UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549  FORM 10-Q  [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.  For the Quarterly Period ended June 30, 2007 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 Number: 0-13316  BROADCAST INTERNATIONAL, INC. (Exact name of registrant as specified in its charter)  Utah  87-0395567 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization)  7050 Union Park Ave. #600, Salt Lake City, Utah 84047 (Address of Principal Executive Offices) (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 (x)  No ( )   Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (check one):  Large accelerated filer ( )   Accelerated filer ( )   Non-accelerated filer (X)  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ( )  No (X)  As of July 31, 2007, there were 30,561,945 shares of the registrants common stock, $0.05 par value, outstanding, which is the only class of common or voting stock the registrant has issued.   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 16 Item 3.   Quantitative and Qualitative Disclosures about Market Risk 23 Item 4.   Controls and Procedures 23 Part II - Other Information Item 1.   Legal Proceedings 24 Item 1A. Risk Factors 24 Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds 24 Item 3.   Defaults Upon Senior Securities 24 Item 4.   Submission of Matters to a Vote of Security Holders  24 Item 5.   Other Information 24 Item 6.   Exhibits  24 Signatures 28


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Item 1. Financial Information   BROADCAST INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS December 31, 2006June 30, 2007 (Unaudited)ASSETS:Current assetsCash and cash equivalents$       807,741$      341,677Trade accounts receivable, net851,473224,954Inventory46,34128,739Prepaid expenses1,400,3612,212,552Total current assets3,105,9162,807,922Property and equipment, net387,058313,279Other assetsTechnology licenses, net1,142,400-Patents, net200,306198,895Debt offering costs346,269145,433Deposits and other assets8,79533,795Total other assets1,697,770378,123Total assets$    5,190,744$   3,499,324 See accompanying notes to consolidated financial statements.     3    BROADCAST INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS (Continued) December 31, 2006June 30, 2007 (Unaudited)LIABILITIES:Current liabilitiesAccounts payable$         705,099$        456,100Payroll and related expenses202,335179,789Other accrued expenses130,79880,625Unearned revenue491,252185,193Current debt obligations666,637422,893Convertible debt (net of $481,249 discount)-1,168,751Derivative valuation4,631,5003,856,500Total current liabilities6,827,6216,349,851Long-term liabilitiesConvertible debt (net of $2,086,692 and $774,192discount, respectively)1,413,308225,808Other long-term obligations35,093-Deferred bonus payable600,000600,000Total liabilities8,876,0227,175,659Commitments and contingenciesSTOCKHOLDERS DEFICITPreferred stock, no par value, 20,000,000 sharesauthorized; none issuedCommon stock, $.05 par value, 180,000,000 sharesauthorized; 29,953,260 and 30,428,612 shares issuedas of December 31, 2006 and June 30, 2007,respectively1,347,6631,521,431Additional paid-in capital35,715,63440,085,775Unexercised stock options and warrants937,4361,936,866Accumulated deficit(41,686,011)(47,220,407)Total stockholders deficit(3,685,278)(3,676,335)Total liabilities and stockholders deficit$      5,190,744$     3,499,324 See accompanying notes to consolidated financial statements.     4    BROADCAST INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)  For the three months ended
June 30,For the six months ended
June 30,2006200720062007Net sales$4,283,115$763,784$7,063,513$2,362,850Cost of sales3,999,406800,8356,737,3572,395,610Gross profit (loss)283,709(37,051)326,156(32,760)Operating expenses:Administrative and general963,5361,304,5082,211,3412,879,192Selling and marketing219,448166,814368,023309,435Research and development296,903199,0261,905,199384,089Impairment of license rights-1,142,400-1,142,400Total operating expenses1,479,8872,812,7484,484,5634,715,116Total operating loss(1,196,178)(2,849,799)(4,158,407)(4,747,876)Other income (expense):Interest income6,3033,54311,39412,578Interest expense(771,571)(353,008)(1,208,119)(1,126,839)Gain on forgiveness of debt--284,000-Derivative valuation gain1,486,5001,982,480242,500328,090Other income (expense), net(8,753)(3,015)(8,480)(349)Total other income (expense)712,4791,630,000(678,705)(786,520)Loss before income taxes(483,699)(1,219,799)(4,837,112)(5,534,396)Provision for income taxes----Net loss$(483,699)$(1,219,799)$(4,837,112)$(5,534,396)Net loss per share  basic & diluted$(.02)$(0.04)$(0.20)$(0.19)Weighted average shares  basic & diluted24,557,30030,125,30023,737,40028,995,900  See accompanying notes to consolidated financial statements.    5     BROADCAST INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)  Six months ended
June 30,20062007Cash flows from operating activities:Net loss$(4,837,112)$(5,534,396)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization135,396116,873Common stock issued for services100,000-Accretion of convertible senior notes payable472,222345,834Accretion of convertible Frankel note payable-166,668Common stock issued for acquisition in excess
of asset valuation1,363,126-Unexercised options and warrant expense571,712999,430Gain on forgiveness of debt(284,000)-Gain on sale of assets-(5,100)Derivative liability valuation(242,500)(328,090)Impairment of license rights-1,142,400Extinguishment of debt340,278318,749Allowance for doubtful accounts5,22550,120Changes in assets and liabilities:Accounts receivable5,773576,399Inventories211,72317,602Debt offering costs245,536200,836Prepaid and other assets361,3631,286,809Accounts payable and accrued expenses306,668(317,218)Deferred revenues(82,274)(306,059)Net cash used in operating activities(1,326,864)(1,269,143)Cash flows from investing activities:Purchase of equipment(33,077)(41,683)Proceeds from sale of assets-5,100Net cash used in investing activities(33,077)(36,583)Cash flows from financing activities:Principal payments on debt(35,093)(583,285)Proceeds for the sale of stock1,243,1861,122,999Loan proceeds-299,948Cash provided in acquisition500,000-Net cash provided by financing activities1,708,093839,662Net increase (decrease) in cash and cash equivalents348,152(466,064)Cash and cash equivalents, beginning of period446,491807,741Cash and cash equivalents, end of period$794,643$341,677  See accompanying notes to consolidated financial statements.    6     BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) June 30, 2007  NOTE 1 - BASIS OF PRESENTATION  In the opinion of management, the accompanying unaudited consolidated financial statements of Broadcast International, Inc. contain the adjustments, all of which are of a normal recurring nature, necessary to present fairly our financial position at June 30, 2007 and December 31, 2006 and the results of operations for the three and six months ended June 30, 2007 and 2006, respectively, with the cash flows for each of the six month periods ended June 30, 2007 and 2006, in conformity with U.S. generally accepted accounting principles.  These 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, 2006.  Operating results for the six months ended June 30, 2007 are not necessarily indicative of the results that may be expected for the year ending December 31, 2007.  NOTE 2 - GOING CONCERN  The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have incurred losses and have not demonstrated the ability to generate sufficient cash flows from operations to satisfy our liabilities and sustain operations. These factors raise substantial doubt about our ability to continue as a going concern.  Our continuation as a going concern is dependent on our ability to generate sufficient income and cash flow to meet our obligations on a timely basis and to obtain additional financing as may be required. We are actively seeking additional capital and financing. There is no assurance we will be successful in our future funding efforts. The accompanying statements do not include any adjustments that might be necessary if we are unable to continue as a going concern.  NOTE 3 - RECLASSIFICATIONS  Certain 2006 financial statement amounts have been reclassified to conform to 2007 presentations.  NOTE 4 - WEIGHTED AVERAGE SHARES  The computation of basic earnings (loss) per common share is based on the weighted average number of shares outstanding during each period.  The computation of diluted earnings per common share is based on the weighted average number of common shares outstanding during the period, plus the common stock equivalents that would arise from the exercise of stock options and warrants outstanding, using the treasury stock method and the average market price per share during the period.  Options and warrants to purchase 15,614,557 and 6,269,664 shares of common stock at prices ranging from $0.02 to $45.90 per share were outstanding at June 30, 2007 and 2006, respectively, but were excluded from the calculation of diluted earnings per share because the effect of stock options and warrants was anti-dilutive.  NOTE 5 - 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.    7     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 the three and six months ended June 30, 2007.  Risk-free interest rate 4.52% -  5.23% Expected lives in years 3.0 - 10.0 Dividend yield 0 Expected volatility 82.20% - 91.72%  Net loss for the six months ended June 30, 2007 and 2006 includes $999,430 and $571,712, respectively, of non-cash stock-based compensation expense. Options issued to directors are immediately vested, all other options and warrants are subject to applicable vesting schedules. Expense is recognized proportionally as each grant vests.  Included in the $999,430 of non-cash stock based compensation expense for the six months ended June 30, 2007 is (i) $499,000 resulting from 600,000 options granted to three directors, (ii) $232,693 resulting from the vesting of unexpired options issued prior to January 1, 2007, (iii) $215,490 resulting from 1,825,000 warrants issued to three 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) $41,887 resulting from the issuance of 366,500 options issued to non-executive management employees, and (v) $10,360 for repriced options previously granted to executive management. Warrants to acquire 748,670 shares of our common stock were also granted to certain equity investors. See note 8.  Included in the $517,712 of non-cash stock based compensation expense for the six months ended June 30, 2006 is (i) $342,500 resulting from 175,000 options granted to two outside directors, (ii) $182,440 resulting from the vesting of unexercised options issued prior to January 1, 2006, (iii) $26,048 for repriced options previously granted to non-executive management employees, and (iv) $20,724 (of a total of $51,808) for repriced options previously granted to executive management which is being recognized over the remaining vesting period. Warrants to acquire 337,457 shares of our common stock were also granted to certain equity investors.  The impact on our results of operations for recording stock-based compensation under FAS 123R for the three and six months ended June 30, 2006 and 2007 are as follows:  For the three months ended
June 30,For the six months ended
June 30,2006200720062007General and administrative$  37,754$  324,269$ 462,330$ 883,457Research and development47,20863,168109,382115,973Total$  84,962$  387,437$ 571,712$ 999,430  Due to unexercised options outstanding at June 30, 2007, we will recognize a total of $2,508,259 of compensation expense over the next four years for employees and consultants as a result of the adoption of FAS 123R based upon option and warrant award vesting parameters as shown below:  2007$      1,659,4842008682,8422009150,770201015,163Total$      2,508,259          8       The following unaudited tables summarize option and warrant activity during the six months ended June 30, 2007.  Optionsand WarrantsOptions or WarrantsOutstandingPrice Per ShareOutstanding at December 31, 200612,652,597$0.02  - $45.90Options granted991,500$0.95 - $1.49Warrants issued2,548,6701.07   -   2.00Expired(400)9.50Forfeited(577,810)0.02  -  4.00Exercised-Outstanding at June 30, 200715,614,557$0.02 - $45.90    OutstandingWeightedExercisableAverageWeightedWeightedRange ofRemainingAverageAverageExerciseNumberContractualExerciseNumberExercisePricesOutstandingLife (years)PriceExercisablePrice$0.02-0.041,264,4952.82$0.031,264,495$0.030.33-0.951,695,6697.410.721,445,6690.681.07-6.2512,650,7933.462.1512,271,1262.159.50-11.502,0004.0310.652,00010.6536.25-45.901,6003.1741.081,60041.08.$.02 - 45.9015,614,5573.84$1.8314,984,890$1.83   NOTE 6- 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 June 30, 2007 and December 31, 2006, we had bank balances in 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.  Trade Account Receivables Trade account receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.     9    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 June 30, 2007, five foreign countries had approved patent rights and we are in a patent pending status in the United States. While we are unsure whether we can develop the technology in order to obtain the full benefits, the patents themselves hold value and could be sold to those with more resources to complete the development. On-going legal expenses incurred for patent follow-up have been expensed from July 2005 forward.  Amortization expense recognized on all patents totaled $674 and $1,411 for the three and six months ended June 30, 2007, respectively. Amortization expense recognized on all patents totaled $315 and $385 for the three and six months ended June 30, 2006, respectively.  Estimated amortization expense, if all patents were issued as of July 1, 2007, for each of the next five years is as follows:  Year ending December 31:2007$              8,665200810,570200910,570201010,570201110,570   Marketable Securities-Available For Sale Securities. We record available for sale securities at the time of acquisition at fair market value and classify them as current or noncurrent assets on our balance sheet based upon our intended holding period. At each reporting period, market value is compared to cost with the cumulative unrealized gain or loss presented as a separate item in our equity section and identified as accumulated other comprehensive gain or loss.  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.  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    10    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, our selling price to our customers is fixed and determinable with required documentation, and collectibility is reasonably assured. We recognize as deferred revenue, payments made in advance by customers for services not yet provided.  When we enter into a multi-year contract with a customer to provide installation, network management, satellite transponder and help desk, or a 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.  Concentration of Credit Risk Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of trade accounts receivable. In the normal course of business, we provide credit terms to our customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have been within the range of managements expectations.  Our three largest customers sales revenues accounted for approximately 65% and 84% of total revenues, with combined balances representing approximately 18% and 83% of our outstanding accounts receivable, for the three months ended June 30, 2007 and 2006, respectively. Included in the numbers above is our single largest customer for the three months ended June 30, 2007 and 2006, which provided 28% and 67%, respectively, of our total revenue. Any material reduction in revenues generated from any one of our largest customers could harm our results of operations, financial condition and liquidity.  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.  NOTE 7- LONG TERM OBLIGATIONS  Unsecured Convertible Note  Effective November 2, 2006, we entered into a Securities Purchase Agreement, which was dated October 28, 2006, with Mr. Leon Frenkel, including a 5% Convertible Note, a Registration Rights Agreement, and we issued four classes of warrants to purchase our common stock.  Pursuant to the Securities Purchase Agreement, (i) we sold to Frenkel a three-year convertible note in the principal amount of $1,000,000 representing the funding received by us; (ii) the convertible note bears an annual interest rate of 5%, payable semi-annually in cash or shares of our common stock; (iii) the convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share; and (iv) we issued to Frenkel four classes of warrants (A Warrants, B Warrants, C Warrants and D Warrants), which give Frenkel the right to purchase a total of 5,500,000 shares of our common stock as described below.  The A and B Warrants expire on January 11, 2008, one year after the effective date of a registration statement filed under the Securities Act of 1933, as amended (the Securities Act), to register the subsequent sale of shares received from exercise of the A and B Warrants. The C Warrants and D Warrants expire at the earlier to occur of eighteen months and twenty-four months, respectively, after the effective date of a registration statement to be filed or five years from the date of issuance.  The A Warrants grant Frenkel 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 Frenkel 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 Frenkel 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 Frenkel the    11    right to purchase up to 2,000,000 shares of common stock at an exercise price of $3.00 per share. The warrants and the embedded conversion feature and prepayment provision of the unsecured convertible note have been accounted for as derivatives pursuant to EFIT 00-19 and SFAS No. 133.  The conversion feature and the prepayment provision of the note 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.  For all periods since the issuance of the unsecured convertible note, 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 note.  As of June 30, 2007, we recorded an aggregate derivative liability of $2,852,500 and a derivative valuation loss of $418,300 to reflect the change in value of the aggregate derivate liability since December 31, 2006.  The aggregate derivative liability of $2,852,500 included $280,000 for the conversion feature and $2,572,500 for the warrants.  These values were calculated using the Black-Scholes pricing model with the following assumptions: (i) risk−free interest rate between 4.87% and 4.92%, (ii) expected life (in years) of 2.30 for the conversion feature and between 0.50 and 4.30 for the warrants; (iii) expected volatility of 77.12% for the conversion feature and between 87.86% and 110.32% for the warrants; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.10.  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 $166,668 was included as interest expense for the three and six months ended June 30, 2007, respectively. The note bears a 5% annual interest rate payable semi annually, and for the three and six months ended June 30, 2007, $12,501 and $25,002, respectively, was included in interest expense.  Senior Secured 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 are due May 16, 2008 and were originally convertible into 1,200,000 shares of 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 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 penalty provision of the registration rights agreement related to the senior secured convertible notes has not been valued and treated as an embedded derivative because our obligation to keep the registration statement effective has expired.  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. 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 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 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 evaluated and adjusted to current fair value.  The note conversion feature and the warrants may be exercised at any time and, therefore, have been reported as current liabilities.  The prepayment provision may not be exercised by us until May 16, 2007, and then only in certain limited circumstances.  For all periods since the issuance of the senior secured convertible notes, the derivative value of the prepayment provision has been nominal and has not had any offsetting effect on the valuation of the conversion feature of the notes.    12     On March 16, 2006, we entered into a Waiver and Amendment Agreement with the four institutional funds regarding our default under a forbearance agreement.  Under the terms of the waiver, the institutional funds terminated the forbearance agreement and waived any and all defaults under the senior secured convertible notes and related transaction agreements.  In consideration of the waiver, we and the funds agreed to amend the transaction agreements as follows: (i) Section 3.12 of the securities purchase agreement was deleted, which provision gave the funds a preemptive right to acquire any new securities issued by us; (ii) Section 3.15(c) of the securities purchase agreement was deleted, which provision prohibited us from completing a private equity or equity-linked financing; (iii) the conversion price, at which the notes are convertible into 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 price protection provisions); and (v) the notes were amended by adding a new event of default, which is that if we had failed to raise and receive at least $3,000,000 in cash net proceeds through one or more private or public placements of our 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 their 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 from $1,750,000 to $1,650,000.  As of June 30, 2007 and 2006, we recorded an aggregate derivative liability of $1,004,000 and $2,122,700 and a derivative valuation gain of $90,210 and a loss of $889,300 to reflect the change in value of the aggregate derivate liability since December 31, 2006 and 2005, respectively. The aggregate derivative liability of $1,004,000 included $308,000 for the conversion feature and $696,000 for the warrants.  These values were calculated using the Black-Scholes pricing model with the following assumptions: (i) risk-free interest rate of 4.91% for conversion feature and 4.89% for warrants; (ii) expected life (in years) of 0.90 for the conversion feature and 2.90 for the warrants; (iii) expected volatility of 91.91% for the conversion feature and 92.29% for the warrants; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $1.10.  The principal value of $1,650,000 of the senior secured convertible notes is being accreted over the term of the obligations, for which (i) $137,499 and $345,834 and is included in interest expense for the three and six months ended June 30, 2007, respectively, and (ii) $222,223 and $472,222 is included in interest expense for the three and six months ended June 30, 2006, respectively.  The notes bear a 6% annual interest rate payable semi annually for which (i) $24,817 and $60,942 for the three and six months ended June 30, 2007, respectively, and (ii) $39,083 and $84,083 for the three and six months ended June 30, 2006, 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 part of this confirmation, we assumed liabilities to be paid in cash of approximately $312,768. For each of the three and six months ended June 30, 2007 and 2006, we paid approximately $17,547 and $35,094, respectively, of the $312,768 original obligation. The balance remaining as of June 30, 2007 and 2006 was approximately $70,187 and $140,374, respectively, of which $70,187 and $70,187, respectively, has been recorded as the current portion with $0 and $70,187, respectively, as long-term debt.  NOTE 8 - SUPPLEMENTAL CASH FLOW INFORMATION  For the six months ended June 30, 2007, we received $1,122,999 from the sale of 748,683 shares of common stock pursuant to a Private Placement Offering at a price of $1.50 per share. Additionally, the holders of 748,670 of    13    these shares received a warrant to acquire one share of our common stock.  The warrants have a three-year exercise period and are exercisable at a $2.00 exercise price.  During the six months ended June 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 996,997 2008 968,655 2009 158,348 --------------- $2,124,000 =========  On March 18, and April 4, 2007, three of the institutional funds converted an aggregate of $850,000 of their senior secured convertible notes into 566,667 shares of our common stock resulting in an extinguishment of debt non-cash expense in the amount of $345,834 included as interest expense for the six months ended June 30, 2007. See Note 7.  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 June 30, 2007 as current debt obligations. Payment of principal and interest are due on December 31, 2007.  For the six months ended June 30, 2007 and 2006, an aggregate non-cash expense of $512,502 and 472,222 was recorded for the accretion of (i) the senior secured convertible notes of $345,834 and 472,222, respectively, and (ii) the unsecured convertible note of $166,668 in 2007, as interest expense. See Note 7.  On January 27, 2006, we acquired 100% of the common stock of Video Processing Technologies Inc. in exchange for an aggregate of 994,063 shares of our common stock. In this transaction, we recognized $1,363,126 as non-cash research and development in process expense.  On February 27, 2006, the Board of Directors approved a Private Placement Offering in anticipation of raising up to $4,500,000 by selling 3,000,000 shares of common stock at a price of $1.50 per share. Additionally, the holder of each share would receive a warrant to acquire one share of our common stock. The warrants have a three-year exercise period and are exercisable at a $2.00 exercise price. As of June 30, 2006, we had raised proceeds of $1,243,186 from the sale of 828,790 shares of our common stock.  In March 2006, we issued 766,666 shares of our common stock to two corporations which provide investor relations services for us. The value of these shares of $1,724,999 was recorded as a prepaid expense and will be recognized over the service periods as follows:  2006 $1,187,499 2007 487,500 2008 50,000 --------------- $1,724,999 =========  We paid no cash for income taxes during the six months ended June 30, 2007 and 2006.  We paid $94,508 and $87,833 for interest expense during the six months ended June 30, 2007 and 2006, respectively.  NOTE 9- RECENT ACCOUNTING PRONOUNCEMENTS  In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities  Including an Amendment of FASB Statement No. 115 which is effective for fiscal years beginning after November 15, 2007. This statement permits an entity to choose to measure many financial instruments and certain other items at fair value at specified election dates. Subsequent    14    unrealized gains and losses on items for which the fair value option has been elected will be reported in earnings. We are currently evaluating the potential impact of this statement. In May 2007, the FASB issued FASB Staff Position (FSP) FIN No. 48-1, Definition of Settlement in FASB Interpretation No. 48 (FSP FIN No. 48-1). FSP FIN No. 48-1 provides guidance on how a company should determine whether a tax position is effectively settled for the purpose of recognizing previously unrecognized tax benefits. FSP FIN No. 48-1 is effective upon initial adoption of FIN No. 48, which we adopted in the first quarter of fiscal 2007    15     Item 2.  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  Cautionary Note Regarding Forward-Looking Information  This quarterly report on Form 10-Q includes 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 risks 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 in them.  All forward-looking statements are qualified in their entirety by reference to the risk factors discussed in our Annual Report on Form 10-K for the year ended December 31, 2006.  Among the key factors that could cause actual results to differ materially from the forward-looking statements are the following:  · dependence on commercialization of our CodecSys technology; · our ability to continue as a going concern; · our need and ability to raise sufficient additional capital; · our limited operating history and continued losses; · restrictions contained in our outstanding convertible notes; · 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 significant customers; · uncertainty of intellectual property protection; · potential infringement on the intellectual property rights of others; · factors affecting our common stock as penny stock; · extreme price fluctuations in our common stock; · price decreases due to future sales of our common stock; · general economic and market conditions; · 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 statements.  Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or    16    circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments.  New factors emerge from time to time, and it is not possible for us to predict which factors will arise.  In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.  Critical Accounting Policies  We prepare our financial statements in conformity with accounting principles generally accepted in the United States.  As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available.  These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented.  Our accounting policies that are the most important to the portrayal of our financial condition and results, and which require the highest degree of management judgment, relate to the reserves for doubtful accounts receivable, the valuation of stock and options issued for services, and revenue recognition.  Reserves for Doubtful Accounts Receivable  Management estimates the amount of required reserves for the potential non-collectibility of accounts receivable based upon past experience of collection and consideration of other relevant factors.  Past experience, however, may not be indicative of future collections and therefore we could incur additional charges in the future to reflect differences between estimated and actual collections.  Valuation of stock and options  We value and account for the issuance of equity instruments to acquire goods and services based on the fair value of the goods and services or the fair value of the equity instrument at the time of issuance, whichever is more reliably measurable.  Revenue Recognition  We recognize revenue when evidence exists that there is an arrangement between us and our customers, delivery of equipment sold or service has occurred, the selling price to our customers is fixed and determinable with required documentation, and collectibility is reasonably assured. We recognize as deferred revenue payments made in advance by customers for services not yet provided.  When we enter into a multi-year contract with a customer that has an established network to provide installation, network management, satellite transponder and help desk, or a combination of these services, we recognize this revenue as the 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.  Executive Overview We continue to need additional capital to fund our operating activities, including the development of our CodecSys technology.  In early 2007, we commenced a private placement offering of our securities by selling shares of our common stock at a price of $1.50 per share.  In the offering, the purchaser of each share has received a warrant to acquire one share of common stock.  The warrants have a three-year exercise period and are exercisable at an exercise price of $2.00 per share.  As of June 30, 2007, we had raised $ 775,000 from the sale of 516,671 shares of our common stock pursuant to the offering.  Notwithstanding the funding received from the offering, we continue to pursue additional equity and debt financing in order to operate our business and meet our liquidity needs.  Although our revenues were significantly less in the six months ended June 30, 2007 compared to the six months ended June 30, 2006, the net cash used for operations decreased for that period in 2007 compared to the same    17    period in 2006. However, decreasing revenues will continue to reduce our available cash and increase our need for future equity and debt financing.  In spite of decreasing revenues, we continue to make progress with the development of the CodecSys technology. We are in the process of adapting our codec operating system for use by IBM in their new proposed video encoder. We believe the encoder will be ready for public release in the fourth quarter of 2007.  Potential future sales of this encoder are anticipated to result in royalties payable to us which, if realized, will increase revenues and cash flow and decrease our reliance on future fund raising.  During the six months ended June 30, 2007, three of the institutional fund holders of our outstanding senior secured convertible notes converted an aggregate of $850,000 of their convertible notes into 566,667 shares of our common stock.  As a result of this conversion, the principal balance of the senior secured convertible notes was reduced from $2,500,000 to $1,650,000.  The outstanding notes are presently convertible into 1,100,000 shares of our common stock.  The conversion feature and the prepayment provision of the senior secured convertible notes and unsecured convertible note have been accounted for as embedded derivatives and valued on the respective transaction dates using a Black-Scholes pricing model.  The warrants related to the convertible notes have been accounted for as derivatives and were valued on the respective transaction dates using a Black-Scholes pricing model as well.  At the end of each quarterly reporting date, the values of the embedded derivatives and the warrants are evaluated and adjusted to current market value.  The conversion features of the convertible notes and the warrants may be exercised at any time and, therefore, have been reported as current liabilities.  Prepayment provisions contained in the convertible notes may not be exercised by us until one year after the respective issuance dates of the notes, and then only in certain limited circumstances.  For all periods since the issuance of the senior secured convertible notes and the unsecured convertible note, the derivative values of the respective prepayment provisions have been nominal and have not had any offsetting effect on the valuation of the conversion features of the notes.   Results of Operations for the Six Months ended June 30, 2007 and June 30, 2006  Revenues  We generated $2,362,850 in revenue during the six months ended June 30, 2007.  During the same six-month period in 2006, we generated revenue of $7,063,513.  The decrease in revenue of $4,700,663 was due primarily to a significant reduction in installation services for one client.  The revenues from services performed for that client decreased by $4,070,981 as a result of our having completed a substantial portion of non-recurring contract work for that client. In the first six months of 2007, we recognized revenue of $1,312,016 related to the sale and installation of equipment, which was a decrease of $4,511,917 over the same period in the prior year.  This decrease was also attributed to the completion of non-recurring client services discussed above.  In addition, license fee revenue decreased by $16,413, production fees decreased by $43,952, and satellite usage fees decreased by $163,269. We experienced these decreases in revenue due to decreased customer demand, but we do not believe it is representative of any trend affecting us in the long term. Satellite usage varies from period to period based on needs of our clients, which are difficult to predict. Production fees vary based on when individual projects come to us, which are also unpredictable. These decreases were partially offset by an increase in web related revenues of $34,889.  Sales revenues from our three largest customers accounted for approximately 65% of total revenues for the six months ended June 30, 2007and 84% of total revenues for the six months ended June 30, 2006. Any material reduction in revenues generated from any one of our largest customers could harm our results of operations, financial condition and liquidity.  Cost of Revenues  Cost of revenues decreased by $4,341,747 to $2,395,610 for the six months ended June 30, 2007 from $6,737,357 for the six months ended June 30, 2006.  The decrease was due primarily to decreased activity in installation of equipment for one customer, as discussed above, which resulted in a decrease of $3,940,265 in the costs related to such installations. In addition, the general operations department costs decreased by $282,942 due primarily to the decrease in installation activity. The satellite distribution costs and depreciation and    18    amortization also decreased by approximately $118,541 primarily because our clients utilized less satellite time during 2007.  Expenses  General and administrative expenses for the six months ended June 30, 2007 were $2,879,192 compared to $2,211,341 for the six months ended June 30, 2006.  The increase of $667,851 resulted from an increase in expenses incurred for outside consultants of $161,258, non-cash stock based compensation expenses of $421,127 for the value of options and warrants issued and outstanding, an increase of $85,290 in technical development, and an increase of $40,000 in bad debt expense. Research and development expenses decreased by $1,521,110 for the six months ended June 30, 2007 to $384,089 from $1,905,199 for the six months ended June 30, 2006.  This decrease resulted primarily from recording a $1,363,126 expense equal to the excess of cost over book value for the acquisition of Video Processing Technology, Inc. in the six months ended June 30, 2006.  Consulting fees for development of technology also decreased by $151,774. These decreases were offset by recording of an impairment of a technology license agreement in the amount of $1,142,400 as discussed below.  Interest Expense  For the six months ended June 30, 2007, we incurred interest expense of $1,126,839 compared to interest expense for the six months ended June 30, 2006 of $1,208,119.  The decrease of $81,280 resulted primarily from recording less interest expense related to our senior secured convertible notes, including accretion of the notes liability due to conversion of a portion of the senior secured convertible notes.  Net Loss  We realized a net loss for the six months ended June 30, 2007 of $5,534,396 compared with a net loss for the six months ended June 30, 2006 of $4,837,112. The increase in the net loss of $1,166,167 is primarily due to (i) an increase in loss of $385,410 related to our derivative valuation calculation, (ii) a one-time gain of $284,000 for gain on forgiveness of debt related to the accrued penalties on our senior secured convertible debt in the first half of 2006, which was not repeated in 2007, (iii) a $358,916 decrease in gross margin as a result of decreased sales activity, and (iv) an increase of $230,553 in operating expenses as previously discussed.  Results of Operations for the Three Months ended June 30, 2007 and June 30, 2006  Revenues  We generated $763,784 in revenue during the three months ended June 30, 2007.  During the same three-month period in 2006, we generated revenue of $4,283,115.  The decrease in revenue of $3,519,331 was due primarily to our performing approximately $3,024,297 less non-recurring installation work for a single customer. Our largest client in the three months ended March 31, 2007 resulted in revenues to us of $668,771.  We received no revenues from this client in the three months ended June 30, 2007 and do not anticipate receiving any in the future. We have, however, obtained another customer that we anticipate will at least partially, if not completely, replace the revenues lost from that customer. However, in the three months ended June 30, 2007, we realized only a nominal amount of revenues from this new customer.   In addition, in the three months ended June 30, 2007, revenues from satellite fees declined $122,824, revenues from studio and production services declined $45,863 and revenues from license fees declined $13,463.  We experienced these decreases in revenue due to decreased customer demand, but we do not believe it is representative of any trend affecting us in the long term. Satellite usage varies from period to period based on needs of our clients, which are difficult to predict. Production fees vary based on when individual projects come to us but are unpredictable. These decreases were partially offset by an increase of $18,221 in streaming and other miscellaneous revenue.  Cost of Revenues  Cost of revenues decreased by $3,198,571 to $800,835 for the three months ended June 30, 2007 from $3,999,406 for the three months ended June 30, 2006.  The decrease was due primarily to decreased activity in non recurring installation of equipment for one customer, which resulted in a decrease in the costs related to such installations of $2,924,987. However, the contracts from which we derived our revenues in 2007 had a higher gross margin than our major contract in 2006.  In addition, the general operations department costs decreased by    19    $187,555 due to the decrease in installation activity and cost of satellite revenues decreased by $78,983 due to decreased usage by our customers.  Expenses  General and administrative expenses for the three months ended June 30, 200 were $1,304,508 compared to $963,536 for the three months ended June 30, 2006.  The increase of approximately $340,972 resulted primarily from an increase in the value of non-cash stock-based compensation expenses incurred for issuance of options and warrants to outside consultants of $286,515, and an increase in expenses for technical development and support staffs of $48,401. Research and development in process decreased by $97,877 for the three months ended June 30, 2007 to $199,026 from $296,903 for the three months ended June 30, 2006, as a result of expensing certain options and patent acquisition costs in the first half of 2006, which were not repeated in 2007.  Sales and marketing expenses also decreased by $52,634 in the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. Total operating expenses increased to $2,812,748 in the three months ended June 30, 2007 from $1,479,887 for the three months ended June 30, 2006.  In addition to the increases in operating expenses described above, the largest segment of the increase was due to an expense we recorded of $1,142,400 related to the impairment of license rights for certain e-publishing software. We made the determination that we would not be able to recover the value of the software due to our inability to effectively market the software with our current resources.  Interest Expense  For the three months ended June 30, 2007, we incurred interest expense of $353,008 compared to interest expense for the three months ended June 30, 2005 of $771,571.  The decrease of $418,563 resulted from recording less interest expense related to our senior secured convertible notes and debt offering costs above what was recorded for the three months ended June 30, 2006. Interest expense for the three months ending June 30, 2006 included expense related to early conversion of $500,000 principal amount of the notes to shares of common stock and accelerated amortization of debt offering costs related to the converted portion of the notes.  Net Loss  We realized a net loss for the three months ended June 30, 2007 of $1,219,799 compared with a net loss for the three months ended June 30, 2006 of $483,699. The increase in the net loss of $736,100 is primarily due to (i) the expense recorded for the impairment of a software license of $1,142,400 as described above, (ii) a decrease in gross margin of $320,760 due to lower revenues, and (iii) increased operating and other expenses other than the impairment of license rights of $190,461, as described above, all of which was offset by an increase in the derivative valuation gain of our embedded derivatives of $495,980 and a decrease in interest expense of $418,563.  Liquidity and Capital Resources  At June 30, 2007, we had cash of $341,677 and total current assets of $2,807,922 compared to total current liabilities of $6,349,851 ($3,856,500 of which is reflected as the derivative valuation of the embedded derivatives in our senior secured convertible notes and unsecured convertible note and related warrants) and total stockholders deficit of $3,676,335.  For the six months ended June 30, 2007, we used  $1,269,143 of cash for operating activities as compared to cash used for operating activities for the six months ended June 30, 2006 of $1,326,864. The cash used for operations was provided in both periods primarily from proceeds from sales of our common stock and from loan financing. We expect to continue to experience negative operating cash flow as long as we continue our CodecSys technology development or until we increase our sales and operating profit significantly.  Our audited financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2006 contained a going concern qualification.  As discussed in Note 3 of the Notes to Consolidated Financial Statements, we have incurred losses and have not demonstrated the ability to generate sufficient cash flows from operations to satisfy our liabilities and sustain operations. Because of these conditions, our independent auditors have raised substantial doubt about our ability to continue as a going concern.     20    On May 16, 2005, we entered into a securities purchase agreement and completed a financing with a consortium of four institutional funds.  In the financing, we received $3,000,000 gross proceeds in cash pursuant to the issuance of senior secured convertible notes to the funds.  We used the proceeds from this financing to support our CodecSys research and development and for general working capital purposes. At June 30, 2007, there was $1,650,000 of the original balance still outstanding as $1,350,000 had been converted to our common stock by the funds.  The senior secured convertible notes are due May 16, 2008 and bear interest at 6% per annum.  Interest-only payments are due semi-annually.  The notes were originally convertible into 1,200,000 shares of our common stock at $2.50 per share, convertible any time during the term of the notes, but are now convertible at $1.50 per share into 1,100,000 shares of our common stock.  The senior secured convertible notes contain a prepayment provision allowing us to prepay, in certain limited circumstances, all or a portion of the notes, subject to a prepayment premium of 25% of the outstanding principal amount of the notes to be prepaid. Even if we elect to prepay the notes, the note holders may still convert any portion of the notes being prepaid pursuant to the conversion feature thereof.  The securities purchase agreement contains, among other things, covenants that may restrict our ability to obtain additional capital, to declare or pay a dividend or to engage in other business activities.  A breach of any of these covenants could result in a default under our senior secured convertible notes, in which event holders of the notes could elect to declare all amounts outstanding to be immediately due and payable, which would require us to secure additional debt or equity financing to repay the indebtedness or to seek bankruptcy protection or liquidation.  The securities purchase agreement provides that we cannot do any of the following without the prior written consent of the holders of at least 85% of the principal amount of the outstanding senior secured convertible notes:  § Issue debt securities or incur, assume, suffer to exist, guarantee or otherwise become or remain, directly or indirectly, liable with respect to certain indebtedness;  § except for those created under the securities purchase agreement, create, incur, assume or suffer to exist, directly or indirectly, any liens, restrictions, security interests, claims, rights of another or other encumbrances on or with respect to any of our assets, of any kind, whether now owned or hereafter acquired, or any income or profits therefrom;  § liquidate, wind up or dissolve (or suffer any liquidation or dissolution); § convey, sell, lease, license, assign, transfer or otherwise dispose of all or any substantial portion of our properties or assets, other than transactions in the ordinary course of business consistent with past practices, and transactions by non-material subsidiaries, if any;  § cause, permit or suffer, directly or indirectly, any change in control transaction as defined in the senior secured convertible notes; § directly or indirectly enter into or permit to exist any transaction with any of our affiliates or any of our subsidiaries, if any, except for transactions that are in the ordinary course of our business, upon fair and reasonable terms, that are fully approved by our Board of Directors, and that are no less favorable to us than would be obtained in an arms length transaction with a non-affiliate; § declare or pay a dividend or return any equity capital to any holder of any of our equity interests or authorize or make any other distribution to any holder of our equity interests in such holders capacity as such, or redeem, retire, purchase or otherwise acquire, directly or indirectly, for consideration any of our equity interests outstanding (or any options or warrants issued to acquire any of our equity interests); provided that the foregoing shall not prohibit (i) the performance by us of our obligations under the warrants related to the senior secured convertible notes or the registration rights agreement entered into in connection with the securities purchase agreement, or (ii) us and any of our subsidiaries, if any, from paying dividends in common stock issued by us or such subsidiary that is neither puttable by any holder thereof nor redeemable, so long as, in the case of any such common stock dividend made by any such subsidiary, the percentage ownership (direct or indirect) of us in such subsidiary is not reduced as a result thereof; or    21    § directly or indirectly, lend money or credit (by way of guarantee or otherwise) or make advances to any person, or purchase or acquire any stock, bonds, notes, debentures or other obligations or securities of, or any other interest in, or make any capital contribution to, any other person, or purchase or own a future contract or otherwise become liable for the purchase or sale of currency or other commodities at a future date in the nature of a futures contract, with very limited exceptions. On September 29, 2006, we entered into a letter of understanding with Triage Capital Management, whereby Triage provided $1,000,000 to us in exchange for us agreeing to enter into a convertible note securities agreement.  The funding provided by Triage was replaced with an unsecured convertible note and accompanying warrants, as described below, issued to Leon Frenkel, an affiliate and assignee of Triage.  On November 2, 2006, we closed on a convertible note securities agreement dated October 28, 2006 with Mr. Frenkel, that provided we issue to Mr. Frenkel (i) an unsecured convertible note in the principal amount of $1,000,000 representing the funding received by us on September 29, 2006, and (ii) four classes of warrants (A warrants, B warrants, C warrants and D warrants) which give Mr. Frenkel the right to purchase a total of 5,500,000 shares of our common stock.  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, including full ratchet price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than $1.50 per share  Under the convertible note securities purchase agreement, Mr. Frenkel has a right of first refusal to participate in any future funding on a pro rata basis until one year after the closing date.  Beginning on the first anniversary of the note, we may prepay all or a portion of the note, including interest as long as we have an effective registration statement covering the resale of the common stock issuable upon conversion.  Our largest client in the three months ended March 31, 2007 resulted in revenues to us of $668,771.  We received no revenues from this client in the three months ended June 30, 2007 and do not anticipate receiving any in the future.  We have, however, obtained another customer that we anticipate will at least partially, if not completely, replace the revenues lost from that customer. However, in the three months ended June 30, 2007, we realized only a nominal amount of revenues from this new customer. We anticipate that our negative cash flow will diminish, in part, as our new customer makes projects and equipment available and as we are able to perform under contract terms with this customer. Although our revenues were significantly reduced for the three months ended June 30, 2007 compared to revenues for the three months ended June 30, 2006, we actually used $57,721 less cash for operations in the six months ended June 30, 2007.  This is in part due to the fact that the contracts from which we derived our revenues in 2007 had a higher gross margin than our major contract in 2006.  Our monthly operating expenses currently exceed our monthly net sales by approximately $175,000 per month.  This amount could increase significantly.  Given our current level of CodecSys development activity, we expect our operating expenses will continue to outpace our net sales until we are able to generate additional revenue.  Our business model contemplates that sources of additional revenue include (i) sales from our private communication network services, (ii) sales resulting from new customer contracts, and (iii) sales related to commercial applications of our CodecSys technology.  Notwithstanding any additional revenue that may be realized for these sources, we will require additional capital in the near term.  Our long-term liquidity is dependent upon execution of our business model and the realization of additional revenue and working capital, as described above, and upon capital needed for continued development of the CodecSys technology.  Commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $2.0 million annually for the foreseeable future.  This estimate will increase or decrease depending on funds available to us.  The availability of funding will also determine, in large measure, the timing and introduction of new product applications in the marketplace.  Capital required for CodecSys is expected to come from internally generated cash flow from operations or from external financing.  To date, we have met our working capital needs through funds received from sales of our common stock, borrowings under the convertible note financings described above and unsecured promissory notes.  Until our operations become profitable, we must continue to sell equity or find another source of operating capital. There    22    can be no assurance that we will be able to obtain adequate working capital or additional financing at all or on terms favorable to us.  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 hold or issue financial instruments for trading purposes or have any derivative financial instruments.  As discussed above, however, the embedded conversion feature and prepayment option of our outstanding convertible notes and related warrants are deemed to be derivatives and are subject to quarterly mark-to-market valuations.  Our principal exposure to market risk is currently confined to our cash and cash equivalents.  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 investments.  We currently do not hedge interest rate exposure and are not exposed to the impact of foreign currency fluctuations.  Item 4.  Controls and Procedures  Evaluation of Disclosure Controls and Procedures  We maintain disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the Exchange Act).  Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.  As required by Rule 13a-15(b) of the Exchange Act, we conducted an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2007.  Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2007 in ensuring that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SECs rules and forms.  Changes in Internal Control Over Financial Reporting  There have been no change in our internal control over financial reporting for the quarter ended June 30, 2007 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.  Important Considerations  The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud.  Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time.  Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.    23      Part II  Other Information  Item 1.    Legal Proceedings  None.  Item 1A.  Risk Factors  There have been no material changes in risk factors described in our Annual Report of Form 10-K for the year ended December 31, 2006.  Item 2. Unregistered Sales of Equity Securities and Use of Proceeds  In June and July, 2007, we issued an aggregate of 233,333 shares of our common stock and accompanying warrants to purchase 233,333 shares of our common stock to six individuals in consideration of a total of $350,000. The warrants are exercisable at $2.00 per share for a period of three years from the date of issuance.  All of the individuals in the transactions were accredited investors and were fully informed regarding their investment.  The securities were sold directly by us and no underwriting discounts or commissions were paid.  In the transactions, we relied on the exemptions from registration under the Securities Act set forth in Section 4(2) and Section 4(6) thereof.  Item 3.    Defaults Upon Senior Securities  None.  Item 4.    Submission of Matters to Vote of Security Holders.  None.  Item 5.    Other Information  (a) None.  (b) None.   Item 6. Exhibits   ExhibitNumberDescription of Document2.1Agreement and Plan of Acquisition dated January 27, 2006 among Broadcast International, Video Processing Technologies, Inc. and UTEK Corporation.  (Incorporated by reference to Exhibit No. 10.14 of the Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 2006 filed with the SEC on May 12, 2006.)3.1Amended 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.)3.2Amended 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.)    24     4.1Specimen 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.)4.2Form of 6.0% Senior Secured Convertible Note dated May 16, 2005 executed by Broadcast International in favor of Gryphon Master Fund, L.P., GSSF Master Fund, LP, Bushido Capital Master Fund, LP and Gamma Opportunity Capital Partners, LP (the Institutional Funds).  (Incorporated by reference to Exhibit No. 4.2 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)4.3Form of A Warrant issued by Broadcast International to each of the Institutional Funds.  (Incorporated by reference to Exhibit No. 4.3 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)4.4Form 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*Employment Agreement of Randy Turner dated April 28, 2004.  (Incorporated by reference to Exhibit No. 10.2 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)10.3*Employment Agreement of Reed L. Benson dated April 28, 2004.  (Incorporated by reference to Exhibit No. 10.3 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)10.4*Broadcast International Long-Term Incentive Plan.  (Incorporated by reference to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 filed with the SEC on March 30, 2004.)10.5Securities Purchase Agreement dated May 16, 2005 among Broadcast International and the Institutional Funds.  (Incorporated by reference to Exhibit No. 10.5 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)10.6Security Agreement dated May 16, 2005 between Broadcast International and Gryphon Master Fund, L.P., as collateral agent for the Institutional Funds.  (Incorporated by reference to Exhibit No. 10.6 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)10.7Registration 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.)10.8Stock 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, preeffective Amendment No. 3 filed with the SEC on October 11, 2005.)    25     10.9Waiver and Amendment Agreement dated March 16, 2006 between Broadcast International and the Institutional Funds.  (Incorporated by reference to Exhibit No. 10.14 of the Companys Current Report on Form 8-K filed with the SEC on March 20, 2006.)10.10Technology 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.)10.11Securities 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.)10.125% 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.)10.13Registration 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 SED on November 6, 2006.)10.14Form 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.)10.15Form 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.)10.16Form of C Warrant dated October 28, 2006 issued by Broadcast International to Leon Frenkel.  (Incorporated by reference to Exhibit 10.6 of the Companys Current Report on Form 8-K filed with the SEC on November 6, 2006.)10.17Form of D Warrant dated October 28, 2006 issued by Broadcast International to Leon Frenkel.  (Incorporated by reference to Exhibit 10.7 of the Companys Current Report on Form 8-K filed with the SEC on November 06, 2006.)10.18Termination 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.)31.1Certification 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 2002.31.2Certification 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 2002.32.1Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2Certification 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     26     SIGNATURES  Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.  Broadcast International, Inc.   Date: August 13, 2007 /s/ Rodney M. Tiede By:  Rodney M. Tiede Its:  President and Chief Executive Officer (Principal Executive Officer)   Date: August 13, 2007 /s/ Reed L. Benson By:  Reed L. Benson Its: Chief Financial Officer (Principal Financial and Accounting Officer)        27