Part II, Item 4, Submission of Matters to Vote of Security Holders. We are
taking corrective action to remedy this situation.  Changes in Internal Control over
Financial Reporting  During the most recent fiscal quarter
covered by this report, we made no changes in our internal control over
financial reporting.  Important Considerations  The effectiveness of our disclosure
controls and procedures and our internal control over financial reporting is
subject to various inherent limitations, including cost limitations, judgments
used in decision making, assumptions about the likelihood of future events, the
soundness of our systems, the possibility of human error, and the risk of fraud.
 Moreover, projections of any evaluation of effectiveness to future periods
are subject to the risk that controls may become inadequate because of changes
in conditions and the risk that the degree of compliance with policies or
procedures may deteriorate over time.  Because of these limitations, there
can be no assurance that any system of disclosure controls and procedures or
internal control over financial reporting will be successful in preventing all
errors or fraud or in making all material information known in a timely manner
to the appropriate levels of management.    Part II  Other
Information  Item
1. Legal
Proceedings  None.  Item 1A. Risk Factors ` There have been no material changes
in risk factors from those described in our Annual Report of Form 10-K for the
year ended December 31, 2007.  Item
2. Unregistered
Sales of Equity Securities and Use of Proceeds  None  Item 3.  Defaults Upon Senior
Securities  None.  Item
4. Submission
of Matters to Vote of Security Holders.  (a)
          The 2008 Annual
Meeting of Shareholders of Broadcast International, Inc. was held on October 29,
2008.  (b)
          Six director
nominees identified below, all of whom were existing directors, were elected to
serve until the next annual meeting of shareholders and until their successors
have been duly elected and qualified or until their earlier resignation or
removal.      30   (c)
         The following matters were
submitted to a vote of security holders at the annual meeting:  Matter

For

Withheld/
Against

Abstentions

Broker
Non-Votes(1)  Election of
Directors:William
Davidson

22,699,361

7,390

-

-Rodney M.
Tiede

22,701,821

4,930

-

-James E.
Solomon

22,691,341

15,410

-

-Kirby D.
Cochran

21,350,855

1,355,896

-

-Richard
Benowitz

22,690,861

15,890

-

-William
Boyd

22,697,257

9,494

-

-(2)  Approval of the
Broadcast International, Inc. 2008 Equity Incentive Plan

10,667,683

970,509

718,323

10,350,236(3)  Ratification of the
selection of HJ & Associates, LLC as independent registered public
accounting firm for the year ending December 31, 2008

22,649,791

5,320

51,640

-  In connection with the annual
meeting, we elected to take advantage of the SECs new e-proxy rules, thereby
allowing us to provide proxy materials to shareholders on the Internet.  We
hired a third-party service provider to assist us in implementing the new rules.
 In the course of implementation, there was a misunderstanding between us
and the service provider which resulted in a copy of our definitive proxy
materials not being filed with the SEC.  This missed filing did not affect
the proxy materials or information provided to our shareholders.  After
consultation with counsel, we believe the filing error did not impact the
results of our annual meeting.  Out of an abundance of caution, however, we
intend to resubmit the 2008 equity incentive plan to our shareholders and
re-elect directors at our next annual meeting of shareholders currently
scheduled for second quarter 2009.  Item
5. Other
Information  (a)
         At an Audit Committee
meeting held on October 29, 2008, Mr. James Solomon resigned as chairman and a
member of the Audit Committee. Mr. Solomon is currently serving as our Chief
Financial Officer .At the same meeting, Mr. William Boyd, an existing member of
the Audit Committee, was appointed as chairman of the committee. Mr. Richard
Benowitz, an existing director, was appointed as a new member of the Audit
Committee. Mr. Kirby Cochran continues as a member of the Audit Committee.  (b)
         None.      31    Item
6. Exhibits  Exhibit  Number
Description of Document3.1
Amended
and Restated Articles of Incorporation of Broadcast International.
  (Incorporated by reference to Exhibit No. 3.1 of the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2006
filed with the SEC on November 14, 2006.)3.2
Amended
and Restated Bylaws of Broadcast International.  (Incorporated by
reference to Exhibit No. 3.2 of the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2006 filed with the SEC on
November 14, 2006.)4.1
Specimen
Stock Certificate of Common Stock of Broadcast International.
 (Incorporated by reference to Exhibit No. 4.1 of the Company's
Registration Statement on Form SB-2, filed under cover of Form S-3,
pre-effective Amendment No. 3 filed with the SEC on October 11,
2005.)4.2
Form of
A Warrant issued by Broadcast International to each 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. 4.3 of the Company's
Registration Statement on Form SB-2, filed under cover of Form S-3,
pre-effective Amendment No. 3 filed with the SEC on October 11,
2005.)4.3
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 Form
S-3, pre-effective Amendment No. 3 filed with the SEC on October 11,
2005.)10.1*
Employment
Agreement of Rodney M. Tiede dated April 28, 2004.  (Incorporated by
reference to Exhibit No. 10.1 of the Company's Quarterly Report on Form
10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12,
2004.)10.2*
Broadcast
International, Inc. 2008 Equity Incentive Plan.10.3*
Broadcast
International Long-Term Incentive Plan.  (Incorporated by reference
to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the
year ended December 31, 2003 filed with the SEC on March 30,
2004.)10.4
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
Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11,
2005.)10.5
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 Form
S-3, pre-effective Amendment No. 3 filed with the SEC on October 11,
2005.)10.6
Technology
License Agreement  e-publishing technology  dated August 15, 2006
between Broadcast International and Yang Lan Studio Ltd. (Incorporated by
reference to Exhibit 10.9 of the Companys Current Report on Form 8-K
filed with the SEC on August 22, 2006.)10.7
Termination
and Release Agreement dated January 17, 2007 among Broadcast
International, Yang Lan Studio Ltd., Broadvision Global, Ltd. and Sun
Media Investment Holdings, Ltd. (Incorporated by reference to Exhibit No.
10.1 of the Companys Current Report on Form 8-K filed with the SEC on
January 25, 2007)    32    10.8
Securities
Purchase Agreement dated October 28, 2006 between Broadcast International
and Leon Frenkel.  (Incorporated by reference to Exhibit 10.1 of the
Companys Current Report on Form 8-K filed with the SEC on November 6,
2006.)10.9
5%
Convertible Note dated October 16, 2006 issued by Broadcast International
to Leon Frenkel.  (Incorporated by reference to Exhibit 10.2 of the
Companys Current Report on Form 8-K filed with the SEC on November 6,
2006.)10.10
Registration
Rights Agreement dated October 28, 2006 between Broadcast International
and Leon Frenkel.  (Incorporated by reference to Exhibit 10.3 of the
Companys Current Report on Form 8-K filed with the SEC on November 6,
2006.)10.11
Form of
A Warrant dated October 28, 2006 issued by Broadcast International to Leon
Frenkel.  (Incorporated by reference to Exhibit 10.4 of the Companys
Current Report on Form 8-K filed with the SEC on November 6,
2006.)10.12
Form of
B Warrant dated October 28, 2006 issued by Broadcast International to Leon
Frenkel.  (Incorporated by reference to Exhibit 10.5 of the Companys
Current Report on Form 8-K filed with the SEC on November 6,
2006.)10.13
Exchange
Agreement dated October 31, 2007 between Broadcast International and Leon
Frenkel.  (Incorporated by reference to Exhibit 10.1 of the Companys
Current Report on Form 8-K filed with the SEC on November 7,
2007.)10.14
Securities
Purchase Agreement dated as of December 21, 2007, by and among Broadcast
International and the investors listed on the Schedule of Buyers attached
thereto. (Incorporated by reference to Exhibit 10.1 of the Companys
Current Report on Form 8-K filed with the SEC on December 26,
2007.)10.15
Registration
Rights Agreement dated as of December 21, 2007, by and among Broadcast
International and the buyers listed therein.  (Incorporated by
reference to Exhibit 10.2 of the Companys Current Report on Form 8-K
filed with the SEC on December 26, 2007.)10.16
6.25%
Senior Secured Convertible Promissory Note dated December 21, 2007 issued
to the holder listed therein.  (Incorporated by reference to Exhibit
10.3 of the Companys Current Report on Form 8-K filed with the SEC on
December 26, 2007.)10.17
Warrant
to Purchase Common Stock dated December 21, 2007 issued to the holder
listed therein.  (Incorporated by reference to Exhibit 10.4 of the
Companys Current Report on Form 8-K filed with the SEC on December 26,
2007.)10.18
Security
Agreement dated as of December 21, 2007, made by each of the parties set
forth on the signatures pages thereto, in favor of the collateral agent
listed therein.  (Incorporated by reference to Exhibit 10.5 of the
Companys Current Report on Form 8-K filed with the SEC on December 26,
2007.)31.1
Certification
of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.31.2
Certification
of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.32.1
Certification
of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
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.*   Management
contract or compensatory plan or arrangement    33       SIGNATURES  Pursuant to the
requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.  Broadcast
International, Inc.   Date:
November 14, 2008 /s/ Rodney
M. Tiede By:  Rodney
M. Tiede Its:
 President and Chief Executive Officer (Principal Executive
Officer)   Date:
November 14, 2008 /s/ James
E. Solomon By:  James
E. Solomon Its: Chief
Financial Officer (Principal Financial and Accounting
Officer)     34