UNITED
STATES

SECURITIES
AND EXCHANGE COMMISSION

Washington, D.C. 20549



Form
10-Q



(Mark
One)



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For
the quarterly period ended June 30, 2012



OR



|o | 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 001-34437



KIT
digital, Inc.

(Exact
Name of Registrant as Specified in Its Charter)



|Delaware                                                               |  | 11-3447894                                  
|---------------------------------------------------------------------- |  | --------------------------------------------
|(State or Other Jurisdiction of
        Incorporation or Organization) |  | (I.R.S. Employer
        Identification No.)



|26 West 17th Street, 2nd Floor, New York, New York |  | 10011     
|-------------------------------------------------- |  | ----------
|(Address of Principal Executive Offices)           |  | (Zip Code)



(646)
553-4845

(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. YesxNoo



Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YesxNoo



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. (Check one):



|Large accelerated Filero                      | Accelerated filerx        
|--------------------------------------------- | --------------------------
|Non-accelerated filero                        | Smaller reporting companyo
|(Do not check if a smaller reporting company) |                           



Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YesoNox



As
of August 13, 2012, there were 57,097,255 shares of the issuer’s common stock outstanding.









KIT
digital, Inc.

TABLE
OF CONTENTS



|                               |                                                                                                                                      | Page |   
|------------------------------ | ------------------------------------------------------------------------------------------------------------------------------------ | ---- | --
|PART I - FINANCIAL INFORMATION |                                                                                                                                      |      |   
|Item 1.                        | Financial Statements                                                                                                                 |      | 3 
|                               | Consolidated Balance Sheets - As of June 30, 2012 (unaudited) and December 31, 2011 (as adjusted)                                    |      | 3 
|                               | Consolidated Statements of Operations and Comprehensive Loss - For the three and six months ended June 30, 2012 and 2011 (unaudited) |      | 4 
|                               | Consolidated Statements of Stockholders’ Equity - For the six months ended June 30, 2012 (unaudited)                                 |      | 5 
|                               | Consolidated Statements of Cash Flows - For the six months ended June 30, 2012 and 2011 (unaudited)                                  |      | 6 
|                               | Notes to Consolidated Financial Statements (unaudited)                                                                               |      | 7 
|Item 2.                        | Management’s Discussion and Analysis of Financial Condition and Results of Operations                                                |      | 25
|Item 3.                        | Quantitative and Qualitative Disclosures About Market Risk                                                                           |      | 32
|Item 4.                        | Controls and Procedures                                                                                                              |      | 32
|PART II - OTHER INFORMATION    |                                                                                                                                      |      |   
|Item 1.                        | Legal Proceedings                                                                                                                    |      | 34
|Item 1A.                       | Risk Factors                                                                                                                         |      | 35
|Item 2.                        | Unregistered Sales of Equity Securities and Use of Proceeds                                                                          |      | 44
|Item 3.                        | Defaults Upon Senior Securities                                                                                                      |      | 44
|Item 4.                        | Mine Safety Disclosures                                                                                                              |      | 44
|Item 5.                        | Other Information                                                                                                                    |      | 44
|Item 6.                        | Exhibits                                                                                                                             |      | 44
|                               |                                                                                                                                      |      |   
|SIGNATURES                     |                                                                                                                                      | 45   |   



All currency amounts
are in thousands in this report. Share, per share and other numerical data are listed without abbreviation.

2







PART
I - FINANCIAL INFORMATION

Item
1.  Financial Statements



KIT
DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED
BALANCE SHEETS

(Amounts
in Thousands, Except Share Data)

|                                                                                                                               |  | June 30,  2012 |          |   | December 31, 2011 (A) |  
|------------------------------------------------------------------------------------------------------------------------------ |  | -------------- | -------- | - | --------------------- | -
|                                                                                                                               |  | (unaudited)    |          |   | (As adjusted)         |  
|Assets:                                                                                                                        |  |                |          |   |                       |  
|Current assets:                                                                                                                |  |                |          |   |                       |  
|Cash and cash equivalents                                                                                                      |  | $              | 30,562   |   |                       | $
|Restricted cash                                                                                                                |  |                | 5,346    |   |                       |  
|Investments                                                                                                                    |  |                | 1,015    |   |                       |  
|Accounts receivable, net                                                                                                       |  |                | 42,924   |   |                       |  
|Unbilled revenue                                                                                                               |  |                | 18,249   |   |                       |  
|Inventory, net                                                                                                                 |  |                | 1,488    |   |                       |  
|Other receivable, current portion                                                                                              |  |                | 1,690    |   |                       |  
|Deferred tax assets, current portion                                                                                           |  |                | 399      |   |                       |  
|Other current assets                                                                                                           |  |                | 11,091   |   |                       |  
|Current assets held for sale                                                                                                   |  |                | -        |   |                       |  
|Total current assets                                                                                                           |  |                | 112,764  |   |                       |  
|Property and equipment, net                                                                                                    |  |                | 9,096    |   |                       |  
|Other receivable, net of current                                                                                               |  |                | 8,668    |   |                       |  
|Deferred tax assets, net of current                                                                                            |  |                | 611      |   |                       |  
|Intangible assets                                                                                                              |  |                | 58,305   |   |                       |  
|Goodwill                                                                                                                       |  |                | 167,619  |   |                       |  
|Long-term assets held for sale                                                                                                 |  |                | -        |   |                       |  
|Total assets                                                                                                                   |  | $              | 357,063  |   |                       | $
|                                                                                                                               |  |                |          |   |                       |  
|Liabilities and Stockholders' Equity:                                                                                          |  |                |          |   |                       |  
|Current liabilities:                                                                                                           |  |                |          |   |                       |  
|Capital lease and other obligations, current portion                                                                           |  | $              | 127      |   |                       | $
|Secured notes payable, net of debt discount, current portion                                                                   |  |                | 7,298    |   |                       |  
|Notes payable                                                                                                                  |  |                | -        |   |                       |  
|Accounts payable                                                                                                               |  |                | 20,688   |   |                       |  
|Accrued expenses                                                                                                               |  |                | 15,973   |   |                       |  
|Deferred revenue                                                                                                               |  |                | 6,066    |   |                       |  
|Income tax payable                                                                                                             |  |                | 1,718    |   |                       |  
|Deferred tax liability, current portion                                                                                        |  |                | 344      |   |                       |  
|Acquisition liabilities, current portion                                                                                       |  |                | 17,032   |   |                       |  
|Derivative liability                                                                                                           |  |                | 28,388   |   |                       |  
|Other current liabilities                                                                                                      |  |                | 27,702   |   |                       |  
|Current liabilities held for sale                                                                                              |  |                | -        |   |                       |  
|Total current liabilities                                                                                                      |  |                | 125,336  |   |                       |  
|Capital lease and other obligations, net of current                                                                            |  |                | 70       |   |                       |  
|Secured notes payable, net of current                                                                                          |  |                | 8,088    |   |                       |  
|Deferred tax liability, net of current                                                                                         |  |                | 9,919    |   |                       |  
|Acquisition liabilities, net of current                                                                                        |  |                | 3,438    |   |                       |  
|Long-term liabilities held for sale                                                                                            |  |                | -        |   |                       |  
|Total liabilities                                                                                                              |  |                | 146,851  |   |                       |  
|                                                                                                                               |  |                |          |   |                       |  
|Equity:                                                                                                                        |  |                |          |   |                       |  
|Stockholders' equity:                                                                                                          |  |                |          |   |                       |  
|Common stock, $0.0001 par value: authorized 150,000,000 shares; issued and outstanding 56,622,201 and 46,342,851, respectively |  |                | 6        |   |                       |  
|Additional paid-in capital                                                                                                     |  |                | 547,605  |   |                       |  
|Accumulated deficit                                                                                                            |  |                | (332,287 | ) |                       |  
|Accumulated other comprehensive loss                                                                                           |  |                | (5,112   | ) |                       |  
|Total stockholders' equity                                                                                                     |  |                | 210,212  |   |                       |  
|Total liabilities and stockholders' equity                                                                                     |  | $              | 357,063  |   |                       | $



The
Company has recasted its December 31, 2011 balance sheet as part of the Sezmi acquisition and certain assets and liabilities have
been reclassified as part of Discontinued Operations. See Note 2.



The
Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

3









|
|

KIT
DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)



|                                                                                                                                            |  |                    |            |   |                  |   |            | As Adjusted | 
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | ---------- | - | ---------------- | - | ---------- | ----------- | 
|                                                                                                                                            |  | Three months ended |            |   | Six months ended |  
|                                                                                                                                            |  | June 30,           |            |   | June 30,         |  
|                                                                                                                                            |  | 2012               |            |   | 2011             |   |            | 2012        | 
|Revenue                                                                                                                                     |  | $                  | 51,149     |   |                  | $ | 44,952     |             | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Variable and direct third party costs:                                                                                                      |  |                    |            |   |                  |   |            |             | 
|Cost of goods and services (exclusive of depreciation shown separately below)                                                               |  |                    | 16,412     |   |                  |   | 9,799      |             | 
|Hosting, delivery, reporting and content costs                                                                                              |  |                    | 3,114      |   |                  |   | 2,650      |             | 
|Direct third party creative production costs                                                                                                |  |                    | 396        |   |                  |   | 317        |             | 
|Total variable and direct third party costs                                                                                                 |  |                    | 19,922     |   |                  |   | 12,766     |             | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Gross profit                                                                                                                                |  |                    | 31,227     |   |                  |   | 32,186     |             | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|General and administrative expenses:                                                                                                        |  |                    |            |   |                  |   |            |             | 
|Compensation, travel and associated costs (including non-cash stock-based compensation of $8,254, $4,384, $15,557 and $6,410, respectively) |  |                    | 44,823     |   |                  |   | 21,108     |             | 
|Legal, accounting, audit and other professional service fees                                                                                |  |                    | 3,752      |   |                  |   | 767        |             | 
|Office, marketing and other corporate costs                                                                                                 |  |                    | 11,715     |   |                  |   | 4,405      |             | 
|Merger and acquisition and investor relations (income) expenses                                                                             |  |                    | (2,241     | ) |                  |   | 10,916     |             | 
|Depreciation and amortization                                                                                                               |  |                    | 4,194      |   |                  |   | 3,096      |             | 
|Restructuring charges                                                                                                                       |  |                    | 3,349      |   |                  |   | 34         |             | 
|Integration expenses                                                                                                                        |  |                    | -          |   |                  |   | 9,710      |             | 
|Impairment of goodwill                                                                                                                      |  |                    | 55,718     |   |                  |   | -          |             | 
|Total general and administrative expenses                                                                                                   |  |                    | 121,310    |   |                  |   | 50,036     |             | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Loss from operations                                                                                                                        |  |                    | (90,083    | ) |                  |   | (17,850    | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Interest income                                                                                                                             |  |                    | 1          |   |                  |   | 69         |             | 
|Interest expense                                                                                                                            |  |                    | (1,203     | ) |                  |   | (383       | )           | 
|Amortization of deferred financing costs and debt discount                                                                                  |  |                    | (104       | ) |                  |   | (76        | )           | 
|Derivative income (expense)                                                                                                                 |  |                    | (3,173     | ) |                  |   | 433        |             | 
|Other expense                                                                                                                               |  |                    | (9,333     | ) |                  |   | (378       | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Net loss before income taxes                                                                                                                |  |                    | (103,895   | ) |                  |   | (18,185    | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Income tax benefit (expense)                                                                                                                |  |                    | 1,319      |   |                  |   | (796       | )           | 
|Net loss from continuing operations                                                                                                         |  | $                  | (102,576   | ) |                  | $ | (18,981    | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Loss from discontinued operations                                                                                                           |  |                    | (48,506    | ) |                  |   | (822       | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Net loss                                                                                                                                    |  | $                  | (151,082   | ) |                  | $ | (19,803    | )           | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Basic and diluted net loss from continuing operations per common share                                                                      |  | $                  | (1.99      | ) |                  | $ | (0.47      | )           | 
|Basic and diluted net loss from discontinued operations per common share                                                                    |  |                    | (0.95      | ) |                  |   | (0.02      | )           | 
|Basic and diluted net loss per common share                                                                                                 |  | $                  | (2.94      | ) |                  | $ | (0.49      | )           | 
|Basic and diluted weighted average common shares outstanding                                                                                |  |                    | 51,418,613 |   |                  |   | 40,063,874 |             | 
|                                                                                                                                            |  |                    |            |   |                  |   |            |             | 
|Comprehensive loss:                                                                                                                         |  |                    |            |   |                  |   |            |             | 
|Net loss                                                                                                                                    |  | $                  | (151,082   | ) |                  | $ | (19,803    | )           | 
|Foreign currency translation                                                                                                                |  |                    | (2,571     | ) |                  |   | (934       | )           | 
|Change in unrealized gain on investments, net                                                                                               |  |                    | (245       | ) |                  |   | 7          |             | 
|Comprehensive loss:                                                                                                                         |  | $                  | (153,898   | ) |                  | $ | (20,730    | )           | 



The
Company has adjusted prior year financials as part of Discontinued Operations. See Note 2.

The
Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

4







KIT
DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY

(Amounts
in Thousands, Except Share Data)

(Unaudited)



|                                                                                  |  | Common Stock |            |  | Common Stock Par Value |   |   | Additional Paid-in Capital |  |   | Accumulated Deficit |   |  | Accumulated Other
    Comprehensive Loss |          |   | Total
    
Stockholders’ Equity |  
|--------------------------------------------------------------------------------- |  | ------------ | ---------- |  | ---------------------- | - | - | -------------------------- |  | - | ------------------- | - |  | ---------------------------------------- | -------- | - | ------------------------------- | -
|Balance – December 31, 2011                                                       |  |              | 46,342,851 |  |                        | $ | 5 |                            |  | $ | 513,882             |   |  | $                                        | (156,326 | ) |                                 | $
|Issue of stock for exercise of stock options                                      |  |              | 63,283     |  |                        |   | — |                            |  |   | 483                 |   |  |                                          | —        |   |                                 |  
|Issue of stock to 3rd party investors in private placement                        |  |              | 7,000,000  |  |                        |   | 1 |                            |  |   | 27,173              |   |  |                                          | —        |   |                                 |  
|Issue of stock for acquisitions                                                   |  |              | 2,717,530  |  |                        |   | — |                            |  |   | 15,273              |   |  |                                          | —        |   |                                 |  
|Stock price reset provision related to the issuance of stock in private placement |  |              | —          |  |                        |   | — |                            |  |   | (10,512             | ) |  |                                          | —        |   |                                 |  
|Initial value of derivative liability                                             |  |              | —          |  |                        |   | — |                            |  |   | (14,333             | ) |  |                                          | —        |   |                                 |  
|Issue of stock for compensation                                                   |  |              | 416,848    |  |                        |   | — |                            |  |   | 3,495               |   |  |                                          | —        |   |                                 |  
|Issue of stock for services                                                       |  |              | 81,689     |  |                        |   | — |                            |  |   | 735                 |   |  |                                          | —        |   |                                 |  
|Issue of warrants for services                                                    |  |              | —          |  |                        |   | — |                            |  |   | 530                 |   |  |                                          | —        |   |                                 |  
|Stock-based compensation                                                          |  |              | —          |  |                        |   | — |                            |  |   | 10,879              |   |  |                                          | —        |   |                                 |  
|Foreign currency translation adjustment                                           |  |              | —          |  |                        |   | — |                            |  |   | —                   |   |  |                                          | —        |   |                                 |  
|Fair market value adjustment for available for sale securities                    |  |              | —          |  |                        |   | — |                            |  |   | —                   |   |  |                                          | —        |   |                                 |  
|Net loss                                                                          |  |              | —          |  |                        |   | — |                            |  |   | —                   |   |  |                                          | (175,961 | ) |                                 |  
|Balance – June 30, 2012                                                           |  |              | 56,622,201 |  |                        | $ | 6 |                            |  | $ | 547,605             |   |  | $                                        | (332,287 | ) |                                 | $



The
Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

5









KIT
DIGITAL, INC. AND SUBSIDIARIES

CONSOLIDATED
STATEMENTS OF CASH FLOWS

(Amounts
in Thousands)

|                                                                                                   |  |                                |          |   | As Adjusted                    |  
|-------------------------------------------------------------------------------------------------- |  | ------------------------------ | -------- | - | ------------------------------ | -
|(Unaudited)                                                                                        |  | Six months ended June 30, 2012 |          |   | Six months ended June 30, 2011 |  
|                                                                                                   |  |                                |          |   |                                |  
|Operating Activities:                                                                              |  |                                |          |   |                                |  
|Net loss                                                                                           |  | $                              | (175,961 | ) |                                | $
|Adjustments to reconcile net loss to net cash used by operating activities:                        |  |                                |          |   |                                |  
|Net loss from discontinued operations                                                              |  |                                | 51,894   |   |                                |  
|Provision for doubtful accounts                                                                    |  |                                | 7,029    |   |                                |  
|Depreciation                                                                                       |  |                                | 2,875    |   |                                |  
|Amortization of intangible assets                                                                  |  |                                | 5,479    |   |                                |  
|Amortization of deferred financing costs and debt discount                                         |  |                                | 208      |   |                                |  
|Loss on impairment of goodwill                                                                     |  |                                | 55,718   |   |                                |  
|Loss on impairment of notes receivable                                                             |  |                                | 6,474    |   |                                |  
|Realized loss on investment                                                                        |  |                                | 1,050    |   |                                |  
|Loss on disposal of property plant and equipment                                                   |  |                                | 948      |   |                                |  
|Derivative expense (income)                                                                        |  |                                | 2,986    |   |                                |  
|Less: merger and acquisition expenses                                                              |  |                                | -        |   |                                |  
|Non-cash stock based compensation                                                                  |  |                                | 15,557   |   |                                |  
|Non-cash warrants for services                                                                     |  |                                | 530      |   |                                |  
|Non-cash stock for services                                                                        |  |                                | 50       |   |                                |  
|Changes in assets and liabilities:                                                                 |  |                                |          |   |                                |  
|Accounts receivable                                                                                |  |                                | (800     | ) |                                |  
|Unbilled revenue                                                                                   |  |                                | (1,692   | ) |                                |  
|Inventory                                                                                          |  |                                | (149     | ) |                                |  
|Other assets                                                                                       |  |                                | (1,088   | ) |                                |  
|Accounts payable                                                                                   |  |                                | 3,763    |   |                                |  
|Accrued expenses                                                                                   |  |                                | 9,943    |   |                                |  
|Income tax payable                                                                                 |  |                                | 300      |   |                                |  
|Other liabilities                                                                                  |  |                                | (2,133   | ) |                                |  
|Total adjustments                                                                                  |  |                                | 158,942  |   |                                |  
|Net cash used by operating activities- continuing operations                                       |  | $                              | (17,020  | ) |                                | $
|Net cash used by operating activities- discontinued operations                                     |  |                                | (8,116   | ) |                                |  
|Net cash used by operating activities                                                              |  | $                              | (25,136  | ) |                                | $
|                                                                                                   |  |                                |          |   |                                |  
|Investing Activities:                                                                              |  |                                |          |   |                                |  
|Cash paid into investment                                                                          |  |                                | (149     | ) |                                |  
|Cash paid in acquisitions                                                                          |  |                                | (5,810   | ) |                                |  
|Cash received in acquisitions                                                                      |  |                                | -        |   |                                |  
|Receipt of payment on notes receivable                                                             |  |                                | -        |   |                                |  
|Merger and acquisition expenses                                                                    |  |                                | -        |   |                                |  
|Purchase of equipment                                                                              |  |                                | (1,824   | ) |                                |  
|Net cash used by investing activities- Continuing operations                                       |  | $                              | (7,783   | ) |                                | $
|Net cash used by investing activities- Discontinued operations                                     |  |                                | (144     | ) |                                |  
|Net cash used by investing activities                                                              |  | $                              | (7,927   | ) |                                | $
|                                                                                                   |  |                                |          |   |                                |  
|Financing Activities:                                                                              |  |                                |          |   |                                |  
|Proceeds from private placement, net                                                               |  |                                | 27,174   |   |                                |  
|Proceeds from exercise of stock options                                                            |  |                                | 483      |   |                                |  
|Payments made to restricted cash accounts and letters of credit                                    |  |                                | (3,495   | ) |                                |  
|Proceeds from exercise of warrants                                                                 |  |                                | -        |   |                                |  
|Proceeds from issuance of secured notes                                                            |  |                                | -        |   |                                |  
|Payments of secured notes                                                                          |  |                                | (2,889   | ) |                                |  
|Repayments of notes payable                                                                        |  |                                | (2,225   | ) |                                |  
|Payment on capital leases                                                                          |  |                                | (65      | ) |                                |  
|Net cash from financing activities- Continuing operations                                          |  | $                              | 18,983   |   |                                | $
|Net cash used by financing activities- Discontinued operations                                     |  |                                | -        |   |                                |  
|Net cash from financing activities                                                                 |  | $                              | 18,983   |   |                                | $
|                                                                                                   |  |                                |          |   |                                |  
|Effect of exchange rate changes on cash                                                            |  |                                | 413      |   |                                |  
|                                                                                                   |  |                                |          |   |                                |  
|Net increase (decrease) in cash and cash equivalents                                               |  | $                              | (13,667  | ) |                                | $
|Cash and cash equivalents - beginning of period                                                    |  |                                | 44,229   |   |                                |  
|Cash and cash equivalents - end of period                                                          |  | $                              | 30,562   |   |                                | $
|                                                                                                   |  |                                |          |   |                                |  
|Supplemental disclosures of cash flow information:                                                 |  |                                |          |   |                                |  
|Cash paid during the period for:                                                                   |  |                                |          |   |                                |  
|Income taxes                                                                                       |  | $                              | 222      |   |                                | $
|Interest                                                                                           |  | $                              | 1,273    |   |                                | $
|Non-cash investing and financing activities:                                                       |  |                                |          |   |                                |  
|Non-cash issuances of stock for acquisitions (2,717,530 and 7,582,056 shares issued, respectively) |  | $                              | (15,273  | ) |                                | $



The
Company has adjusted prior year financials as part of Discontinued Operations. See Note 2.

The
Accompanying Notes are an Integral Part of these Consolidated Financial Statements.

6









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





(1)
Nature of Business and Nature of Presentation



KIT
digital, Inc. (“we,” “us,” “our,” the “Company” or “KIT digital”),
through our operating subsidiaries, provides software solutions that enable our customers to manage and distribute video content
through Internet websites, mobile and tablet devices and both closed network Internet Protocol television (“IPTV”)
and over-the-top (“OTT”) connected television environments. Our core video asset management software suite, marketed
under the “KIT Platform” brand (and “KIT Cosmos” and “KIT Cloud” sub-brands), includes online
and mobile video players, ingestion and trans-coding for Internet and mobile connected devices, live and video-on-demand OTT and
IPTV video serving, editing and content transformation, content meta-tagging, content localization and syndication, digital rights
management, hosting, storage, content delivery and content syndication. We currently provide IP video solutions internationally
through over 20 offices globally, including principal locations in Atlanta, Beijing, Boston, Chennai, Cologne, Delhi, Dubai, Ely
(UK), Grenoble (France), London, Madrid, Melbourne (Australia), Mumbai, New York, Paris, Prague, San Francisco, Singapore, and
Sydney. In support of our KIT Platform deployments, we provide systems integration, broadcast engineering services, content transformation
services and integrated marketing services.



The
accompanying interim consolidated financial statements are unaudited and have been prepared in accordance with accounting principles
generally accepted in the United States of America, or GAAP, for interim financial information. These financial statements include
the accounts of KIT digital and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated
in the accompanying financial statements.



Certain
information and footnote disclosures normally included in the Company’s annual audited consolidated financial statements
and accompanying notes have been condensed or omitted in these interim financial statements. Accordingly, the unaudited consolidated
financial statements included herein should be read in conjunction with the audited consolidated financial statements and accompanying
notes included in KIT digital’s annual report on Form 10-K for the year ended December 31, 2011, filed with the U.S. Securities
and Exchange Commission.



The
results of operations presented in this quarterly report on Form 10-Q are not necessarily indicative of the results of operations
that may be expected for any future periods. In the opinion of management, these unaudited consolidated financial statements include
all adjustments and accruals, consisting only of normal recurring adjustments, that are necessary for a fair statement of the results
of all interim periods reported herein.



(2)
Adjustments to prior period financials and discontinued operations.



Certain
amounts have been reclassified to present the Company’s divesture of its Content Solutions Businesses and Sezmi business
as discontinued operations. Unless otherwise indicated, information presented in the notes
to the financial statements relates only to KIT digital’s continuing operations. Information related to discontinued operations
is included in Note 25 and in some instances, where appropriate, is included as a separate disclosure within the individual footnotes.



The
Company has recasted its December 31, 2011 balance sheet as it relates to the purchase accounting of Sezmi as the Company has
determined that projections and certain assumptions used in the establishment of the earn-out liability were inaccurate.
Therefore, the Company has reduced the original recorded earn-out liability by reducing goodwill in the amount of $25,003 and
has reduced the acquisition liability by the same amount.







(3)
Recent Accounting Pronouncements



In
May 2011, the Financial Accounting Standards Board (FASB) issued a new accounting standard update which amends the fair value measurement
guidance and includes some enhanced disclosure requirements. The most significant change in disclosures is an expansion of the
information required for Level 3 measurements based on unobservable inputs. The standard is effective for fiscal years beginning
after December 15, 2011. We adopted this standard in the first quarter of 2012 and the adoption of the guidance did not have a
material impact on our financial statements and disclosures.



In
June 2011, the FASB issued a new accounting standard which eliminates the current option to report other comprehensive income and
its components in the statement of stockholders’ equity. Instead, an entity will be required to present items of net income
and other comprehensive income in one continuous statement or in two separate, but consecutive, statements. The standard is effective
for fiscal years beginning after December 15, 2011. We adopted this standard in the first quarter of 2012. There is no impact to
our consolidated financial results as the amendments relate only to changes in financial statement presentation.

7









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







In
September 2011, the FASB issued a revised accounting standard, which is intended to reduce the cost and complexity of the annual
goodwill impairment test by providing entities an option to perform a “qualitative” assessment to determine whether
further impairment testing is necessary. Specifically, an entity has the option to first assess qualitative factors to determine
whether it is necessary to perform the current two-step test. If an entity believes, as a result of its qualitative assessment,
that it is more-likely-than-not that the fair value of a reporting unit is less than its carrying amount, the quantitative impairment
test is required. Otherwise, no further testing is required. We adopted this standard during the first quarter of 2012. The adoption
of the standard did not have material impact on our consolidated financial

statements.



(4)
Net income (loss) per share



Basic
net income per share is computed using the weighted average number of common shares outstanding during the applicable period. Diluted
net income per share is computed using the weighted average number of common shares outstanding during the period, plus the dilutive
effect of potential common stock. Potential common stock consists of shares issuable pursuant to stock options, warrants and restricted
stock awards (“RSAs”).



The
following table sets forth the components used in the computation of basic and diluted net loss per common share (in thousands,
except share and per share data):



|                                                               |  | For the Three Months Ended June 30, |            |   | For the Six Months Ended June 30, |  
|-------------------------------------------------------------- |  | ----------------------------------- | ---------- | - | --------------------------------- | -
|                                                               |  | 2012                                |            |   | 2011                              |  
|Numerator:                                                     |  |                                     |            |   |                                   |  
|Net loss from continuing operations                            |  | $                                   | (102,576   | ) |                                   | $
|Loss from discontinued operations                              |  |                                     | (48,506    | ) |                                   |  
|Net loss                                                       |  | $                                   | (151,082   | ) |                                   | $
|Denominator:                                                   |  |                                     |            |   |                                   |  
|Denominator for basic net loss per common share                |  |                                     | 51,418,613 |   |                                   |  
|Effect of dilutive securities:                                 |  |                                     |            |   |                                   |  
|Stock options                                                  |  |                                     | -          |   |                                   |  
|Warrants                                                       |  |                                     | -          |   |                                   |  
|RSAs                                                           |  |                                     | -          |   |                                   |  
|Denominator for diluted net income (loss) per common share     |  |                                     | 51,418,613 |   |                                   |  
|Basic net loss from continuing operations per common share     |  | $                                   | (1.99      | ) |                                   | $
|Basic net loss from discontinued operations per common share   |  |                                     | (0.95      | ) |                                   |  
|Basic net loss per common share                                |  | $                                   | (2.94      | ) |                                   | $
|Diluted net loss from continuing operations per common share   |  | $                                   | (1.99      | ) |                                   | $
|Diluted net loss from discontinued operations per common share |  |                                     | (0.95      | ) |                                   |  
|Diluted net loss per common share                              |  | $                                   | (2.94      | ) |                                   | $





All
equivalent shares underlying stock options, warrants and RSAs were excluded from the calculation of diluted loss per share because
we had net losses for all periods presented and therefore equivalent shares would have an anti-dilutive effect.

8









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)









Potentially
dilutive shares excluded as a result of the effects being anti-dilutive were as follows:



|                      |  | For the Three Months Ended June 30, |         |  | For the Six Months Ended June 30, | 
|--------------------- |  | ----------------------------------- | ------- |  | --------------------------------- | 
|                      |  | 2012                                |         |  | 2011                              | 
|Stock options         |  |                                     | 136,370 |  |                                   | 
|Warrants              |  |                                     | 77,860  |  |                                   | 
|RSAs                  |  |                                     | 273,432 |  |                                   | 
|Total dilutive shares |  |                                     | 487,662 |  |                                   | 





(5)
Cash and Cash Equivalents



We
consider all highly liquid investments with original maturities of ninety days or less when purchased to be cash and cash equivalents.
 Cash and cash equivalents in financial institutions outside the United States as of June 30, 2012 was $5,333 and $24,379
for December 31, 2011.



(6)
Fair Value of Financial Instruments



Fair
value is the amount that would be received upon sale of an asset or paid to transfer a liability in the principal or most advantageous
market for the asset or liability in an orderly transaction between market participants on the measurement date. Accounting Standards
Codification (“ASC”) Topic 820 also establishes a fair value hierarchy which prioritizes the types of inputs to valuation
techniques that companies may use to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in
active markets for identical assets or liabilities (Level 1). The next highest priority is given to inputs other than quoted prices
included in Level 1 that are observable for the asset or liability, either directly or indirectly (Level 2). The lowest priority
is given to unobservable inputs in which there is little or no market data available and which require the reporting entity to
develop its own assumptions (Level 3).



The
assets and liabilities that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy
are Investments and Derivative Liabilities. Investments are measured using net asset value as a practical expedient (Level 2).
See Note 15 for fair value hierarchy on the Derivative Liabilities.



(7)
Accounts Receivable



Trade
accounts receivable are stated net of allowances for doubtful accounts. Specific customer provisions are made when a review of
significant outstanding amounts, customer creditworthiness and current economic trends, indicates that collection is doubtful.
In addition, provisions are made at differing amounts, based upon the balance and age of the receivable and the Company’s
historical collection experience. Trade accounts are charged off against the allowance for doubtful accounts or expense when it
is probable the accounts will not be recovered. The allowance for doubtful accounts as of June 30, 2012 and December 31, 2011 was
$2,821 and $2,943, respectively.



(8)
Concentration of Credit Risk



Financial
instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and
trade accounts receivable. We place our cash and cash equivalents with high credit quality institutions to limit credit exposure.
We believe no significant concentration of credit risk exists with respect to these balances. The amount held in foreign currencies
as of June 30, 2012 and December 31, 2011 was $4,869 and $9,329, respectively. The amount of cash in excess of FDIC insured amounts
as of June 30, 2012 and December 31, 2011, was $29,785 and $43,366, respectively.



Concentrations
of credit risk with respect to trade accounts receivable are limited due to the nature of our customers who are dispersed across
many industries and geographic regions. As of June 30, 2012 and December 31, 2011, no customer accounted for 10% or more of our
trade accounts receivable. As of the three and six months ended June 30, 2012 and for the three months ended June 30, 2011, no
customer accounted for 10% or more of the revenue for the respective period. For the three months ended June 30, 2011, we had one
customer who accounted for approximately 11% of our revenue for the quarter. We routinely assess the financial strength of customers
and, based upon factors concerning credit risk, establish an allowance for doubtful accounts. We believe that accounts receivable
credit risk exposure beyond such allowance is limited.



(9)
Inventory



Inventory
is valued at the lower of cost (first-in, first-out method) or market and is comprised of finished goods. On a quarterly basis,
we review inventory quantities on hand and analyze the provision for excess and obsolete inventory based primarily on product age
in inventory and our estimated sales forecast, which is based on sales history and anticipated future demand. As of June 30, 2012
and December 31, 2011, our reserves for excess and obsolete inventory were $144 and $146, respectively.

9









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







(10)
Goodwill and Intangible Assets



The
change in the carrying amount of goodwill is as follows:





|                                |  | Goodwill |         
|------------------------------- |  | -------- | --------
|Balance as of December 31, 2011 |  | $        | 206, 101
|Acquisitions- Hyro              |  |          | 15,390  
|Impairment charge of goodwill   |  |          | (55,718 
|Other adjustments, net          |  |          | 1,846   
|Balance as of June 30, 2012     |  | $        | 167,619 



We
evaluate the carrying value of our goodwill annually at the end of December and whenever events or circumstances make it more likely
than not that an impairment may have occurred. Accounting standard on Goodwill and Other Intangible Assets prescribes a
two-step method for determining goodwill impairment. In the first step, we compare the estimated fair value of each reporting unit
to its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the estimated fair value, step two
is completed to determine the amount of the impairment loss. Step two requires the allocation of the estimated fair value of the
reporting unit to the assets, including any unrecognized intangible assets, and liabilities in a hypothetical purchase price allocation.
Any remaining unallocated fair value represents the implied fair value of goodwill, which is compared to the corresponding carrying
value of goodwill to compute the goodwill impairment amount.



As
part of our impairment analysis for each reporting unit, we estimate the fair value of each unit utilizing the income approach
and market approach. The income approach requires management to estimate a number of factors for each reporting unit, including
projected future operating results, economic projections, anticipated future cash flows, discount rates, and the allocation of
shared service or corporate items. The market approach was used as a test of reasonableness of the conclusions reached in the income
approach. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry
grouping.



Goodwill
represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired
in each business combination. During the second quarter ended June 30, 2012, our market capitalization declined significantly.
As this measure is our significant indicator of the fair value of our business unit, management considered this decline to be a
triggering event, requiring us to perform an interim impairment analysis. As of June 30, 2012, we completed this interim analysis
and our management has concluded that an impairment charge of $55,718 should be recognized. This is a noncash charge and has been
recorded in the second quarter ended June 30, 2012. As of December 31, 2011, approximately $32,169 of goodwill was part of discontinued
operations and is included in long-term assets held for sale. (See Note 25).



The
determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within
those reporting units requires management to make significant estimates and assumptions. These estimates and assumptions primarily
include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions
in the industries in which we compete; the discount rate; terminal growth rates; and forecasts of net sales, operating income,
depreciation and amortization and capital expenditures. Although we believe our estimates of fair value are reasonable, actual
financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes
in assumptions concerning future financial results or other underlying assumptions could have a significant impact on the fair
value of the reporting units.



Intangible
assets include the following:



|                                           |  | June 30, 2012                                       |    
|------------------------------------------ |  | --------------------------------------------------- | ---
|                                           |  | WeightedAverageRemaining AmortizationPeriod (Years) |    
|Intangible assets with determinable lives: |  |                                                     |    
|Software                                   |  |                                                     | 4.0
|Customer list                              |  |                                                     | 7.0
|Trademarks                                 |  |                                                     | 4.0
|Other                                      |  |                                                     | 2.0
|Total                                      |  |                                                     |    





10









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





|                                           |  | December 31, 2011                                   |    
|------------------------------------------ |  | --------------------------------------------------- | ---
|                                           |  | WeightedAverageRemaining AmortizationPeriod (Years) |    
|Intangible assets with determinable lives: |  |                                                     |    
|Software                                   |  |                                                     | 4.0
|Customer list                              |  |                                                     | 7.0
|Trademarks                                 |  |                                                     | 3.5
|Other                                      |  |                                                     | 2.5
|Total                                      |  |                                                     |    



Amortization
expense on intangible assets for the three months ended June 30, 2012 and 2011 were $2,735 and $1,403, respectively and for the
six months ended June 30, 2012 and 2011 were $5,479 and $2,689 respectively. No impairment charges were recorded for the three
and six months ended June 30, 2012 and 2011.



Estimated
future annual amortization expense as of June 30, 2012 is as follows:





|           |  | Software |       |  | Customer List |   |        | Trademarks |  |   | Other |  |  | Total |    
|---------- |  | -------- | ----- |  | ------------- | - | ------ | ---------- |  | - | ----- |  |  | ----- | ---
|2012       |  | $        | 1,304 |  |               | $ | 4,000  |            |  | $ | 8     |  |  | $     | 184
|2013       |  |          | 2,407 |  |               |   | 7,947  |            |  |   | 17    |  |  |       | 344
|2014       |  |          | 2,121 |  |               |   | 7,921  |            |  |   | 17    |  |  |       | 110
|2015       |  |          | 1,851 |  |               |   | 7,780  |            |  |   | 17    |  |  |       | -  
|2016       |  |          | 706   |  |               |   | 7,196  |            |  |   | 1     |  |  |       | -  
|Thereafter |  |          | -     |  |               |   | 14,374 |            |  |   | -     |  |  |       | -  
|Totals     |  | $        | 8,389 |  |               | $ | 49,218 |            |  | $ | 60    |  |  | $     | 638





(11)
Acquisitions



Hyro
Acquisition



On
June 22, 2012, the Company acquired certain technology assets through the purchase of stock of certain subsidiaries of
Hyro Limited, an Australian technology company that delivers enterprise level online and mobile solutions to
the telecommunications, broadcast, retail, finance and government sectors. These technology assets will be a part of
KIT digital’s continued focus on video software and service offerings in the Asia-Pacific region and to further benefit
our existing tier-one customer base. KIT digital has elected to pay consideration of $1,211 in cash and 1,838,134 shares of
KIT digital common stock valued at $7,628, subject to adjustment under certain conditions. The number of shares of the
Company’s common stock being paid as consideration to Hyro may be increased depending on the price of such common stock
in the future, an acquisition liability of $6,461 has been recorded for this provision, See Note  14.



The
following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of
acquisition.



|Current assets         |  | $ | 3,107  | 
|---------------------- |  | - | ------ | 
|Property and equipment |  |   | 818    | 
|Purchased Software     |  |   | 151    | 
|Goodwill               |  |   | 15,390 | 
|Total assets acquired  |  |   | 19,466 | 
|Current liabilities    |  |   | 4,166  | 
|Net assets acquired    |  | $ | 15,300 | 





11









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







(12)
Other Receivables



|                                                       |  | June 30, 2012 |        |   | December 31, 2011 |  
|------------------------------------------------------ |  | ------------- | ------ | - | ----------------- | -
|Loan receivable on sale of subsidiary, net of reserves |  | $             | 2,158  |   |                   | $
|Other receivables                                      |  |               | 8,200  |   |                   |  
|Total other receivables                                |  |               | 10,358 |   |                   |  
|Less: current                                          |  |               | (1,690 | ) |                   |  
|Other receivables, net of current                      |  | $             | 8,668  |   |                   | $





In
December 2010, we lent $10,847 as part of the sale of subsidiary which matures on January 28, 2015 with payments commencing on
February 28, 2011, due in forty-eight equal consecutive monthly payments of $226. The loan is secured by accounts receivable, cash
and other assets of the business sold. As of June 30, 2012, the Company has approximately $2,158 remaining on the loan net of $6,474
in reserves. During the second quarter of 2012, the receivable went into default as the purchaser has failed to make certain payments.
The Company is currently exploring its legal remedies and has recorded a reserve against this receivable during the three months
ended June 30, 2012 of approximately $6,474.



During
the three months ended June 30, 2012, the Company recorded a receivable of approximately $8,200 related to the sale of the Content
Solutions business of which $1,690 is recorded in current assets. See Note 25.



(13)
Secured Notes Payable



|                                                                                          |  | June 30, 2012 |        |   | December 31, 2011 |  
|----------------------------------------------------------------------------------------- |  | ------------- | ------ | - | ----------------- | -
|April 2010 secured note payable for $5,000, net of discount of $55 and $84, respectively  |  | $             | 2,500  |   |                   | $
|June 2010 secured note payable for $1,000, net of discount of $9 and $13, respectively    |  |               | 565    |   |                   |  
|May 2011 secured note payable for $15,000, net of discount of $683 and $854, respectively |  |               | 12,321 |   |                   |  
|                                                                                          |  |               | 15,386 |   |                   |  
|Less: current portion                                                                     |  |               | (7,298 | ) |                   |  
|Secured notes payable, net of current                                                     |  | $             | 8,088  |   |                   | $



In
May 2011, we received $15,000 in gross proceeds from the issuance of a note to a third party investor, as called for in the negotiated
structure of our acquisition of ioko, as a means of financing the additional accounts receivable acquired. Interest is payable
monthly in advance at 13.6% per year and matures on July 1, 2014.  We paid total interest only of $187 for May and June
2011 and agreed to pay interest only of $122 per month for the next seven months. Commencing on February 1, 2012, payments for
principal and interest are due in thirty equal consecutive payments of $561. A final balloon payment of $1,149 will be due and
payable upon maturity. The note is secured by our property, including accounts receivable and inventory.  In conjunction
with the borrowing, we issued to the lender a warrant entitling it to purchase, for $13.29 per share, 141,083 shares of our common
stock with a seven year term through May 15, 2018. A debt discount of $1,081 was recorded related to these warrants and is being
amortized over the term of the loan.



In
June 2010, we received $1,000 in gross proceeds from the issuance of a note to a third party investor. Interest is payable monthly
in advance at 12.7% per year and matures on September 1, 2013. We paid interest only of $5 for June 2010 and agreed to pay interest
only of $8 per month for the next nine months. Commencing on April 1, 2011 payments for principal and interest are due in thirty
equal consecutive payments of $38. A final balloon payment of $108 will be due and payable upon maturity. The note is secured by
the Company’s property, including accounts receivable and inventory. In conjunction with the borrowing, we issued to the
lender a warrant entitling it to purchase, for $13.76 per share, 8,480 shares of our common stock with a five year term through
June 14, 2015. A debt discount of $27 was recorded related to these warrants and is being amortized over the term of the loan.



In
April 2010, we received $5,000 in gross proceeds from the issuance of a note to a third party investor. Interest is payable monthly
in advance at 12.7% per year and matures on July 1, 2013. We paid interest only of $22 for April 2010 and agreed to pay interest
only of $42 per month for the next nine months. Commencing on February 1, 2011, payments for principal and interest are due in
thirty equal consecutive payments of $188. A final balloon payment of $538 will be due and payable upon maturity. The note is secured
by the Company’s property, including accounts receivable and inventory. In conjunction with the borrowing, we issued to the
lender a warrant entitling it to purchase, for $14.24 per share, 40,976 shares of our common stock with a five year term through
April 15, 2015. A debt discount of $183 was recorded related to these warrants and is being amortized over the term of the loan.

12









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







As
of June 30, 2012, we were in compliance with our debt covenants on all of our secured notes payable.



(14)
Acquisition Liabilities



The
fair value of the acquisition-related contingent consideration for potential earn-out and other payments was estimated based on
the various revenue and gross margin thresholds in each purchase agreement. The varying potential earn-out amounts were then probability
weighted and discounted to present value at the average rate of the weighted average cost of capital for each acquired company
and the after-tax cost of debt. The potential earn-out payments must be recognized at their fair value, as of the acquisition date,
and included as part of the total consideration transferred. The accounting standard requires that the fair value of these liabilities
be re-measured at the end of every reporting period with the change in value over the period reported in the statement of operations.



Acquisition
Liabilities consisted of the following:



|                                         |  | June 30, 2012 |        |  | December 31, 2011 |  
|---------------------------------------- |  | ------------- | ------ |  | ----------------- | -
|Acquisition liabilities, current portion |  |               |        |  |                   |  
|Benchmark                                |  | $             | 4,047  |  |                   | $
|WWB                                      |  |               | 2,377  |  |                   |  
|ioko                                     |  |               | 1,374  |  |                   |  
|Polymedia                                |  |               | 2,573  |  |                   |  
|Hyro                                     |  |               | 6,461  |  |                   |  
|Peerset                                  |  |               | 200    |  |                   |  
|                                         |  | $             | 17,032 |  |                   | $
|                                         |  |               |        |  |                   |  
|Acquisition liabilities, net of current  |  |               |        |  |                   |  
|Benchmark                                |  | $             | -      |  |                   | $
|WWB                                      |  |               | 2,421  |  |                   |  
|ioko                                     |  |               | -      |  |                   |  
|Polymedia                                |  |               | 1,017  |  |                   |  
|                                         |  | $             | 3,438  |  |                   | $





Pursuant
to the Benchmark Stock Purchase Agreement on May 14, 2010, following the 12-month anniversary of the closing, we agreed to
pay the seller in the form of shares of our common stock $0.60 for every $1.00 of recognized revenue generated by Benchmark
during the 12-month period following the closing, less the purchase price paid at closing. As of June 30, 2011,
the fair value of the acquisition-related contingent consideration for the second anniversary on May 15, 2012 for Benchmark increased
by $3,208 based on changes in management’s estimates and other factors that occurred during the three months ended June 30,
2011. The increase in the liabilities were recorded as a charge to earnings and is included in the “Merger and acquisition
and investor relations expenses” line item in the Consolidated Statements of Operations. Also in the three months ended June
30, 2011, the working capital liability was agreed and paid for $357 with the difference of $762 recorded as an offset to the “Merger
and acquisition and investor relations expenses” line item in the Consolidated Statements of Operations.



In
July 2011, we paid the $1,375 in relation to the Peerset Acquisition liability.



As
part of the Hyro acquisition, the Company has recorded an acquisition liability in the amount of $6,461 as an estimate of the
top-off provision, which is based on the minimum value per the Hyro SPA of $14,346 for the 1,838,134 shares granted as of
June 30, 2012. This top-off provision will be due upon and calculated upon the date that the 1,838,134 shares issued are able
to be sold under Rule 144 or a change of control. See Note 11.



(15)
Derivative Liabilities



On May 8, 2008, the Company entered into a Securities Purchase
Agreement pursuant to which it sold 2,142,858 units to 35 accredited investors, each unit comprising of one share of common stock
plus one warrant to purchase one share of common stock. The units were sold at a price of $7.00 per unit for aggregate gross proceeds
of $15,000. The warrants have an exercise price of $11.90 per share and a term of five years. The warrants provide the investors
with full ratchet anti-dilution protection with relation to the exercise price of each warrant.

13









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





On May 15, 2012, the
Company entered into a definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting
placement agents’ fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares
of the Company’s common stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May
17, 2012) with an effective strike price of $5.00. After deducting the fees of the placement agent and other estimated
offering expenses, the net proceeds to the Company from the private placement were approximately $27,174.



During the
six months ended June 30, 2012 and in conjunction with this share issuance, the Company record a liability of approximately $10,512
representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the stock purchase
agreement. This amount consists of approximately 2,588,408 shares and
approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 17 and 19.



The warrants issued as part of the Securities Purchase Agreement
contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair value. On May 17,
2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in capital.



The Warrants were valued using a Monte Carlo simulation model.
See Note 17 and 19.



In
relation to the May 2008 warrants the actual number of common shares indexed to the warrants at December 31, 2011 and June 30,
2012 were 251,021 and 421,382, respectively. Upon the issuance of the shares in the May 2012 private placement at $4.17 per share,
the anti-dilution provision in the May 2008 warrants was triggered and resulted in the reduction of the exercise price to $4.17
from $7.00 and an increase of 170,361 shares under these warrants.



In
relation to the May 2012 warrants, the actual number of common shares indexed to the warrants at May 15, 2012 and June 30, 2012
were 5,250,000 and 5,250,000, respectively.



We
estimate fair values of derivative financial instruments using various techniques (and combinations thereof) that are considered
to be consistent with the objective measuring fair values. In selecting the appropriate technique, we consider, among other factors,
the nature of the instrument, the market risks that it embodies and the expected means of settlement. For less complex derivative
instruments, such as free-standing warrants, we generally use the Black-Scholes model, adjusted for the effect of dilution, because
it embodies all of the requisite assumptions (including trading volatility, estimated terms, dilution and risk free rates) necessary
to fair value these instruments.



Estimating
fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and
are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition,
option-based techniques (such as Black-Scholes model) are highly volatile and sensitive to changes in the trading market price
of our common stock. Since derivative financial instruments are initially and subsequently carried at fair values, our income (expense)
going forward will reflect the volatility in these estimate and assumption changes. Under the terms of the new accounting standard,
increases in the trading price of our common stock and increases in fair value during a given financial quarter result in the application
of non-cash derivative expense. Conversely, decreases in the trading price of our common stock and decreases in trading fair value
during a given financial quarter result in the application of non-cash derivative income.



The
following table summarizes the components of derivative liabilities as of June 30, 2012 and December 31, 2011 for the May
2008 warrants:



|                                                     |  | June 30,  2012 |       |   | December 31,  2011 |  
|---------------------------------------------------- |  | -------------- | ----- | - | ------------------ | -
|Fair value of warrants with anti-dilution provisions |  | $              | (604  | ) |                    | $
|Significant assumptions (or ranges):                 |  |                |       |   |                    |  
|Trading market values  (1)                           |  | $              | 4.29  |   |                    | $
|Term (years) (3)                                     |  |                | 0.86  |   |                    |  
|Volatility   (1)                                     |  |                | 90.00 | % |                    |  
|Risk-free rate   (2)                                 |  |                | 0.27  | % |                    |  
|Effective Exercise price  (3)                        |  | $              | 4.17  |   |                    | $





14









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





The
following table summarizes the components of derivative liabilities as of June 30, 2012 and the measurement date of May 17, 2012
for the May 2012 warrants:



|                                                     |  | June 30,  2012 |         |   | May 17,  2012 |  
|---------------------------------------------------- |  | -------------- | ------- | - | ------------- | -
|Fair value of warrants with anti-dilution provisions |  | $              | (17,273 | ) |               | $
|Significant assumptions (or ranges):                 |  |                |         |   |               |  
|Trading market values  (1)                           |  | $              | 4.29    |   |               | $
|Term (years) (3)                                     |  |                | 5.38    |   |               |  
|Volatility   (1)                                     |  |                | 90.00   | % |               |  
|Risk-free rate   (2)                                 |  |                | 0.79    | % |               |  
|Effective Exercise price  (3)                        |  | $              | 5.00    |   |               | $



Fair
value hierarchy:



|(1) | Level 1 inputs are quoted prices in active markets for identical assets and liabilities, or derived there from. Our trading market values and the volatilities that are calculated thereupon are level 1 inputs.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(2) | Level 2 inputs are inputs other than quoted prices that are observable. We use the current published yields for zero-coupon US Treasury Securities, with terms nearest the remaining term of the warrants for our risk free rate.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|(3) | Level 3 inputs are unobservable inputs. Inputs for which any parts are level 3 inputs are classified as level 3 in their entirety. The remaining term used equals the remaining contractual term as our best estimate of the expected term and the effective exercise price which is based on the stated exercise price adjusted for anti-dilution provisions.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The
effects on our income (expense) associated with changes in the fair values of our derivative financial instruments for the three
months ended June 30, 2012 and 2011 were ($3,173) and $433, respectively. For the six months ended June 30, 2012 and 2011, effects
on our income (expense) associated with changes in the fair values of our derivative financial instruments were ($2,986) and $3,042,
respectively.



(16)
Other Current Liabilities



Other current liabilities
consisted of the following:



|                                                           |  | June 30, 2012 |        |  | December 31, 2011 |  
|---------------------------------------------------------- |  | ------------- | ------ |  | ----------------- | -
|Accrued salaries and benefits                              |  | $             | 19,348 |  |                   | $
|Liabilities assumed and to be paid related to acquisitions |  |               | 5,564  |  |                   |  
|Other                                                      |  |               | 2,790  |  |                   |  
|                                                           |  | $             | 27,702 |  |                   | $



(17) Fair Value
Measurement



The following table provides
the assets and liabilities carried at fair value measured on a recurring basis:



|                                          |  | Fair Value Measurements at June 30, 2012 |       
|----------------------------------------- |  | ---------------------------------------- | ------
|                                          |  | CarryingValue                            |       
|Liabilities                               |  |                                          |       
|Acquisition liabilities (see note 14)     |  | $                                        | 20,470
|Derivative liability (see note 15 and 19) |  | $                                        | 28,388



|                                          |  | Fair Value Measurements at December 31, 2011 |       
|----------------------------------------- |  | -------------------------------------------- | ------
|                                          |  | CarryingValue                                |       
|Assets                                    |  |                                              |       
|Investments                               |  | $                                            | 1,352 
|                                          |  |                                              |       
|Liabilities                               |  |                                              |       
|Acquisition liabilities (see note 14)     |  | $                                            | 16,652
|Derivative liability (see note 15 and 19) |  | $                                            | 557   



A reconciliation of the
change in the carrying value of the level 3 acquisition liabilities is as follows:



|Balance at January 1, 2012                          |  | $ | 16,652 |  
|--------------------------------------------------- |  | - | ------ | -
|Payment of acquisition liabilities                  |  |   | -      |  
|Increase in earn out estimates and new acquisitions |  |   | 7,649  |  
|Decrease in earn out estimates and payments         |  |   | (3,831 | )
|Balance at June 30, 2012                            |  | $ | 20,470 |  





15











KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





The amount of total gains
or losses for the six months ended June 30, 2012 included in losses attributable to the change in unrealized gains or losses relating
to liabilities still held at June 30, 2012:



|Included in statement of operations in Interest expense                              |  | $ | 164    |  
|------------------------------------------------------------------------------------ |  | - | ------ | -
|Included in statement of operations in Merger and acquisition and investor relations |  | $ | (3,006 | )



A reconciliation of the
change in the carrying value of the level 3 derivative liability is as follows:

|Balance at January 1, 2012                        |  | $ | 557    | 
|------------------------------------------------- |  | - | ------ | 
|Initial valuation of May 2012 warrants (Note 19)  |  |   | 14,333 | 
|Valuation of May 2012 stock price reset provision |  |   | 10,512 | 
|Change in valuation                               |  |   | 2,986  | 
|Balance at June 30, 2012                          |  | $ | 28,388 | 



The amount of total gains
or losses for the six months included in losses attributable to the change in unrealized gains or losses relating to liabilities
still held at June 30, 2012:



|Included in statement of operations in Derivative expense |  | $ | 2,986 | 
|--------------------------------------------------------- |  | - | ----- | 



As of June 30, 2012 and
December 31, 2012, the Company has approximately $1,015 and $563, respectively, of cost investments recorded on the balance sheet.



(18)
Stock-Based Compensation



In
December 2010, our board of directors voted unanimously to increase the number of shares which may be issued under the 2008 Incentive
Plan by 1,500,000 to an aggregate of 5,000,000 shares of common stock, subject to ratification by our stockholders. Subsequently,
as a result of acquisition activity, our board of directors authorized at its meetings on March 5, 2011 and August 5, 2011 to amend
and increase the number of shares which may be issued under the 2008 Incentive Plan to a new total of 9,500,000 shares of common
stock. The holders of a majority of our outstanding shares of common stock approved the amendment to the 2008 Incentive Plan at
the stockholders meeting held on October 21, 2011. The 2008 Incentive Plan had 772,417 shares of common stock available for future
grants as of June 30, 2012. The 2004 Stock Option Plan has reserved 342,858 shares of common stock for issuance of which 264,108
shares of common stock were available for future grants as of June 30, 2012.



The
Company’s outstanding unvested stock options have maximum contractual terms of up to five years, principally vest on a quarterly
basis ratably over four years and were granted at exercise prices equal to the market price of the Company’s common stock
on the date of grant. The Company’s outstanding stock options are exercisable into shares of the Company’s common stock.
The Company measures the cost of employee services received in exchange for an award of equity instruments, including grants of
employee stock options, warrants and restricted stock awards, based on the fair value of the award at the date of grant in accordance
with the modified prospective method. The Company uses the Black-Scholes model for purposes of determining the fair value of stock
options and warrants granted and recognizes compensation costs ratably over the requisite service period, net of estimated forfeitures.
For restricted stock awards, the grant-date fair value is the quoted market price of the stock.



As
of June 30, 2012, there was approximately $17,732 of total unrecognized compensation cost related to unvested share-based compensation
grants, which is expected to be amortized over a weighted-average period of approximately 2.6 years. As of December 31, 2011, there
was approximately $26,513 of total unrecognized compensation cost related to unvested share-based compensation grants, which is
expected to be amortized over a weighted-average period of 2.8 years.

16











KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





The
fair value of each option grant is estimated on the date of grant using the Black-Scholes model with the following weighted-average
assumptions:



|                         |  | Six months ended  June 30, 2012 |        |   | Six months ended  June 30, 2011 | 
|------------------------ |  | ------------------------------- | ------ | - | ------------------------------- | 
|Expected life (in years) |  |                                 | 3.96   |   |                                 | 
|Risk-free interest rate  |  |                                 | 0.61   | % |                                 | 
|Volatility               |  |                                 | 102.77 | % |                                 | 
|Dividend yield           |  |                                 | 0      |   |                                 | 



In
2012 and 2011, we estimated the expected term of stock options using historical exercise experience and used a forfeiture rate
of 25% for employees and 0% for officers and directors.



A
summary of the status of stock option awards and changes during the six months ended June 30, 2012 is presented below:



|                                 |  | Shares |            |   | Weighted Average Exercise Price |   |       | Weighted Average Remaining Contractual Life (Years) |  |  | Intrinsic Value | 
|-------------------------------- |  | ------ | ---------- | - | ------------------------------- | - | ----- | --------------------------------------------------- |  |  | --------------- | 
|Outstanding at December 31, 2011 |  |        | 6,415,669  |   |                                 | $ | 9.90  |                                                     |  |  |                 | 
|Granted                          |  |        | 703,857    |   |                                 |   | 9.36  |                                                     |  |  |                 | 
|Exercised                        |  |        | (63,283    | ) |                                 |   | 7.63  |                                                     |  |  |                 | 
|Cancelled, expired, or forfeited |  |        | (1,236,049 | ) |                                 |   | 10.82 |                                                     |  |  |                 | 
|Outstanding at June 30, 2012     |  |        | 5,820,194  |   |                                 |   | 9.67  |                                                     |  |  | 3.47            | 
|Exercisable at June 30, 2012     |  |        | 2,882,048  |   |                                 | $ | 9.36  |                                                     |  |  | 3.16            | 



The
weighted-average grant-date fair value of option awards granted during the six months ended June 30, 2012 was $6.19.



Restricted
Stock Awards



The
following table summarizes the different types of restricted stock awards granted:





|                                                                                              |  | Six months ended |           |  | Six months ended | 
|--------------------------------------------------------------------------------------------- |  | ---------------- | --------- |  | ---------------- | 
|                                                                                              |  | June 30, 2012    |           |  | June 30, 2011    | 
|                                                                                              |  |                  |           |  |                  | 
|Restricted stock units ("RSUs") with time-based vesting conditions                            |  |                  | 204,423   |  |                  | 
|Performance-contingent restricted stock units ("PCRSUs") with market-based vesting conditions |  |                  | 425,000   |  |                  | 
|Restricted stock with vesting conditions                                                      |  |                  | 541,170   |  |                  | 
|                                                                                              |  |                  | 1,170,593 |  |                  | 
|                                                                                              |  |                  |           |  |                  | 



RSUs,
PCRSUs and restricted stock awards represent the right to receive one share of our common stock upon vesting. We have
issued time-based restricted stock units (“RSUs”), performance and time-based RSUs, market-based PCRSUs, and
restricted stock with vesting conditions. The time-based RSUs vest in 36 or 48 equal monthly installments based on continued
employment. The performance and time-based RSUs vest in 48 equal monthly installments based on continued employment and our
common stock 20-day volume weighted average stock price exceeds the grant date closing price by 115% for 50% of the grant and
by 130% for 50% of the grant. Both of these performance targets were met before the end of October 2010. The PCRSUs vesting
is generally determined based upon the common stock’s highest 90-Day VWAP attained over a series of vesting periods
(each such period is three months in duration) over the term of the agreement or, in the event of a change in control
of the company, the fair market value of our common stock on the effective date of the change in control.
These performance targets have not been met as of the latest vesting period on June 30, 2012.	 No grants were made during
the six months ended June 30, 2011.





|                                 |  | Restricted Stock |           |   | Weighted Average Exercise Price |  
|-------------------------------- |  | ---------------- | --------- | - | ------------------------------- | -
|Outstanding at December 31, 2011 |  |                  | 1,689,250 |   |                                 | $
|Granted                          |  |                  | 1,170,593 |   |                                 |  
|Vested                           |  |                  | (416,848  | ) |                                 |  
|Cancelled                        |  |                  | (328,223  | ) |                                 |  
|Outstanding at June 30, 2012     |  |                  | 2,114,772 |   |                                 | $





17









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





The
total pre-tax intrinsic value of restricted stock awards granted during the six months ended June 30, 2012 was $11,915. The total
fair value of restricted stock awards vested during the six months ended June 30, 2012 was $7,655. The grant-date fair value of
each RSU and restricted stock is calculated based upon the Company’s closing stock price on the date of grant. The grant-date
fair value of PCRSUs was calculated using the Monte-Carlo simulation model due to the market-based vesting conditions.



The
fair value of each PCRSU is estimated on the date of grant using the Monte Carlo simulation model with the following assumptions
included (1) 0.66% risk free rate, (2) estimated vesting period (3) expected stock price volatility of 85%, and (4) common stock
price of the underlying share on the valuation date.



During
the three months ended June 30, 2012 the Company recorded approximately $3,400 net, PCRSU expense related to terminations of
certain executives.



(19)
Stock Issuances



During
the six months ended June 30, 2012, we issued 10,279,350 shares of common stock. Of this amount, we issued 7,000,000 shares in
the May 2012 private placement described below, 1,838,134 shares related to the acquisition of Hyro, 879,396 shares related to
the acquisition of Sezmi, 81,689 shares for services, 416,848 shares for restricted stock and 63,283 shares for the exercise of
options with proceeds of $483.



As
of June 30, 2012, the outstanding warrants (excluding the warrants included in the derivative liability of 5,671,382 were 1,017,167
with a weighted average exercise price of $10.84 As of December 31, 2011, the outstanding warrants (excluding the warrants included
in the derivative liability of 251,021 and stock-based compensation of 34,286) were 1,361,935 with a weighted average exercise
price of $24.21.



May
2012 Share Issuance



On May 15, 2012, the Company entered into a
definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting placement agents’
fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares of the Company’s common
stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May 17, 2012) with an effective
strike price of $5.00. After deducting the fees of the placement agent and other estimated offering expenses, the net
proceeds to the Company from the private placement were approximately $27,174.



During the
six months ended June 30, 2012 and in conjunction with this share issuance, the Company recorded a liability of approximately $10,512
representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the stock purchase
agreement. This amount consists of approximately 2,588,408 shares and
approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 15 and 17.



The warrants issued as part of the Securities Purchase Agreement
contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair value. On May 17,
2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in capital.



The Warrants were valued using a Monte Carlo simulation model
at $14,333. See Note 15 and 17.



(20)
Restructuring Charges



In
the first quarter of 2010, management approved restructuring plans for entities acquired in the fourth quarter of 2009 which
included a workforce reduction, reduction in costs related to excess and vacated facilities under non-cancelable leases and settlement
of contracts. We expect to make the remaining facility closing costs and contract settlement payments in 2012.



In
the first quarter of 2011, management approved a companywide restructuring plan related to a workforce reduction. Payments
against this plan were completed in 2011.



During
the second quarter of 2012, management approved a restructuring plan to focus its resources to support its strategic and core assets,
streamline its cost structure and move its headquarters to New York and reduce the staff at its former headquarters in Prague.
As such, the Company recorded a restructuring charge of $3,349 during the three months ended June 30, 2012. The Company expects
to complete this plan within 12 months from the end of the second quarter of 2012.

18









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





The
following table summarizes the restructuring accruals for the year ended December 31, 2011 and the six months ended June 30, 2012:



|                                 |  | EmployeeTerminationCosts |        |   | ContractSettlements |   |    | FacilityClosingCosts |  |   | Total |  
|-------------------------------- |  | ------------------------ | ------ | - | ------------------- | - | -- | -------------------- |  | - | ----- | -
|Balance as of December 31, 2010  |  | $                        | 1,212  |   |                     | $ | 13 |                      |  | $ | 518   |  
|Additions                        |  |                          | 3,973  |   |                     |   | -  |                      |  |   | 34    |  
|Reversal                         |  |                          | (654   | ) |                     |   | -  |                      |  |   | -     |  
|Cash payments                    |  |                          | (4,531 | ) |                     |   | (8 | )                    |  |   | (337  | )
|Balance as of  December 31, 2011 |  | $                        | -      |   |                     | $ | 5  |                      |  | $ | 215   |  
|Additions                        |  |                          | 3,349  |   |                     |   | -  |                      |  |   | -     |  
|Reversal                         |  |                          | -      |   |                     |   | -  |                      |  |   | -     |  
|Cash payments                    |  |                          | (587   | ) |                     |   | (5 | )                    |  |   | (134  | )
|Balance as of  June 30, 2012     |  | $                        | 2,762  |   |                     | $ | -  |                      |  | $ | 81    |  



The
accrued restructuring of $220 and $2,843 were included in accrued expenses in the consolidated balance sheets as of December 31,
2011 and June 30, 2012, respectively.





The
following table summarizes the restructuring charges:



|                            |  | Three months ended June 30, 2012 |       |  | Three months ended June 30, 2011 |   |    | Six months ended June 30, 2012 |  |   | Six months ended June 30, 2011 | 
|--------------------------- |  | -------------------------------- | ----- |  | -------------------------------- | - | -- | ------------------------------ |  | - | ------------------------------ | 
|Employee termination costs  |  | $                                | 3,349 |  |                                  | $ | -  |                                |  | $ | 3,349                          | 
|Contract settlements        |  |                                  | -     |  |                                  |   | -  |                                |  |   | -                              | 
|Facility closing costs      |  |                                  | -     |  |                                  |   | 34 |                                |  |   | -                              | 
|Total restructuring charges |  | $                                | 3,349 |  |                                  | $ | 34 |                                |  | $ | 3,349                          | 





(21)
Integration Expenses



The
Company has recorded integration charges related to the cost overlap due to the reorganization and integration of acquisitions
of $9,710 and $18,398 for the three and six months ended June 30, 2011, respectively. Integration expenses includes expenses for
integrating acquired businesses together and eliminating duplication and inefficiencies. This includes rationalizing hosting and
delivery infrastructure (data center consolidation, related hardware purchases, trunk T1 and T3 purchases and combinations, etc.)
to merging software platforms and physical plant/office combination. These expenses include directly allocable staff time, travel
and associated charges related to executing these integration initiatives. These expenses are almost all without exception cash-based.
No such expenses were recorded for the three months and six months ended June 30, 2012.





(22)
Segment Reporting



We
have presented operating segments in the past for Digital Media Solutions and Professional Services, but since Professional Services
represents less than 5% of total assets and total revenues and this segment continues to decrease, we are not presenting financial
information for operating segments.



The
following table provides revenue and assets by major geographical location.





|              |  | For the Three Months Ended June 30, |        |  | For the Six Months Ended June 30, |  
|------------- |  | ----------------------------------- | ------ |  | --------------------------------- | -
|              |  | 2012                                |        |  | 2011                              |  
|Revenue:      |  |                                     |        |  |                                   |  
|EMEA          |  | $                                   | 29,235 |  |                                   | $
|AsiaPac       |  |                                     | 8,746  |  |                                   |  
|Americas      |  |                                     | 13,168 |  |                                   |  
|Total revenue |  | $                                   | 51,149 |  |                                   | $





19









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







|             |  | June 30, |         |  | December 31, |  
|------------ |  | -------- | ------- |  | ------------ | -
|             |  | 2012     |         |  | 2011         |  
|Assets:      |  |          |         |  |              |  
|EMEA         |  | $        | 177,215 |  |              | $
|AsiaPac      |  |          | 28,449  |  |              |  
|Americas     |  |          | 65,027  |  |              |  
|Corporate    |  |          | 86,372  |  |              |  
|Total assets |  | $        | 357,063 |  |              | $



In
the assets listed above, Corporate includes all intangible assets and goodwill. Assets held for sale related to the divesture of
Content Solutions has been included within the EMEA total assets for approximately $23,310 as of December 31, 2011. For the divesture
of Sezmi assets held for sale of approximately $31,796 has been included within the Americas segments total assets as of December
31, 2011. See Note 25.



(23)
Related Party Transactions



The
managerial services of Kaleil Isaza Tuzman, our former Chairman and Chief Executive Officer, and other non-executive personnel,
were provided through KIT Capital, which is beneficially controlled by Mr. Isaza Tuzman. The total amount included in our results
of operations in the three months ended June 30, 2012 and 2011 were $0and $97, respectively,
and $53 and $97 for the six months ended June 30, 2012 and 2011, respectively. As of the end of the first quarter of 2012 and as
part of the resignation of Mr. Isaza Tuzman on March 31, 2012 as Chief Executive Officer, we no longer use KIT Capital for managerial
services.





(24)
Income Taxes



Income
taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated
annual effective tax rate of 9.9% for the six months ended June 30, 2012 and 2.3% for the six months ended June 30, 2011. The effective
tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings,
losses and tax planning. During the three and six months ended June 30, 2012, the Company recorded a tax benefit of approximately
$1,319 and $1,259, respectively. This tax benefit is primarily driven by the reversal of deferred tax liabilities from acquisition
related intangibles. During the three and six months ended June 30, 2011, the Company recorded a tax expense of approximately $796
and $910, respectively. Prior period’s tax expense relates to estimated tax payments for state and local.



We
are not currently under examination by any taxing authorities.





(25)
Discontinued Operations



During
the second quarter of 2012,following the guidance established under “ASC 360, Impairment and Disposal of Long-Lived
Assets”, the Company committed to a plan to sell its Content Solutions Businesses which includes Digital Media Productions
and its Sezmi business.



Digital
Media Production Acquisition



On
October 3, 2011, we acquired Digital Media Production a.s. (“DMP”), a Czech company with its principal office in Prague.
A former competitor of Brickbox, DMP is engaged in multimedia video production with a focus on enterprise customers. We acquired
DMP in exchange for $2,750 cash and 42,500 shares of our common stock valued at a price of $7.53 for a total of $320. The consideration
also includes contingent consideration of $4,284 based upon meeting revenue and profit targets for the periods ending December
31, 2011, December 31, 2012 and December 31, 2013. We have allocated the aggregate cost of the acquisition to DMP’s net tangible and identifiable intangible assets
based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net estimated fair value of
the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.



The
following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of
acquisition.



|Current assets                    |  | $ | 971   |  
|--------------------------------- |  | - | ----- | -
|Property and equipment            |  |   | 1     |  
|Intangible assets - customer list |  |   | 500   |  
|Goodwill                          |  |   | 6,289 |  
|Total assets acquired             |  |   | 7,761 |  
|                                  |  |   |       |  
|Current liabilities               |  |   | (265  | )
|Deferred tax liability            |  |   | (95   | )
|Deferred revenue - long term      |  |   | (41   | )
|Other long-term liabilities       |  |   | (6    | )
|Total liabilities                 |  |   | (407  | )
|                                  |  |   |       |  
|Net assets acquired               |  | $ | 7,354 |  





20









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





During
the second quarter of 2012, the Company decided to divest itself of the Content Solutions Businesses which include DMP, and therefore
it has been recorded as discontinued operations. The Company has provided below the details of the components of the assets and
liabilities held for sale as of December 31, 2011 for the Content Solutions Business. On June 26, 2012, the Company completed a
sale of its Content Solutions Businesses to Netherlands-based Content Solutions International NV for $1,000 in cash and up to $18.8
million in earn-outs. Therefore, during the second quarter of 2012, the Company recorded a loss from disposal of approximately
$15,462 and has provided a breakout of the loss from discontinued operations for the Content Solutions Businesses for the three
and six months ended June 30, 2012 and 2011.



Sezmi
Acquisition



On
December 30, 2011, we acquired substantially all the assets and assumed certain liabilities of Sezmi Corporation (“Sezmi”),
a Delaware corporation, pursuant to an Asset Purchase Agreement dated as of December 30, 2011. Headquartered in Belmont, CA, Sezmi
is a leading global provider of broadband-broadcast hybrid TV solutions. Sezmi employs a cloud-based software-as-a-service model
and its target customers are service operators, such as telecommunication companies and Internet service providers, as well as
content providers who desire to provide licensed or owned video content to subscribers across mobile and Internet protocol (IP)-connected
home entertainment devices. Total consideration was $7,850 in cash, the assumption of $16,525 in liabilities, $2,625 owed to the
shareholders of Sezmi which will be issued in shares and held in escrow for a period of up to 12 months following the closing date.
The excess of the aggregate cost of the acquisition over the net estimated fair value of the tangible and identifiable intangible
assets and liabilities assumed was recorded as goodwill.



The
following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed at the date of
acquisition.



|Current assets         |  | $ | 138    | 
|---------------------- |  | - | ------ | 
|Property and equipment |  |   | 400    | 
|Software               |  |   | 1,000  | 
|Goodwill               |  |   | 27,108 | 
|Total assets acquired  |  |   | 28,646 | 
|                       |  |   |        | 
|Current liabilities    |  |   | 1,646  | 
|                       |  |   |        | 
|Net assets acquired    |  | $ | 27,000 | 



During
the second quarter of 2012, the Company decided to divest itself of Sezmi and therefore it has been recorded as discontinued operations.
The Company has provided below the details of the components of the assets and liabilities held for sale as of December 31, 2011
for Sezmi. On June 26, 2012, the Company completed the sale of Sezmi to Total Media for $2,950 to be paid in cash and has recorded
a corresponding receivable as of June 30, 2012 which was subsequently received. Due to the divesture of Sezmi during the second
quarter of 2012, the Company recorded a loss from disposal of approximately $28,578 and has provided a breakout of the loss from
discontinued operations for the Sezmi business for the three and six months ended June 30, 2012 and 2011.

21









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)







Assets and Liabilities of Discontinued
Operations



At June 30, 2012,
the assets of Sezmi and Content Solutions are presented separately on our consolidated balance sheet. The components of the assets
of discontinued operations are as follows (in thousands):



|                                                     |  | Discontinued Operations |   |  | Discontinued Operations for December 31, 2011 |  
|---------------------------------------------------- |  | ----------------------- | - |  | --------------------------------------------- | -
|                                                     |  | June 30,  2012          |   |  | ContentSolutions                              |  
|                                                     |  | (unaudited)             |   |  |                                               |  
|Assets held for sale:                                |  |                         |   |  |                                               |  
|Cash and cash equivalents                            |  | $                       | - |  |                                               | $
|Accounts receivable, net                             |  |                         | - |  |                                               |  
|Unbilled revenue                                     |  |                         | - |  |                                               |  
|Inventory, net                                       |  |                         | - |  |                                               |  
|Other current assets                                 |  |                         | - |  |                                               |  
|Current assets held for sale                         |  |                         | - |  |                                               |  
|                                                     |  |                         |   |  |                                               |  
|Property and equipment, net                          |  |                         | - |  |                                               |  
|Intangible assets                                    |  |                         | - |  |                                               |  
|Goodwill                                             |  |                         | - |  |                                               |  
|Long-term assets held for sale                       |  | $                       | - |  |                                               | $
|                                                     |  |                         |   |  |                                               |  
|Liabilities for sale:                                |  |                         |   |  |                                               |  
|Capital lease and other obligations, current portion |  | $                       | - |  |                                               | $
|Accounts payable                                     |  |                         | - |  |                                               |  
|Accrued expenses                                     |  |                         | - |  |                                               |  
|Deferred revenue                                     |  |                         | - |  |                                               |  
|Other current liabilities                            |  |                         | - |  |                                               |  
|Current liabilities held for sale                    |  |                         | - |  |                                               |  
|                                                     |  |                         |   |  |                                               |  
|Other long-term liabilities                          |  |                         | - |  |                                               |  
|Long-term liabilities held for sale                  |  | $                       | - |  |                                               | $





Results of Discontinued
Operations



As Sezmi and Content
Solutions represented a component of our business and its results of operations and cash flows can be separated from the rest of
our operations, the results for the periods presented are disclosed as discontinued operations on the face of the consolidated
statements of operations. Net revenues and (loss) from discontinued operations, net of tax, for the three months ended June 30,
2012 and 2011, and for the six months ended June 30, 2012 and 2011, respectively, are as follows (in thousands):



|Discontinued Operations- Sezmi                               |  |                    |         |   |                  |  
|------------------------------------------------------------ |  | ------------------ | ------- | - | ---------------- | -
|                                                             |  | Three months ended |         |   | Six months ended |  
|                                                             |  | June 30,           |         |   | June 30,         |  
|                                                             |  | 2012               |         |   | 2011             |  
|Revenue                                                      |  | $                  | 109     |   |                  | $
|Net loss from operations                                     |  |                    | (4,310  | ) |                  |  
|Loss from Disposal                                           |  |                    | (28,578 | ) |                  |  
|Loss before provision for taxes from discontinued operations |  |                    | (32,888 | ) |                  |  
|Provision for income taxes                                   |  |                    | -       |   |                  |  
|Net loss from discontinued operations                        |  | $                  | (32,888 | ) |                  | $



|Discontinued Operations- Content Solutions                   |  |                    |         |   |                  |  
|------------------------------------------------------------ |  | ------------------ | ------- | - | ---------------- | -
|                                                             |  | Three months ended |         |   | Six months ended |  
|                                                             |  | June 30,           |         |   | June 30,         |  
|                                                             |  | 2012               |         |   | 2011             |  
|Revenue                                                      |  | $                  | 1,333   |   |                  | $
|                                                             |  |                    |         |   |                  |  
|Net income (loss) from operations                            |  |                    | (156    | ) |                  |  
|Loss from Disposal                                           |  |                    | (15,462 | ) |                  |  
|Loss before provision for taxes from discontinued operations |  |                    | (15,618 | ) |                  |  
|Provision for income taxes                                   |  |                    | -       |   |                  |  
|Net loss from discontinued operations                        |  | $                  | (15,618 | ) |                  | $





22









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





|Discontinued Operations- Total                               |  |                    |         |   |                  |  
|------------------------------------------------------------ |  | ------------------ | ------- | - | ---------------- | -
|                                                             |  | Three months ended |         |   | Six months ended |  
|                                                             |  | June 30,           |         |   | June 30,         |  
|                                                             |  | 2012               |         |   | 2011             |  
|Revenue                                                      |  | $                  | 1,442   |   |                  | $
|                                                             |  |                    |         |   |                  |  
|Net loss from operations                                     |  |                    | (4,466  | ) |                  |  
|Loss from Disposal                                           |  |                    | (44,040 | ) |                  |  
|Loss before provision for taxes from discontinued operations |  |                    | (48,506 | ) |                  |  
|Provision for income taxes                                   |  |                    | -       |   |                  |  
|Net loss from discontinued operations                        |  | $                  | (48,506 | ) |                  | $





(26)
Legal Matters





Other
than as set forth below, we are not a party to any pending legal proceeding nor is our property the subject of a pending legal
proceeding that is not in the ordinary course of business or otherwise material to the financial condition of our business.



In
December 2007, two former consultants of ROO Media Corporation (ROO Media) (currently KIT Media Corporation) sued that entity together
with ROO Group, Inc. (now KIT digital, Inc.) and its founder and former Vice Chairman and ROO Media’s former President and
Chief Operating Officer in New York Supreme Court, New York County, New York, alleging breach of an oral employment agreement,
fraudulent inducement and other claims relating to the plaintiffs’ employment at ROO Media. In March 2009, the court dismissed
all of plaintiffs’ claims except their breach of contract claim on the grounds that it is based on an alleged oral agreement,
which, according to the court, plaintiffs may be able to prove. In July 2011, following the completion of discovery, defendants
made a motion for summary judgment dismissing the remaining claim in the case. By decision and order dated July 2, 2012, the court
denied defendants’ motion. Trial was scheduled for July 23, 2012 but was adjourned to October 9, 2012. On August 9, 2012,
defendants filed a motion for leave to reargue the court’s denial of their summary judgment motion, and oral argument on
such motion has been scheduled for August 24, 2012. We believe that there is no merit to this suit and we intend to continue to
defend vigorously.



In
November 2007, our wholly-owned subsidiary, ROO HD, Inc., now KIT HD, Inc. (“KIT HD”), was named as the defendant in
a purported class action lawsuit entitled Julie Vittengl et al. vs. ROO HD, Inc., in New York Supreme Court, Saratoga County, New
York. The suit, brought by four former employees of Wurld Media, Inc. (“Wurld”), purportedly on behalf of themselves
and “others similarly situated,” claims that KIT HD’s acquisition of certain assets of Wurld was a fraudulent
conveyance and that KIT HD is the alter-ego of Wurld. Plaintiffs seek the appointment of a receiver to take charge of our property
in constructive trust for plaintiffs and payment of plaintiffs’ unpaid wages and costs of suit, both in an unspecified dollar
amount. KIT HD filed its answer to the complaint in January 2008. In December 2009, plaintiffs served an amended complaint, dropping
the class action allegations and joined by 15 additional former employees of Wurld, added us as a defendants and purport to seek
to enforce judgments plaintiffs had obtained against Wurld as the result of an arbitration against Wurld in March 2009. In February
2010, we and KIT HD answered the amended complaint, and the case is currently in discovery. We believe that the suit is without
merit, and we and KIT HD intend to defend ourselves vigorously.



In
May 2009, a former employee of Wurld filed suit against ten shareholders of Wurld, Wurld, ROO HD (now KIT HD), and ROO Group,
Inc. (now KIT digital, Inc.), in New York Supreme Court, Albany County, New York. Plaintiff seeks to hold the ten largest
shareholders of Wurld liable under Business Corporation Law §630, for $100 in wages that Wurld allegedly failed to pay
plaintiff. She further asserts a variety of claims based on the allegation that KIT HD’s acquisition of certain assets
of Wurld was a fraudulent conveyance, and that KIT HD is the successor to Wurld and liable for Wurld’s debts. Based on
these allegations, plaintiff seeks payment of her wages, the (unspecified) fair market value of her shares of stock in Wurld,
rescission of the asset purchase agreement between Wurld and KIT HD, plus attorney’s fees. In October 2009, the court
dismissed plaintiff's claims against three shareholder/defendants on the grounds that BCL §630 does not apply to Wurld
because it is not a New York corporation, a decision that plaintiff unsuccessfully appealed. Consequently, all of
plaintiff’s claims against the Wurld shareholder defendants are, or will be, finally dismissed; and this case should
move into the discovery phase with respect to plaintiff’s claims against us and KIT HD. We and KIT HD have been served
and answered. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

23









KIT
DIGITAL, INC. AND SUBSIDIARIES

NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS

(Amounts
in Thousands, Except Share and Per Share Data)

(Unaudited)





On
May 29, 2012, McHardy, a shareholder, filed a purported securities class action complaint against the Company and certain former
executive officers alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
in connection with purchases of our common stock between November 8, 2011 and May 3, 2012.  The complaint alleges, among other
things, that certain prior statements regarding the Company’s past and expected future results of operations were false and
misleading. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.



On
July 13, 2012, Stephen Conrad, through Pershing LLC, a shareholder, filed a purported shareholder derivative complaint against
the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and other
misconduct from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe
that this lawsuit is without merit and we intend to defend ourselves vigorously.



On
July 18, 2012, Venkata, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current
and former Board members and executive officers alleging breaches of fiduciary duties and in connection with prior statements regarding
the Company’s past and expected future results of operations from November 8, 2011 to the present that have caused substantial
losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.







The Company and its former chairman and
chief executive officer have been responding to SEC subpoenas seeking, in general, documents related to June 2010 transactions
in Company common stock and a related Form 4 filing by our former chairman and chief executive officer that reported a purchase
of 54,745 shares of Company common stock, as well as certain emails that may have been deleted from his computer but were maintained
in the Company’s system.  We are cooperating with the SEC in its investigation, however, we cannot be certain of
the scope or outcome of the investigation.  Also, we have disagreements with our former chairman and chief executive
officer concerning amounts purportedly owed him under arrangements entered into prior to his departure from those roles earlier
this year.  It is uncertain whether those disagreements will be resolved or whether litigation may be filed.





The Audit Committee of our Board of Directors
has retained independent professional advisors in connection with an investigation it is directing in respect of certain transactions
that gave rise to impairments that have been taken by the Company as well as some of the foregoing issues.



24









ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Amounts
in Thousands, Except Share and Per Share Data)



Overview



Through
our operating subsidiaries, we are in the business of providing software solutions that enable our customers to manage and distribute
video content through Internet websites, mobile and tablet devices and both closed network Internet Protocol television (“IPTV”)
and over-the-top (“OTT”) connected television environments. Our core video asset management software suite, marketed
under the “KIT Platform” brand (and “KIT Cosmos” and “KIT Cloud” sub-brands), includes online
and mobile video players, ingestion and trans-coding for Internet and mobile connected devices, live and video-on-demand OTT and
IPTV video serving, editing and content transformation, content meta-tagging, content localization and syndication, digital rights
management, hosting, storage, content delivery and content syndication. We currently provide IP video solutions internationally
through over 20 offices globally, including principal locations in Atlanta, Beijing, Boston, Chennai, Cologne, Delhi, Dubai, Ely
(UK), Grenoble (France), London, Madrid, Melbourne (Australia), Mumbai, New York, Paris, Prague, San Francisco, Singapore, and
Sydney. In support of our KIT Platform deployments, we provide systems integration, broadcast engineering services, content transformation
services and integrated marketing services.



Set
forth below is a discussion of the financial condition and results of operations of KIT digital, Inc. and its consolidated subsidiaries
(collectively, “we,” “us” or “our”), for the three and six months ended June 30, 2012 and 2011.
The following discussion should be read in conjunction with the information set forth in the consolidated financial statements
and the related notes thereto appearing elsewhere in this report.



Critical
Accounting Policies and Estimates



The
policies discussed below are considered by our management to be critical to an understanding of our financial statements because
their application places the most significant demands on our management’s judgment, with financial reporting results relying
on our estimation about the effect of matters that are inherently uncertain. Specific risks for these critical accounting policies
are described below. For these policies, we caution that future events rarely develop as forecast, and that best estimates may
routinely require adjustment.



The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management
to make judgments and estimates. On an ongoing basis, we evaluate our estimates, the most significant of which include establishing
allowances for doubtful accounts and determining the recoverability of our long-lived tangible and intangible assets. The basis
for our estimates are historical experience and various assumptions that are believed to be reasonable under the circumstances,
given the available information at the time of the estimate, the results of which form the basis for making judgments about the
carrying values of assets and liabilities that are not readily available from other sources. We caution that future events rarely
develop as forecast, and that best estimates may routinely require adjustment. Actual results may differ from the amounts estimated
and recorded in our financial statements.



We
believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation
of our consolidated financial statements.



Revenue
Recognition.  We recognize revenue in accordance with the accounting standard, which requires that four basic criteria
be met before revenue can be recognized: (i) persuasive evidence that an arrangement exists; (ii) the price is fixed or determinable;
(iii) collectability is reasonably assured; and (iv) product delivery has occurred or services have been rendered. We recognize
revenue, net of sales taxes assessed by any governmental authority. Our material revenue streams are related to the delivery of
IP video software solutions, including software-as-a-service (“SaaS”) fees, software usage fees, enterprise license
fees, set-up/support services, storage, hardware components, content delivery and content syndication. Our solutions also include
technical integration services, interface design, branding, strategic planning, creative production, online marketing, media planning
and analytics. We enter into revenue arrangements that may consist of multiple deliverables of components and services due to the
needs of its customers. In addition to these general revenue recognition criteria, the following specific revenue recognition policies
are followed:



Multiple-Element
Arrangements — Arrangements with customers may include multiple deliverables, including any combination of hardware components,
software and services and make up less than 10% of our revenue arrangements. For our multiple-element arrangements, deliverables
are separated into more than one unit of accounting when (i) the delivered element(s) have value to the customer on a stand-alone
basis, and (ii) delivery of the undelivered element(s) is probable and substantially in our control. Based on the new accounting
guidance adopted July 1, 2010 and applied retrospectively to January 1, 2010, revenue is then allocated to each unit of accounting
based on the estimated selling price determined using a hierarchy of evidence based first on Vendor-Specific Objective Evidence
(“VSOE”) if it exists, based next on Third-Party Evidence (“TPE”) if VSOE does not exist, and finally,
if both VSOE and TPE do not exist, based on best estimate of selling price (“BESP”). The general timing of the delivery
of components and performance of services within our multiple-element arrangements are completed within three to six months of
commencement. Our arrangements generally do not include any provisions for cancellation, termination, or refunds that would impact
recognized revenue.

25







We
determine BESP for a deliverable in a multiple element arrangement by collecting all reasonably available data points including
sales, cost and margin analysis of the product, and other inputs based on our normal pricing practices. We have experience selling
components, installation and integration services at a standard combined price and consider this to be BESP when contracting with
customers. The determination of BESP is a formal process within our company that includes review and approval by our management.



After
determination of the estimated selling price of each deliverable in a multiple-element arrangement, the arrangement consideration
is then allocated using the relative selling price method. Under the relative selling price method, the estimated selling price
for each deliverable is compared to the sum of the estimated selling price for all deliverables. The percentage that is calculated
for each deliverable is then multiplied by the total contractual value of the multiple-element arrangement to determine the revenue
allocated to each deliverable.



The
revenue allocated to each deliverable will then be recorded in accordance with existing revenue recognition guidance for stand-alone
component sales and services.



Services
— Revenue for services is generally recognized when the contractually required services have been delivered and approved
by the customer.



Software
– Software revenue is recognized separately if it has stand-alone value, works on customer available hardware and does not
require any significant production, modification or customization. When the software does require significant production, modification
or customization, the revenue is recognized when the software and modifications are delivered and accepted. Delivery constitutes
the customer having access to the software and evidence of acceptance from the customer. If the software is available on-line or
delivered electronically, evidence may also include the provision of authorization codes for use.



Hardware
Components — For hardware component sales (one deliverable only), revenue recognition generally occurs when products or equipment
have been shipped, risk of loss has transferred to the customer, objective evidence exists that customer acceptance provisions
have been met, no significant obligations remain and an allowance for discounts, returns and customer incentives can be reliably
estimated. If software is delivered as an integral functional part of the hardware then the revenue for the hardware and software
is recognized as a single unit of revenue. Recorded revenues are reduced by these allowances. We base our estimates of these allowances
on historical experience taking into consideration the type of products sold, the type of customer and the specific type of transaction
in each arrangement.



Allowance
for Doubtful Accounts.  We maintain an allowance for doubtful accounts based on the expected collectability of
our accounts receivable, which requires a considerable amount of judgment in assessing the creditworthiness of customers
and related aging of past due balances. The allowance for doubtful accounts as of June 30, 2012 and December 31, 2011 was
$2,821 and $2,943, respectively. Charges for bad debts recorded on the statement of operations for the three and six months
ended June 30, 2012 was $5,067 and $7,027, respectively. Included in the three months June 30, 2012, the Company recorded a
write-off for approximately $6,490 related to certain receivables the Company has determined are no longer collectible.
For the three and six months June 30, 2011, bad debt expense was $250 and $1,255, respectively. Based on historical
information, we believe that our allowance is adequate. Changes in general economic, business and market conditions could
result in an impairment in the ability of our customers to make their required payments, which would have an adverse effect
on cash flows and our results of operations.



Impairment
of Goodwill. We evaluate the carrying value of our goodwill annually at the end of December and whenever events or circumstances
make it more likely than not that an impairment may have occurred. Accounting standard on Goodwill and Other Intangible Assets,
prescribes a two-step method for determining goodwill impairment. In the first step, we compare the estimated fair value of each
reporting unit to its carrying amount, including goodwill. If the carrying amount of a reporting unit exceeds the estimated fair
value, step two is completed to determine the amount of the impairment loss. Step two requires the allocation of the estimated
fair value of the reporting unit to the assets, including any unrecognized intangible assets, and liabilities in a hypothetical
purchase price allocation. Any remaining unallocated fair value represents the implied fair value of goodwill, which is compared
to the corresponding carrying value of goodwill to compute the goodwill impairment amount.



As
part of our impairment analysis for each reporting unit, we estimate the fair value of each unit utilizing the income approach
and market approach. The income approach requires management to estimate a number of factors for each reporting unit, including
projected future operating results, economic projections, anticipated future cash flows, discount rates, and the allocation of
shared service or corporate items. The market approach was used as a test of reasonableness of the conclusions reached in the income
approach. The market approach estimates fair value using comparable marketplace fair value data from within a comparable industry
grouping.



Goodwill
represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired
in each business combination. During the second quarter ended June 30, 2012, our market capitalization declined significantly.
As this measure is our significant indicator of the fair value of our business unit, management considered this decline to be a
triggering event, requiring us to perform an interim impairment analysis. As of June 30, 2012, we completed this interim analysis
and our management has concluded that an impairment charge of $55,718 should be recognized. This is a noncash charge and has been
recorded in the second quarter ended June 30, 2012. As of December 31, 2011, approximately $32,169 of goodwill was part of discontinued
operations and is included in long-term assets held for sale

26







The
determination of the fair value of the reporting units and the allocation of that value to individual assets and liabilities within
those reporting units requires management to make significant estimates and assumptions. These estimates and assumptions primarily
include, but are not limited to: the selection of appropriate peer group companies; control premiums appropriate for acquisitions
in the industries in which we compete; the discount rate; terminal growth rates; and forecasts of net sales, operating income,
depreciation and amortization and capital expenditures. Although we believe our estimates of fair value are reasonable, actual
financial results could differ from those estimates due to the inherent uncertainty involved in making such estimates. Changes
in assumptions concerning future financial results or other underlying assumptions could have a significant impact on the fair
value of the reporting units.





Long-Lived
Assets.  Long-lived assets, including property, plant and equipment, and intangible assets with determinable lives,
are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not
be fully recoverable. An impairment is assessed if the undiscounted expected future cash flows generated from an asset are less
than its carrying amount. Impairment losses are recognized for the amount by which the carrying value of an asset exceeds its fair
value. The estimated useful lives of all long-lived assets are periodically reviewed and revised if necessary.





Results
of Operations - Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011



Revenue.
Consolidated revenue increased by $6,197 from $44,952 for the three months ended June 30, 2011 to $51,149 for the three months
ended June 30, 2012, an increase of approximately 14%. This increase was primarily due to increased spending by existing customers,
an increase in customers and revenue from the acquired companies not included in prior period results. In 2012, our average monthly
revenue per client increased, reflecting the company’s focus on higher-end opportunities in the market and large, multi-year
contracts in emerging geographies. The primary contributors to inorganic growth in 2012 over 2011 were the acquisitions of ioko,
Megahertz and Polymedia.



Variable
and Direct Third Party Costs



Cost
of Goods and Services (Exclusive of Depreciation shown separately below). These costs increased by $6,613 from $9,799 for the
three months ended June 30, 2011 to $16,412 for the three months ended June 30, 2012, an increase of approximately 67%. These costs
represent the costs of equipment and services for the supply of digital media and IPTV solutions, services and components. The
increase was primarily due to the timing of the sale of services for the supply of digital media solutions, services and components
in the three months ended June 30, 2012. These costs will increase in 2012 due to the increase in the sale of services for
the supply of digital media solutions, services and components..



Hosting,
Delivery, Reporting and Content Costs. These costs increased by $464 from $2,650 for the three months ended June 30, 2011 to
$3,114 for the three months ended June 30, 2012, an increase of approximately 18%. These costs increased primarily due to the increase
in revenue over 2011 and costs relating to the acquisition of ioko in May 2011 for hosting, delivery and reporting. We expect these
costs to decrease as an overall percentage of revenue through the continued consolidation of our data centers and price negotiations
with our content delivery providers due to our increased size and bargaining power.



Direct
Third Party Creative Production Costs. Direct third party creative production costs increased by $79 from $317 for the three
months ended June 30, 2011 to $396 for the three months ended June 30, 2012, an increase of 25% attributable to an increase in
revenue requiring creative production costs.



General
and Administrative Expenses



Compensation,
Travel and Associated Costs (Including Non-Cash Stock-Based Compensation). These costs increased by $23,715 from $21,108 for
the three months ended June 30, 2011 to $44,823 for the three months ended June 30, 2012, an increase of approximately 112%. 
The increase was primarily due to the acquisitions in 2011, increase in non-cash stock based compensation and increase in consulting
fees which was offset in part by continuing cost cutting measures as we integrated the acquired businesses. Non-cash stock-based
compensation expense increased by 88% or $3,870 to $8,254 for the three months ended June 30, 2012, from $4,384 for the three months
ended June 30, 2011. This increase in non-cash stock based compensation is primarily driven by expenses incurred as part of certain
executive termination.



Legal,
Accounting, Audit and Other Professional Services Fees. These expenses increased by $2,985 from $767 for the three months ended
June 30, 2011 to $3,752 for the three months ended June 30, 2012, an increase of over 300%. These costs increased primarily due
to increases in legal fees in association with litigation, board and executive restructurings, and audit fees combined with an
overall increase in these expenses from the acquisitions.

27







Office,
Marketing and Other Corporate Costs. These expenses increased by $7,310 from $4,405 for the three months ended June 30, 2011
to $11,715 for the three months ended June 30, 2012, an increase of 165%.  The increase was primarily due to a write-off of
bad debt for items determined to be no longer collectible for approximately $6,490 during second quarter of 2012 and an increase
in offices and related facility costs through acquisitions.



Merger
and Acquisition Related Expenses. Merger and acquisition related expenses decreased by $13,157 from $10,916 for the three months
ended June 30, 2011 to a credit of $2,241 for the three months ended June 30, 2012, a decrease of approximately 120%. The decrease
was primarily due to the significant acquisitions in the three months ended June 30, 2011 as compared to one in the three months
ended June 30, 2012. Included in the three months ended June 30, 2012 are reversals of approximately $3,995 for previously recorded
earn-outs which will no longer be achieved.



Depreciation
and Amortization. Depreciation and amortization expense increased by $1,098 from $3,096 for the three months ended June 30,
2011 to $4,194 for the three months ended June 30, 2012, an increase of 36%. The increase was primarily due to the acquisitions
in 2011. We expect these costs to remain relatively stable for the rest of 2012.



Restructuring
Charges. Restructuring charges was $3,349 for the three months ended June 30, 2011. These charges reflect the 2012 plan that
was initiated in the second quarter of 2012 and consists primarily of employee termination costs. Restructuring charges in the
three months ended June 30, 2012 were minimal.



Impairment
of Goodwill. During the three months ended June 30, 2012, the Company recorded an impairment of goodwill of approximately $55,718.
This charge was based on the results of the Company’s interim impairment test performed during the second quarter of 2012
as the Company experienced a significant decrease in the market price of its shares.



Integration
Expenses. Integration expenses were $9,710 for the three months ended June 30, 2011. There were no integration charges for
the three months ended June 30, 2012. Integration expenses in 2011 consisted of cost overlap due to the integration of acquisitions.



Interest
Expense. Interest expense increased by $820 from $383 for the three months ended June 30, 2011 to $1,203 for the three months
ended June 30, 2012, an increase of 214%. This increase was mainly due to the issuance of secured notes in May 2011.



Derivative
Income (Expense). Derivative expense was $3,173 for the three months ended June 30, 2012 as compared to derivative income of
$433 for the three months ended June 30, 2011. Derivative income or expense is the change in the period based on the fair value
of warrants containing reset provisions.



Other
Income/(Expense). Other income/(expense) changed by $8,955 from $378 in other expense for the three months ended June 30, 2011
to other expense of $9,333 for the three months ended June 30, 2012. This majority of this increase relates to the receivable reserve
recorded of approximately $6,432 against the receivable from the 2010 sale of subsidiary, $1,200 charge related to the write-down
of investments and approximately $1,435 expense related to a share price guaranteed to be issued related to acquisitions.



Income
Tax Income/(Expense). Income tax income/(expense) changed by $2,115 from $796 expense in the three months ended June 30, 2011
to a benefit of $1,319 for the three months ended June 30, 2012. This tax benefit is primarily driven by the reversal of deferred
tax liabilities from acquisition related intangibles. Prior period’s tax expense relates to estimated tax payments for state
and local.



Loss
from Discontinued Operations. Loss from the discontinued operations for the three months ended June 30, 2012 totaled $48,506
which is comprised of the activity from the divesture of Sezmi and Content Solutions. Sezmi’s loss from operations for the
period total $4,310 and a loss of $28,578 from disposal. Content Solutions divesture includes a loss from operations of $156 and
a loss from disposal of $15,462. During the three months ended June 30, 2011, the $822 loss related primarily from loss from operations
from the Content Solutions Business. The Sezmi acquisition did not occur until December 2011.



Net
Loss. As a result of the factors described above, we reported net loss available to common shareholders of $151,082 for the
three months ended June 30, 2012 compared to a net loss available to common shareholders of $19,803 for the three months ended
June 30, 2011.

28







Results
of Operations - Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011



Revenue.
Consolidated revenue increased by $31,528 from $75,739 for the six months ended June 30, 2011 to $107,267 for the six months ended
June 30, 2012, an increase of approximately 42%. This increase was primarily due to increased spending by existing customers, an
increase in customers and revenue from the acquired companies not included in prior period results. In 2012, our average monthly
revenue per client increased, reflecting the company’s focus on higher-end opportunities in the market and large, multi-year
contracts in emerging geographies. The primary contributors to inorganic growth in 2012 over 2011 were the acquisitions of ioko,
Megahertz and Polymedia.



Variable
and Direct Third Party Costs



Cost
of Goods and Services (Exclusive of Depreciation shown separately below). These costs increased by $15,431 from $17,841 for
the six months ended June 30, 2011 to $33,272 for the six months ended June 30, 2012, an increase of approximately 86%. These costs
represent the costs of equipment and services for the supply of digital media and IPTV solutions, services and components. The
increase was primarily due to the timing of the sale of services for the supply of digital media solutions, services and components
in the six months ended June 30, 2012. These costs will increase in 2012 due to the increase in the sale of services for the
supply of digital media solutions, services and components.



Hosting,
Delivery, Reporting and Content Costs. These costs increased by $2,320 from $3,883 for the six months ended June 30, 2011 to
$6,203 for the six months ended June 30, 2012, an increase of approximately 60%. These costs increased primarily due to the increase
in revenue over 2011 and costs relating to the acquisition of ioko in May 2011 for hosting, delivery and reporting. We expect these
costs to decrease as an overall percentage of revenue through the continued consolidation of our data centers and price negotiations
with our content delivery providers due to our increased size and bargaining power.



Direct
Third Party Creative Production Costs. Direct third party creative production costs increased by $331 from $682 for the six
months ended June 30, 2011 to $1,013 for the six months ended June 30, 2012, an increase of 49% attributable to an increase in
revenue requiring creative production costs.





General
and Administrative Expenses



Compensation,
Travel and Associated Costs (Including Non-Cash Stock-Based Compensation). These costs increased by $51,957 from $32,443 for
the six months ended June 30, 2011 to $84,400 for the six months ended June 30, 2012, an increase of approximately 160%. 
The increase was primarily due to the acquisitions in 2011, increase in non-cash stock based compensation, consulting fees and
by non-cash stock-based compensation expense, which was offset in part by continuing cost cutting measures as we integrated the
acquired businesses and some of these costs were included in integration expenses. Non-cash stock-based compensation expense increased
by 143% or $9,147 to $15,557 for the six months ended June 30, 2012, from $6,410 for the six months ended June 30, 2011. This increase
in non-cash stock based compensation is primarily driven by expenses incurred as part of certain executive termination.



Legal,
Accounting, Audit and Other Professional Services Fees. These expenses increased by $3,191 from $1,344 for the six months ended
June 30, 2011 to $4,535 for the six months ended June 30, 2012, an increase of over 200%. These costs increased primarily due to
increases in legal fees in association with litigation, board and executive restructurings, and audit fees combined with an overall
increase in these expenses from the acquisitions.



Office,
Marketing and Other Corporate Costs. These expenses increased by $10,784 from $8,145 for the six months ended June 30, 2011
to $18,929 for the six months ended June 30, 2012, an increase of approximately 132%.  The increase was primarily due to a
write-off of bad debt for items determined to be no longer collectible for approximately $6,490 during second quarter of fiscal
2012 and an increase in offices and related facility costs through acquisitions.



Merger
and Acquisition Related Expenses. Merger and acquisition related expenses decreased by $13,917 from $16,166 for the six months
ended June 30, 2011 to $2,249 for the six months ended June 30, 2012, a decrease of approximately 86%. The decrease was primarily
due to the significant acquisitions in the six months ended June 30, 2011 as compared to one in the six months ended June 30, 2012.
are reversals of approximately $3,995 for previously recorded earn-outs which will no longer be achieved.



Depreciation
and Amortization. Depreciation and amortization expense increased by $2,885 from $5,469 for the six months ended June 30, 2011
to $8,354 for the six months ended June 30, 2012, an increase of approximately 53%. The increase was primarily due to the acquisitions
in 2011. We expect these costs to remain relatively stable for the rest of 2012.



Restructuring
Charges. Restructuring charges was $3,349 for the six months ended June 30, 2012. These charges reflect the 2012 plan that
was initiated in the second quarter of 2012 and consists primarily of employee termination costs. Restructuring charges in the
six months ended June 30, 2011 of $3,352 relates to restructuring plans initiated in the first quarter of 2011.



Impairment
of Goodwill. During the six months ended June 30, 2012, the Company recorded an impairment of goodwill of approximately $55,718.
This charge was based on the results of the Company’s interim impairment test performed during the second quarter of 2012
as the Company experienced a significant decrease in the market price of its shares.

29









Integration
Expenses. Integration expenses was $18,398 for the six months ended June 30, 2011. There were no integration charges for the
six months ended June 30, 2012. Integration expenses in 2011 consisted of cost overlap due to the integration of acquisitions.



Interest
Expense. Interest expense increased by $1,256 from $636 for the six months ended June 30, 2011 to $1,892 for the six months
ended June 30, 2012, an increase of 197%. This increase was mainly due to the issuance of secured notes in May 2011.



Derivative
Income (Expense). Derivative expense was $2,986 for the six months ended June 30, 2012 as compared to derivative income of
$3,042 for the six months ended June 30, 2011. Derivative income or expense is the change in the period based on the fair value
of warrants containing reset provisions. Derivative income or expense is the change in the period based on the fair value of warrants
containing reset provisions.



Other
Income/(Expense). Other income/(expense) changed by $9,089 from $448 in other expense for the six months ended June 30, 2011
to other expense of $9,537 for the six months ended June 30, 2012 This majority of this increase relates to the receivable reserve
recorded of approximately $6,432 against the receivable from the 2010 sale of subsidiary, $1,200 charge related to the write-down
of investments and approximately $1,435 expense related to a share price guaranteed to be issued related to acquisitions.



Income
Tax Income/(Expense). Income tax income/(expense) changed by $2,169 from $910 expense in the six months ended June 30, 2011
to a benefit of $1,259 for the six months ended June 30, 2012. This tax benefit is primarily driven by the reversal of deferred
tax liabilities from acquisition related intangibles. Prior period’s tax expense relates to estimated tax payments for state
and local.



Loss
from Discontinued Operations. Loss from the discontinued operations for the three months ended June 30, 2012 totaled $51,894
which is comprised the activity from the divesture of Sezmi and Content Solutions. Sezmi’s loss from operations for the period
total $7,880 and a loss of $28,578 from disposal. Content Solutions divesture includes income from operations of $26 and a loss
from disposal of $15,462. During the six months ended June 30, 2011, the $1,415 loss relates primarily from loss from operations
from the Content Solutions Business. The Sezmi acquisition did not occur until December 2011.



Net
Loss. As a result of the factors described above, we reported net loss available to common shareholders of $175,961 for the
six months ended June 30, 2012 compared to a net loss available to common shareholders of $32,304 for the six months ended June
30, 2011.







Liquidity
and Capital Resources



As
of June 30, 2012, we had cash and cash equivalents of $30,562 and working capital deficit of approximately $12,572. Excluding the
current portions of derivatives liabilities and the current portion of acquisition liabilities as the majority will not be paid
in cash but in the Company’s common stock, working capital would have been $32,848. Management anticipates that it has enough
cash reserves and cash flows from its operating activities to be sufficient to fund its operations, anticipated capital expenditures
and debt repayment obligations for at least the next 12 months.



On May 15, 2012, the Company
entered into a definitive Securities Purchase Agreement to raise $29,190 in gross proceeds, before deducting placement
agents’ fees and other estimated offering expenses, in a private placement of (i) 7,000,000 shares of the
Company’s common stock and (ii) warrants to purchase 5,250,000 shares of Common Stock (issued on May 17,
2012) with an effective strike price of $5.00. After deducting the fees of the placement agent and other estimated offering
expenses, the net proceeds to the Company from the private placement were approximately $27,174.



During
the six months ended June 30, 2012 and in conjunction with this share issuance, the Company record a liability of approximately
$10,512 representing the estimated amount of additional shares to be granted as part of the stock price reset provision in the
stock purchase agreement. This amount consists of approximately 2,588,408
shares and approximately $3,000 in cash to be paid on or about August 13, 2012. See Note 14
and 16.



The warrants issued as part of the Securities
Purchase Agreement contain an embedded anti-dilution provision which is required to be carried as a derivative liability at fair
value. On May 17, 2012, we recorded the fair value of $14,333 as a derivative liability and as a reduction in additional paid-in
capital.



The Warrants were valued using a Monte Carlo
simulation model at $14,333.



As
of June 30, 2012, we were in compliance with our debt covenants on all of our secured notes payable.

30









Our
ability to meet our short and long-term liquidity needs depends on our future operating performance and on economic, financial,
competitive and other factors. See “Risks Related to Our Business” under Item 1A. Risk Factors in our 2011 Form 10-K
for more detail. Our financial projections are based on assumptions, which we believe are reasonable but contain significant uncertainties.
These projections include an increase in revenue, improved operating margins and significant decreases in costs related to the
restructuring and integration of acquired companies.



Net
cash used by continuing operating activities was $17,020 for the six months ended June 30, 2012, compared to $10,184 for the six
months ended June 30, 2011, a decrease of $6,836. This was primarily due the increased net loss in the period as opposed to the
prior period offset by non-cash charges and funding from working capital in period. Net used by discontinued operating activities
increase to $8,116 from a use of $1,075 due to the cash support need to support the Sezmi operations during the six months ended
June 30, 2012. Sezmi was not purchased until December 2011 and had no effect during the six months ended June 30, 2011.



Net
cash used by continuing investing activities was $7,783 for the six months ended June 30, 2012, compared to $111,944 for the six
months ended June 30, 2011, a decrease in net cash used in investing activities of $104,161. The decrease in net cash used in investing
activities was primarily attributable to the decrease in cash paid in acquisitions in 2012 of $114,781. Net cash used by discontinued
investing activities was minimal in each period.



Net
cash from continuing financing activities was $18,983 for the six months ended June 30, 2012, compared to net cash from continuing
financing activities of $17,677 for the six months ended June 30, 2011. The increase is due to the issuance of equity of approximately
$27,173 offset by payments of notes in the period as opposed to proceeds from the secured notes in 2011 of $15,000. Net cash used
by discontinued financing activities was minimal in each period.





Off-Balance
Sheet Arrangements



We
do not have any off-balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition,
revenues, results of operations, liquidity or capital expenditures.



SPECIAL
NOTE REGARDING FORWARD-LOOKING INFORMATION



This
Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). 
We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained
in the United States Private Securities Litigation Reform Act of 1995.  All statements, other than statements of historical
facts, included in this Form 10-Q regarding our strategy, future operations, financial position, future revenues, projected costs,
prospects, plans and objectives of management are forward-looking statements.  The words “anticipates,” “believes,”
“estimates,” “expects,” “intends,” “may,” “plans,” “projects,”
“will,” “would” and similar expressions are intended to identify forward-looking statements, although not
all forward-looking statements contain these identifying words. We cannot guarantee that we actually will achieve the plans, intentions
or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. 
There are a number of important factors that could cause our actual results to differ materially from those indicated by these
forward-looking statements.  These important factors include risks related to our history of net losses and accumulated deficits,
integration of acquired businesses, future capital requirements, competition and technological advances, dependence on the market
for digital advertising, and other factors that we identify in this Form 10-Q and in other filings we make with the SEC. 
For additional factors that can affect these forward-looking statements, see the “Risk Factors” section in our Annual
Report on Form 10-K for the year ended December 31, 2011.  You should read these factors and other cautionary statements made
in this Form 10-Q as being applicable to all related forward-looking statements wherever they appear in the Form 10-Q.  Except
to the extent required by federal securities laws, we do not assume any obligation to update any forward-looking statements made
by us.

31







ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.



We
conduct our operations in primary functional currencies: the United States dollar, the Euro, the British pound, the Czech koruna, the Australian dollar, the Indian rupee and the Swedish krona We currently do not hedge any of our foreign
currency exposures and are therefore subject to the risk of exchange rate fluctuations.



However,
we attempt to employ a “natural hedge” by matching as much as possible in like currencies our customer revenues with
associated customer delivery costs. We invoice our international customers primarily in U.S. dollars, British pounds, Australian
dollars and Euros.



We
are exposed to foreign exchange rate fluctuations as the financial results of foreign subsidiaries are translated into U.S. dollars
in consolidation and as our foreign currency consumer receipts are converted into U.S. dollars. Our exposure to foreign exchange
rate fluctuations also arises from payables and receivables to and from our foreign subsidiaries, vendors and customers.



Financial
instruments which potentially subject us to concentrations of credit risk consist principally of cash and cash equivalents and
trade accounts receivable. We endeavor to place our cash and cash equivalents with high credit quality institutions to limit credit
exposure. We have obtained callable cash collateral wherever we have identified credit risk exists with respect to these investments.



Concentrations
of credit risk with respect to trade accounts receivable are limited due to the wide variety of our customers who are dispersed
across many geographic regions. We routinely assess the financial strength of customers and, based upon factors concerning credit
risk, we establish an allowance for uncollectible accounts. Our management believes that accounts receivable credit risk exposure
beyond such allowance is limited.



ITEM
4. CONTROLS AND PROCEDURES.



Conclusion
Regarding the Effectiveness of Disclosure Controls and Procedures



As
of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of
our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e)
and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures are still not effective with respect to the material weakness disclosed in our 2011
Form 10-K to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act
is: (1) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate
to allow timely decisions regarding required disclosure; and (2) 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
was no change to our internal controls or in other factors that could affect these controls during our last fiscal quarter that
has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.



Status
of Remediation Efforts



Prior
to the filing date of this Form 10-Q, we have undertaken and completed the following activities as part of our remediation plan
for the Material Weakness disclosed in our 2011 Form 10-K filing. Items completed include:



| | · | Hired a new Chief Financial Officer with extensive technology and software public company experience.
| | - | -----------------------------------------------------------------------------------------------------





| | · | Hired a new Regional Finance Director with extensive US GAAP and SEC experience to bolster regional finance oversight.
| | - | ----------------------------------------------------------------------------------------------------------------------



| | · | Established an internal audit function and hired a Director of Internal Audit.
| | - | ------------------------------------------------------------------------------



| | · | Hired a new Corporate Controller with extensive US GAAP and SEC experience.
| | - | ---------------------------------------------------------------------------



| | · | Appointed a “Big-4” accounting/consulting firm to provide best practices and remediation assistance.
| | - | ----------------------------------------------------------------------------------------------------



| | · | Selected HSBC as our global financial service provider to support our regional and corporate cash management and pooling functions.
| | - | -----------------------------------------------------------------------------------------------------------------------------------





32









Items
undertaken and in progress include:



| | · | Continued recruiting and hiring of both senior and support finance personnel trained in US GAAP.
| | - | ------------------------------------------------------------------------------------------------



| | · | Improvements and enhancements of senior level disclosure reviews including the establishment of an internal disclosure committee
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |   |                                                                                                                                 
| | · | Planning and performing risk-based audits and walk-throughs of regional/local controls and procedures.                          



| | · | Updating and enhancing the documentation and training of regional/local finance personnel about US GAAP reporting and compliance.
| | - | ---------------------------------------------------------------------------------------------------------------------------------



| | · | Enhancing corporate reviews of material balances and estimates from regional/local offices.
| | - | -------------------------------------------------------------------------------------------



| | · | Continue to work with previously appointed “Big-4” accounting/consulting firm in improving on the Company’s controls and remediation efforts.
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------





Management
is committed to aggressively remediating and strengthening our internal controls in order to remediate the material weakness reported
in our 2011 Form 10-K.





33







PART
II - OTHER INFORMATION



ITEM
1. LEGAL PROCEEDINGS.



Other
than as set forth below, we are not a party to any pending legal proceeding or is any of our property the subject of a pending
legal proceeding that is not in the ordinary course of business or is otherwise material to the financial condition of our business.



In
December 2007, two former consultants of ROO Media Corporation (ROO Media) (currently KIT Media Corporation) sued that entity together
with ROO Group, Inc. (now KIT digital, Inc.) and its founder and former Vice Chairman and ROO Media’s former President and
Chief Operating Officer in New York Supreme Court, New York County, New York, alleging breach of an oral employment agreement,
fraudulent inducement and other claims relating to the plaintiffs’ employment at ROO Media. In March 2009, the court dismissed
all of plaintiffs’ claims except their breach of contract claim on the grounds that it is based on an alleged oral agreement,
which, according to the court, plaintiffs may be able to prove. In July 2011, following the completion of discovery, defendants
made a motion for summary judgment dismissing the remaining claim in the case. By decision and order dated July 2, 2012, the court
denied defendants’ motion. Trial was scheduled for July 23, 2012 but was adjourned to October 9, 2012. On August 9, 2012,
defendants filed a motion for leave to reargue the court’s denial of their summary judgment motion, and oral argument on
such motion has been scheduled for August 24, 2012. We believe that there is no merit to this suit and we intend to continue to
defend it vigorously.



In
November 2007, our wholly-owned subsidiary, ROO HD, Inc., now KIT HD, Inc. (“KIT HD”), was named as the defendant in
a purported class action lawsuit entitled Julie Vittengl et al. vs. ROO HD, Inc. in New York Supreme Court, Saratoga County, New
York. The suit, brought by four former employees of Wurld Media, Inc. (“Wurld”), purportedly on behalf of themselves
and “others similarly situated,” claims that KIT HD’s acquisition of certain assets of Wurld was a fraudulent
conveyance and that KIT HD is the alter-ego of Wurld. Plaintiffs seek the appointment of a receiver to take charge of our property
in constructive trust for plaintiffs and payment of plaintiffs’ unpaid wages and costs of suit, both in an unspecified dollar
amount. KIT HD filed its answer to the complaint in January 2008. In December 2009, plaintiffs served an amended complaint, dropping
the class action allegations and joined by 15 additional former employees of Wurld, added us as a defendants and purport to seek
to enforce judgments plaintiffs had obtained against Wurld as the result of an arbitration against Wurld in March 2009. In February
2010, we and KIT HD answered the amended complaint, and the case is currently in discovery. We believe that the suit is without
merit, and we and KIT HD intend to defend ourselves vigorously.



In
May 2009, a former employee of Wurld filed suit against ten shareholders of Wurld, ROO HD (now KIT HD), and ROO Group, Inc. (now
KIT digital, Inc.) in New York Supreme Court, Albany County, New York. Plaintiff seeks to hold the ten largest shareholders of
Wurld liable under Business Corporation Law §630, for $100 in wages that Wurld allegedly failed to pay plaintiff. She further
asserts a variety of claims based on the allegation that KIT HD’s acquisition of certain assets of Wurld was a fraudulent
conveyance, and that KIT HD is the successor to Wurld and liable for Wurld’s debts. Based on these allegations, plaintiff
seeks payment of her wages, the (unspecified) fair market value of her shares of stock in Wurld, rescission of the asset purchase
agreement between Wurld and KIT HD, plus attorney’s fees. In October 2009, the court dismissed plaintiff's claims against
three shareholder/defendants on the grounds that BCL §630 does not apply to Wurld because it is not a New York corporation,
a decision that plaintiff unsuccessfully appealed. Consequently, all of plaintiff’s claims against the Wurld shareholder
defendants are, or will be, finally dismissed; and this case should move into the discovery phase with respect to plaintiff’s
claims against us and KIT HD. We and KIT HD have been served and answered. We believe that this lawsuit is without merit and we
intend to defend ourselves vigorously.



On
May 29, 2012, McHardy, a shareholder, filed a purported securities class action complaint against the Company and certain former
executive officers alleging claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder
in connection with purchases of our common stock between November 8, 2011 and May 3, 2012.  The complaint alleges, among other
things, that certain prior statements regarding the Company’s past and expected future results of operations were false and
misleading. We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.



On
July 13, 2012, Stephen Conrad, through Pershing LLC, a shareholder, filed a purported shareholder derivative complaint against
the Company and certain current and former Board members and executive officers alleging breaches of fiduciary duties and other
misconduct from November 8, 2011 to the present that have caused substantial losses and damages to the Company.  We believe
that this lawsuit is without merit and we intend to defend ourselves vigorously.



On
July 18, 2012, Venkata, a shareholder, filed a purported shareholder derivative complaint against the Company and certain current
and former Board members and executive officers alleging breaches of fiduciary duties and in connection with prior statements regarding
the Company’s past and expected future results of operations from November 8, 2011 to the present that have caused substantial
losses and damages to the Company.  We believe that this lawsuit is without merit and we intend to defend ourselves vigorously.

34













The Company and its former chairman and
chief executive officer have been responding to SEC subpoenas seeking, in general, documents related to June 2010 transactions
in Company common stock and a related Form 4 filing by our former chairman and chief executive officer that reported a purchase
of 54,745 shares of Company common stock, as well as certain emails that may have been deleted from his computer but were maintained
in the Company’s system.  We are cooperating with the SEC in its investigation, however, we cannot be certain of
the scope or outcome of the investigation.  Also, we have disagreements with our former chairman and chief executive
officer concerning amounts purportedly owed him under arrangements entered into prior to his departure from those roles earlier
this year.  It is uncertain whether those disagreements will be resolved or whether litigation may be filed.





The Audit Committee of our Board of Directors
has retained independent professional advisors in connection with an investigation it is directing in respect of certain transactions
that gave rise to impairments that have been taken by the Company as well as some of the foregoing issues.





ITEM
1A. RISK FACTORS.





You should carefully consider the risks
and uncertainties described below, as well as other information provided to you in this report, including information at the beginning
of this document entitled “Special Note Regarding Forward-Looking Information,” and in other documents that we subsequently
file with the SEC that update, supplement or supersede such information. The risks and uncertainties described below are not the
only ones facing us. Additional risks and uncertainties not presently known to us or which we consider immaterial based on information
currently available to us may also materially adversely affect us. If any of the events anticipated by the risks and uncertainties
described occur, our results of operations and financial condition could be adversely affected, which could result in a decline
in the market price of our common stock.



Risks Related to Our Business



We have a history of net losses which may continue and
which may negatively impact our ability to achieve our business objectives.



For
the six months ended June 30, 2012, we had revenue of $107,267 and a net loss of $175,961.There can be no assurance that,
even if our revenue increases, our future operations will result in net income. Our failure to increase our revenues or improve
our gross margins will harm our business. We may not be able to sustain or increase profitability on a quarterly or annual basis
in the future. If our revenues grow more slowly than we anticipate, our gross margins fail to improve or our operating expenses
exceed our expectations, our operating results will suffer. The prices we charge for our Internet software and services may decrease,
which would reduce our revenues and gross margins, and harm our business. If we are unable to sell our solutions at acceptable
prices relative to our costs, or if we fail to develop and introduce on a timely basis new products from which we can derive additional
revenues, our financial results will suffer.



Our ability to
raise equity financing in the near term may be limited.



We
may wish to attempt to sell additional shares of our common stock, and securities exercisable or convertible into shares of our
common stock, in the future to satisfy our capital and operating needs. If we sell shares in the future, the prices at which we
sell these future shares will vary, and these variations may be significant. Pursuant to the terms of a private placement of common
stock and warrants to four institutional investors that closed in May 2012 (the “May 2012 private placement”), as described
under "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources"
in Item 2 of Part I of this Form 10-Q, we have agreed not to make any offers or sales of any of our (or our subsidiaries') equity
or equity-equivalent securities in a subsequent placement until February 17, 2013, without the approval of the majority private
placement investor (subject to certain permitted offers and sales including the incurrence of non-convertible debt together with
warrants), or to file any new registration statement, other than as required by the May 2012 private placement, until September
13, 2012. Additionally, we are required to deliver to each May 2012 private placement investor a written notice of any proposed
issuance, sale or exchange of securities being offered in a subsequent placement through November 17, 2013, and offer to issue
and sell to or exchange with such private placement investors 25% of the offered securities. These agreements may make it more
difficult to obtain additional financing.

35









Our operations have limited histories and therefore we cannot
ensure the long-term successful operation of our business or the execution of our business plan.



Our prospects must be considered in light
of the risks, expenses and difficulties frequently encountered by growing companies in new and rapidly evolving markets, such as
the software and services markets in which we operate. We must meet many challenges including:



| | · | establishing
and maintaining broad market acceptance of our products and services and converting that acceptance into direct and indirect sources
of revenue;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | establishing
and maintaining adoption of our technology on a wide variety of platforms and devices;
| | - | ---------------------------------------------------------------------------------------------------



| | · | timely
and successfully developing new products, product features and services and increasing the functionality and features of existing
products and services;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | developing
services and products that result in high degrees of corporate client satisfaction and high levels of end-customer usage;
| | - | ------------------------------------------------------------------------------------------------------------------------------------



| | · | successfully
responding to competition, including competition from emerging technologies and solutions;
| | - | -------------------------------------------------------------------------------------------------------



| | · | developing
and maintaining strategic relationships to enhance the distribution, features, content and utility of our products and services;
and
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------



| | · | identifying,
attracting and retaining talented technical and creative services staff at reasonable compensation rates in the markets in which
we employ.
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------





Our business strategy may be unsuccessful and we may be unable
to address the risks we face in a cost-effective manner, if at all. If we are unable to successfully address these risks, our business
will be harmed.



Our resources may not be sufficient to manage our expected
growth; failure to properly manage our potential growth would be detrimental to our business.



We may fail to adequately manage our anticipated
future growth. Any growth in our operations will place a significant strain on our administrative, financial and operational resources,
and increase demands on our management and on our operational and administrative systems, controls and other resources. We cannot
assure you that our existing personnel, systems, procedures or controls will be adequate to support our operations in the future
or that we will be able to successfully implement appropriate measures consistent with our growth strategy. As part of this growth,
we may have to implement new operational and financial systems, procedures and controls to expand, train and manage our employee
base and maintain close coordination among our technical, accounting, finance, marketing and sales staff. We cannot guarantee that
we will be able to do so, or that if we are able to do so, we will be able to effectively integrate them into our existing staff
and systems. There may be greater strain on our systems mainly because we have acquired a number of businesses over the last three
years and have had to devote significant management time and expense to the ongoing integration and alignment of management, systems,
controls and marketing. To the extent we acquire other businesses, we will also need to integrate and assimilate new operations,
technologies and personnel. If we are unable to manage growth effectively, such as if our sales and marketing efforts exceed our
capacity to install, maintain and service our products or if new employees are unable to achieve performance levels, our business,
operating results and financial condition could be materially and adversely affected.



We may not have successfully integrated recent acquisitions
to realize the full benefits of the combined businesses.



Our recent acquisitions involve the integration
of businesses that have previously operated separately. The difficulties of combining the operations of these businesses include:



| | · | the
challenge of effecting technical and staff integration while carrying on the ongoing businesses;
| | - | ----------------------------------------------------------------------------------------------------



| | · | the
necessity of coordinating geographically separate organizations; and
| | - | ------------------------------------------------------------------------



| | · | effective
integration of personnel with diverse business backgrounds.
| | - | ---------------------------------------------------------------------





The process of completing the integration of these businesses
could cause an interruption of, or loss of momentum in, the activities of our company and the loss of key personnel. The multinational
nature of our operations can make it especially challenging to successfully integrate our recent acquisitions. The diversion of
management’s attention and any delays or difficulties encountered in connection with the acquisitions and the integration
of these operations could have an adverse effect on our business, financial condition or results of operations.

36







The market price of our common stock could be subject to
significant fluctuation in response to rumors or developments relating to possible transactions and ourstrategic transaction process.



As we have previously disclosed, we have
from time to time received expressions of interest concerning the possible purchase of our company. The company has not made a
decision to pursue a strategic transaction nor has it entered into any agreement with a prospective purchaser with regard to any
such transaction.





Our competitors may have greater financial and other resources
than we do and those advantages could make it difficult for us to compete with them.



The market for IP video content management
is relatively new and constantly changing. We expect that competition in this industry will intensify. Increased competition may
result in price reductions, reduced margins, loss of customers and changes in our business and marketing strategies, any of which
could harm our business. Current and potential competitors may have longer operating histories, greater name recognition, more
employees and significantly greater financial, technical, marketing, public relations and distribution resources than we do. In
addition, new competitors with potentially unique or more desirable products or services may enter the market at any time. The
competitive environment may require us to make changes in our products, pricing, licensing, services or marketing to maintain and
extend our current brand and technology. Price concessions or the emergence of other pricing, licensing and distribution strategies
or technology solutions of competitors may reduce our revenue, margins or market share. Other changes we have to make in response
to competition could cause us to expend significant financial and other resources, disrupt our operations, strain relationships
with partners, release products and enhancements before they are thoroughly tested or result in customer dissatisfaction, any of
which could harm our operating results and stock price.



If other market participants in the general video management
market enter into social media and IP-based VAMs (“video asset management systems”), we may be negatively impacted.



If dedicated firmware vendors were to enter
into our space, they may have longer operating histories, greater name recognition, more employees and greater financial, technical,
marketing, public relations and distribution resources than we do. The competitive environment may require us to make changes in
our products, pricing, licensing, services or marketing to maintain and extend our current brand and technology. Price concessions
or the emergence of other pricing, licensing and distribution strategies or technology solutions of competitors may reduce our
revenue, margins or market share. Other changes we have to make in response to competition could cause us to expend significant
financial and other resources, disrupt our operations, strain relationships with partners, release products and enhancements before
they are thoroughly tested or result in customer dissatisfaction, any of which could harm our operating results and stock price.





If we do not successfully develop new software products and
solutions, our business may be harmed.



Our business and operating results may be
harmed if we fail to expand our software and services suite (either through internal product or capability development initiatives
or through strategic partnerships and acquisitions) in such a way that achieves widespread market acceptance or that generates
significant revenue and gross profits to offset our operating and other costs. We may not successfully identify, develop and market
new product and service opportunities in a timely manner. If we introduce new products and services, they may not attain broad
market acceptance or contribute meaningfully to our revenue or profitability. Competitive or technological developments may require
us to make substantial, unanticipated investments in new products and technologies or in new strategic partnerships, and we may
not have sufficient resources to make these investments. Because the markets for our solutions are subject to rapid change, we
may need to expand and/or evolve our product and service offerings quickly. Delays and cost overruns could affect our ability to
respond to technological changes, evolving industry standards, competitive developments or customer requirements and harm our business
and operating results.

37







If we are unable to maintain or expand our direct sales capabilities,
we may not be able to generate anticipated revenues.



We rely primarily on our direct sales force
to sell a substantial portion of our software and services (although we also use channels and partnerships for sales). As of June
30, 2012, we had a team of approximately 120 dedicated sales and sales support professionals. We generally expand our sales
force to generate increased revenue from new customers. Failure to hire or retain qualified sales personnel may preclude us from
expanding our business and generating anticipated revenue. Competition for such personnel is intense, and there can be no assurance
that we will be able to retain our existing sales personnel or attract, assimilate or retain enough highly qualified sales personnel.
Certain companies with which we compete for experienced personnel may have greater resources than we have. New sales hires require
training and take time to achieve full productivity. If we experience high turnover in our sales force in the future, we cannot
be certain that new hires will become as productive as necessary to maintain or increase our revenue within anticipated timeframes.



Our business depends substantially on customers renewing
and upgrading their subscriptions for our services. Any decline in our customer renewals and upgrades would harm our future operating
results.



We typically maintain multi-year working
relationships with our customers. Most of our customer contracts cover multi-year periods and contain an automatic renewal clause;
however, optional notification of non-renewal is permitted to be given by customers at the end of the contract term. Maintaining
the renewal rate of our contracts is important to our future success. Our customers have no obligation to renew their relationship
with us after the expiration of the term of their agreements, and occasionally customers have elected not to do so. We cannot guarantee
that customer agreements will be renewed at the same pace as they have been previously. Our renewal rates, which have been very
high, may decline due to a variety of factors, including:



| | · | the
performance and functionality of the KIT Video Platform;
| | - | ------------------------------------------------------------



| | · | the
availability, price, performance and functionality of competing platforms and services;
| | - | -------------------------------------------------------------------------------------------



| | · | our
ability to demonstrate to new customers the value of our platform within initial contract terms;
| | - | ----------------------------------------------------------------------------------------------------



| | · | the
relative ease of moving to a competing software platform or service;
| | - | ------------------------------------------------------------------------



| | · | the
effects of economic downturns, including the current global economic recession; or
| | - | --------------------------------------------------------------------------------------



| | · | reductions in our
customers’ spending levels.
| | - | ---------------------------------------------





If our renewal rates are lower than anticipated or decline for
any reason, or if customers renew on terms less favorable to us, our revenue may be negatively impacted and our profitability and
gross margin may be harmed, which would have a material adverse effect on our business, results of operations and financial condition.





The average sales price of the KIT Video Platform or our
services may decrease, which may reduce our profitability.



Although we have been able to maintain or
increase our prices historically, the average sales price for the KIT Video Platform or our services may decline for a variety
of reasons, including competitive pricing pressures, a change in the mix of our services, anticipation of the introduction of new
solutions or promotional programs. Competition continues to increase in the market for end-to-end VAMS and related services and
we expect competition to further increase in the future, thereby leading to increased pricing pressures. We cannot assure you that
we will be successful maintaining our prices at levels that will allow us to reach profitability. Failure to maintain our prices
could have an adverse effect on our business, results of operations and financial condition.



Any failure of major elements of our system and operations
could lead to significant disruptions in our ability to serve customers, which could damage our reputation, reduce our revenues
or otherwise harm our business.



Our business is dependent upon providing
our customers with fast, efficient and reliable services. A reduction in the performance, reliability or availability of our network
infrastructure may harm our ability to distribute our software to our customers, as well as our reputation and ability to attract
and retain customers and content providers. Our systems and operations are susceptible to, and could be damaged or interrupted
by outages caused by fire, flood, power loss, telecommunications failure, Internet or mobile network breakdown, earthquake and
similar events. Our systems are also subject to human error, security breaches, power losses, computer viruses, break-ins, “denial
of service” attacks, sabotage, intentional acts of vandalism and tampering designed to disrupt our computer systems and network
communications. A sudden and significant increase in traffic on our customers’ websites or demand from mobile users could
strain the capacity of the software, hardware and telecommunications systems that we deploy or use. This could lead to slower response
times or system failures. Our failure to protect our network against damage from any of these events could harm our business.



Our operations also depend on web browsers,
ISPs (Internet service providers) and mobile networks to provide our clients’ end-users access to websites, IPTV (Internet
protocol television) and mobile content. Many of these providers have experienced outages in the past, and could experience outages,
delays and other difficulties due to system failures unrelated to our systems. Any such outage, delay or difficulty could adversely
affect our ability to effectively provide our software and services, which would harm our business.

38







Our success depends on our customers’ continued high-speed
access to the Internet and the continued reliability of the Internet infrastructure.



Our future sales growth depends on our customers’
high-speed access to the Internet, as well as the continued maintenance and development of the Internet infrastructure. The future
delivery of our services will depend on third-party Internet service providers to expand high-speed Internet access, to maintain
a reliable network with the necessary speed, data capacity and security, and to develop complementary products and services, including
high-speed modems, for providing reliable and timely Internet access and services. The success of our business depends directly
on the continued accessibility, maintenance and improvement of the Internet as a convenient means of customer interaction, as well
as an efficient medium for the delivery and distribution of information among businesses and by businesses to their employees.
All of these factors are out of our control. If for any reason the Internet does not remain a widespread communications medium
and commercial platform, the demand for our services would be significantly reduced, which would harm our business, results of
operations and financial condition.



To the extent that the Internet continues
to experience increased numbers of users, frequency of use or bandwidth requirements, the Internet may become congested and be
unable to support the demands placed on it, and its performance or reliability may decline. Any future Internet outages or delays
could adversely affect our ability to provide services to our customers, which could adversely affect our business.



We depend on various third parties to maintain much of our
content delivery, storage and computer hardware operations. If the third parties’ hardware or operations fail, our business
will be harmed.



A portion of our content delivery, storage
and computer hardware operations are operated or safeguarded by third parties such as Akamai Technologies, Equinix, Internap, Limelight,
RRSat, Satlink and various other content delivery and transport, hosting and telecommunications providers. If these providers’
operations, networks, hardware or security systems fail, particularly if they fail in unison,
our reputation and business may suffer. A problem with, or failure of, these systems or operations could result in interruptions
or increases in response times for our customers. If we cannot maintain our system in the event of unexpected occurrences, make
necessary modifications and/or improvements to the technology, such deficiencies could have a material adverse effect upon our
business, financial condition and results of operations.



We license technology from third parties. If we are unable
to maintain these licenses, our operations and financial condition may be negatively impacted.



We license technology from third parties.
The loss of, or our inability to maintain, these licenses could result in increased costs or delay sales of our software and services.
We anticipate that we will continue to license technology from third parties in the future. This technology may not continue to
be available on commercially reasonable terms, if at all. Although we do not believe that we are substantially dependent on any
individual licensed technology, some of the component technologies that we license from third parties could be difficult for us
to replace. The impairment of these third-party relationships, especially if this impairment were to occur in unison, could result
in delays in the delivery of our software and services until equivalent technology, if available, is identified, licensed and integrated.
This delay could adversely affect our operating results and financial condition.



Certain of our service delivery and content handling services
are subject to industry regulations, certifications and approvals.



The commercialization of certain of the
service delivery and content handling services we provide at times require or are made more costly due to industry acceptance and
regulatory processes, such as ISO certification and strict content security handling standards for Hollywood studios, such as those
required by the Motion Picture Association of America (MPAA). If we are unable to obtain or retain these or other formal and informal
industry certifications in a timely manner, or at all, our operating results could be adversely affected.



If we do not adequately protect our intellectual property
rights, we may experience a loss of revenue and our operations may be materially harmed.



Historically, we have not had a mandatory
practice of registering patents or copyrights on the software and technology we have developed. We believe our intellectual property
is better protected by the long-term usage precedent for our software solutions than by patent filings, and we rely upon confidentiality
agreements signed by our employees, consultants and third parties, and trade secret laws of general applicability, as an ongoing
safeguard for our software and technology. We cannot assure you that we can adequately protect our intellectual property or successfully
prosecute potential infringement of our intellectual property rights. Also, we cannot assure you that others will not assert rights
in, or ownership of, trademarks and other proprietary rights of ours or that we will be able to successfully resolve these types
of conflicts to our satisfaction. Our failure to protect our intellectual property rights may result in a loss of revenue and could
materially harm our operations and financial condition.

39







If we are found to infringe on the proprietary rights of
others, we could be required to redesign aspects of the KIT Video Platform, pay significant royalties or enter into license agreements
with third parties, which may significantly increase our costs or adversely affect our results of operations.



Although we believe that our core intellectual
property is protected by usage precedents that supersede the statute of limitation for copyright infringement claims in most jurisdictions
worldwide, a third-party may assert that our technology or services violates its intellectual property rights. Any claims, regardless
of their merit, could:



| | · | be
expensive and time-consuming to defend;
| | - | ------------------------------------------



| | · | force
us to temporarily or permanently stop providing services that incorporate the challenged intellectual property;
| | - | ---------------------------------------------------------------------------------------------------------------------



| | · | require
us to redesign our technology and services;
| | - | ---------------------------------------------------



| | · | divert
management’s attention and other company resources; and
| | - | --------------------------------------------------------------



| | · | require
us to enter into royalty or licensing agreements in order to obtain the right to use necessary technologies, which may not be available
on terms acceptable to us, if at all.
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





We may be subject to legal liability for providing third-party
content.



We have certain arrangements to offer third-party
content via certain of our clients’ websites. Although we believe we are in compliance with all legal requirements for content
use in all jurisdictions, we may be subject to claims concerning this content by virtue of our involvement in marketing, branding,
broadcasting or providing access to it, even if we do not ourselves host, operate or provide access to the content. While our agreements
with these parties most often provide that we will be indemnified against such liabilities, such indemnification may not be adequate
or available. Investigating and defending any of these types of claims can be expensive, even if the claims do not result in liability.
While to date we have not been subject to material claims, if any potential claims do result in liability, we could be required
to pay damages or other penalties, which could harm our business and operating results.



Fluctuations in foreign currency exchange rates affect our
operating results in U.S. dollar terms.



A portion of our revenues arises from international
operations. Revenues generated and expenses incurred by our international subsidiaries are often denominated in the currencies
of the local countries. While we seek to roughly match client revenues with associated costs of delivery and client service (“natural
hedging,” which is oriented to maximizing predictability of operating cash flow), our consolidated U.S. dollar financial
statements are subject to fluctuations due to changes in exchange rates as the financial results of our international subsidiaries
are translated from local currencies into U.S. dollars. In addition, our financial results are subject to changes in exchange rates
that impact the settlement of transactions in non-local currencies.



A significant portion of our operations is conducted through
our subsidiaries, and we therefore rely on our subsidiaries to make funds available to us.



A significant portion of our operations
is conducted through our subsidiaries. We, therefore, will be dependent upon the receipt of dividends or other distributions from
our subsidiaries. The declaration of dividends by our subsidiaries will be subject to the discretion of their boards of directors
and will depend on a number of factors, including their results of operations, financial condition, liquidity requirements and
indebtedness and restrictions imposed by applicable law. Our inability to receive funds from our operating subsidiaries would adversely
affect our ability to meet our obligations and to make dividend payments and other distributions, if any, to holders of our common
stock.



Our operating results may fluctuate from quarter to quarter,
which could make them difficult to predict.



Our quarterly operating results are tied
to certain financial and operational metrics that have fluctuated in the past and may fluctuate significantly in the future. As
a result, you should not rely upon our past quarterly operating results as indicators of future performance.



Our operating results depend on numerous
factors, many of which are outside of our control. In addition to the other risks described in this “Risk
Factors section, the following risks could cause our operating results to fluctuate:



| | · | our
ability to retain existing customers and attract new customers;
| | - | -------------------------------------------------------------------



| | · | the
mix of annual and monthly customers at any given time;
| | - | ----------------------------------------------------------



| | · | the
timing and amount of costs of new and existing marketing and advertising efforts;
| | - | -------------------------------------------------------------------------------------



| | · | the
timing and amount of operating costs and capital expenditures relating to expansion of our business, operations and infrastructure;
| | - | ---------------------------------------------------------------------------------------------------------------------------------------





40







| | · | the
cost and timing of the development and introduction of new product and service offerings by us or our competitors; and
| | - | --------------------------------------------------------------------------------------------------------------------------



| | · | system
or service failures, security breaches or network downtime.
| | - | ------------------------------------------------------------------







We may be required to record a significant charge to earnings
if our goodwill or amortizable intangible assets become impaired.



We are required under U.S. generally accepted
accounting principles to test goodwill for impairment at least annually and to review our amortizable intangible assets for impairment
when events or changes in circumstance indicate the carrying value may not be recoverable. Factors that could lead to impairment
of goodwill and amortizable intangible assets include asignificant decline in market capitalization,
which we experienced in the second quarter ended June 30, 2012. We recognized a non-cash impairment charge of $55,718 in the second
quarter of 2012. We may be required in the future to record additional charges to earnings if a portion of our goodwill
or amortizable intangible assets becomes impaired. Any such charge would adversely impact our financial results.



Our international operations are subject to increased risks,
which could harm our business, operating results and financial condition.



In addition to uncertainty about our ability
to continue to generate revenues from our foreign operations and expand our international market position, there are risks inherent
in doing business internationally, including:



| | · | trade
barriers and changes in trade regulations;
| | - | ------------------------------------------------



| | · | difficulties
in developing, staffing and simultaneously managing a large number of varying foreign operations as a result of distance, language
and cultural differences;
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | · | the
need to comply with varied local laws and regulations;
| | - | ----------------------------------------------------------



| | · | longer payment cycles;
| | - | ----------------------



| | · | possible
credit risk and higher levels of payment fraud;
| | - | --------------------------------------------------------



| | · | import or export regulations;
| | - | -----------------------------



| | · | compliance
with U.S. laws (such as the Foreign Corrupt Practices Act) and local laws prohibiting corrupt payments to government officials;
| | - | ------------------------------------------------------------------------------------------------------------------------------------------



| | · | laws
and business practices that favor local competitors or prohibit foreign ownership of certain businesses; and
| | - | -----------------------------------------------------------------------------------------------------------------



| | · | different
and more stringent user protection, data protection, privacy and other laws.
| | - | --------------------------------------------------------------------------------------





Violations of complex foreign and U.S. laws and regulations
that apply to our international operations could result in fines, criminal sanctions against us, our officers or our employees,
prohibitions on the conduct of our business and damage to our reputation.



Although we have implemented policies and
procedures designed to promote compliance with these laws, there can be no assurance that our employees, contractors or agents
will not violate our policies. These risks inherent in our international operations and expansion increase our costs of doing business
internationally and could result in harm to our business, operating results and financial condition.



If we fail to maintain proper and effective internal controls
in the future, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating
results, investors’ views of our company and, as a result, the value of our common
stock.



Ensuring that we have effective internal
control over financial reporting and disclosure controls and procedures in place is a costly and time-consuming effort that needs
to be frequently evaluated. As a public company, we conduct an annual management assessment of the effectiveness of our internal
controls over financial reporting and receive a report from our independent registered public accounting firm addressing the effectiveness
of our internal controls over financial reporting for compliance with Section 404 of the Sarbanes-Oxley Act of 2002. If we are
not able to comply with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002, or if we or our independent registered
public accounting firm identify ongoing deficiencies in our internal controls over financial reporting that could rise to the level
of a material weakness, we may not be able to complete our evaluation, testing and any required remediation in a timely fashion.
During the evaluation and testing process, if we identify one or more material weaknesses in our internal controls over financial
reporting, we will be unable to assert that our internal controls over financial reporting are effective. If we are unable to assert
that our internal controls over financial reporting are effective, or if our independent registered public accounting firm is unable
to express an opinion on the effectiveness of our internal controls over financial reporting, we could be subject to investigations
or sanctions by the U.S. Securities and Exchange Commission or other regulatory authorities, and we could lose investor confidence
in the accuracy and completeness of our financial reports, which could cause an adverse effect on the market price of our common
stock, our business, reputation, financial position and results of operation. In addition, we could be required to expend significant
management time and financial resources to correct any material weaknesses that may be identified or to respond to any regulatory
investigations or proceedings.

41







We have had a material weakness in internal control over
financial reporting in the past and cannot assure you that additional material weaknesses will not be identified in the future.
Our failure to implement and maintain effective internal control over financial reporting could result in material misstatements
in our financial statements which could require us to restate financial statements, cause investors to lose confidence in our reported
financial information and have a negative effect on our stock price.



During theyear ended December 31, 2011,
management identified a material weakness in our internal controls over financial reporting as defined in the Public Company Accounting
Oversight Board’s Auditing Standard No. 5. While we have significantly improved our internal controls over financial reporting, our disclosure controls and procedures were
still not effective as of June 30, 2012 with respect to such material weakness.We cannot assure you that additional significant
deficiencies or material weaknesses in our internal control over financial reporting will not be identified and
persistin the future. Any failure to maintain or implement required new or improved controls, or any difficulties we encounter
in their implementation, could result in additional significant deficiencies or material weaknesses, cause us to fail to meet our
periodic reporting obligations or result in material misstatements in our financial statements. Any such failure could also adversely
affect the results of periodic management evaluations and annual auditor attestation reports regarding the effectiveness of our
internal control over financial reporting required under Section 404. The existence of a material weakness could result in our
financial statements that could result in a restatement of financial statements, cause us to fail to meet our reporting obligations
and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.



Our use of "open source" software could negatively
affect our ability to sell our services and subject us to possible litigation.



A small portion of the technology licensed
by us incorporates "open source" software, and we may incorporate open source software in the future. Such open source
software is generally licensed by its authors or other third parties under open source licenses. If we fail to comply with these
licenses, we may be subject to certain conditions, including requirements that we offer our services that incorporate the open
source software for no cost, that we make available source code for modifications or derivative works we create based upon, incorporating
or using the open source software and that we license such modifications or alterations under the terms of the particular open
source license. If an author or other third party that distributes such open source software were to allege that we had not complied
with the conditions of one or more of these licenses, we could be required to incur legal expenses defending against such allegations
and could be subject to damages, enjoined from the sale of our services that contained the open source software and required to
comply with the foregoing conditions, which could disrupt the distribution and sale of some of our services.



Unfavorable results
of legal proceedings, disputes, and investigations could harm our business and result in substantial costs.



We
are involved in various legal proceedings, disputes and investigations, including those described under “Legal Proceeding”
in Item 1 of Part II of this Form 10-Q. Additional legal claims or regulatory matters may arise in the future, including as a result
of such ongoing disputes and investigations. Litigation is inherently unpredictable. Regardless of the merit of the claims, litigation
may be costly, time consuming and disruptive to our business. Therefore, we could incur judgments or enter into settlements of
claims that could adversely affect our business, operating results or cash flows. We may also become subject to costly indemnification
obligations to current and former officers, directors or employees, which may not be covered by insurance.



Risks Related to Our Common Stock



Our historic stock price has been volatile and the future
market price for our common stock is likely to continue to be volatile.



The public market for our common stock has
historically been volatile. Any future market price for our shares is likely to continue to be volatile. This price volatility
may make it more difficult for you to sell shares when you want at prices you find attractive. The stock market in general has
experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance
of specific companies. Broad market factors and the investing public’s negative perception of our business may reduce our
stock price, regardless of our operating performance. Further, the market for our common stock is limited and we cannot assure
you that a larger market will ever be developed or maintained.



Shares of common stock issuable upon exercise of our outstanding
stock options, restricted stock awards and warrants may adversely affect the market price of our common stock.



As of June
30, 2012, we had outstanding under our 2004 Stock Option Plan and 2008 Incentive Stock Plan stock options to purchase 5,820,194
shares of common stock and 2,114,772 of  restricted stock awards, and outstanding warrants to purchase 6,688,549
shares of common stock. The issuance of common stock pursuant to the stock options, restricted stock awards and warrants would reduce
a stockholder’s percentage voting and ownership interest in our company. The stock options and warrants are likely to be
exercised when our common stock is trading at a price that is higher than the exercise price of these stock options and warrants.

42







Future sales of
our common stock issued and issuable in connection with our May 2012 private placement may depress the market price of our common
stock and make it difficult to raise additional equity capital.



The
market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public
market. On May 18, 2012, pursuant to a Securities Purchase Agreement dated as of May 15, 2012, we issued 7,000,000 shares of
common stock and warrants to purchase 5,250,000 shares of common stock to four institutional investors. We also agreed to
issue certain additional shares of our common stock, if and to the extent the trading price of our common stock is below
certain levels on specified dates. We are obligated to issue an additional 2,588,427 shares of common stock to those
investors and approximately $3,000 in cash. All of the shares are freely tradeable. The terms of the Securities Purchase
Agreement and the warrants, including the dilution adjustment provision in the Securities Purchase Agreement which expires if
our registration statement on behalf of the investor remains effective until October 12, 2012, and full-ratchet
dilution provision in the warrants which reduces the exercise price but does not increase the underlying number of shares,
may make it difficult for us to raise additional equity capital consistent with prevailing market terms in the near term, if
at all, while these provisions are effective.



If equity research analysts do not publish research or reports
about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.



The trading market for our common stock
relies in part on the research and reports that equity research analysts publish about us and our business. We do not control these
analysts. The price of our common stock could decline if one or more equity analysts downgrade our common stock or if analysts
issue other unfavorable commentary or cease publishing reports about us or our business.



We have provisions in our certificate of incorporation that
substantially eliminate the personal liability of members of our board of directors for violations of their fiduciary duty of care
as a director and that allow us to indemnify our officers and directors. This could make it very difficult for you to bring any
legal actions against our directors for such violations or could require us to pay any amounts incurred by our directors in any
such actions.



Pursuant to our certificate of incorporation,
members of our board of directors will have no liability for violations of their fiduciary duty of care as a director, except in
limited circumstances. This means that you may be unable to prevail in a legal action against our directors even if you believe
they have breached their fiduciary duty of care. In addition, our certificate of incorporation allows us to indemnify our directors
from and against any and all expenses or liabilities arising from or in connection with their serving in such capacities with us.
This means that if you were able to enforce an action against our directors or officers, in all likelihood we would be required
to pay any expenses they incurred in defending the lawsuit and any judgment or settlement they otherwise would be required to pay.



Provisions of Delaware law and our charter documents could
delay or prevent an acquisition of our company, even if the acquisition would be beneficial to our stockholders, and could make
it more difficult for you to change management.



Provisions of Delaware law and our certificate
of incorporation, as amended, and by-laws, as amended, may discourage, delay or prevent a merger, acquisition or other change in
control that stockholders may consider favorable, including transactions in which stockholders might otherwise receive a premium
for their shares. These provisions may also prevent or delay attempts by stockholders to replace or remove our current management
or members of our board of directors. These provisions include:



| | · | advance
notice requirements for stockholder proposals and nominations;
| | - | ----------------------------------------------------------------------



| | · | limitations
on the ability of stockholders to call special meetings; and
| | - | ------------------------------------------------------------------------



| | · | the
ability of our board of directors to adopt, amend or repeal our by-laws.
| | - | ----------------------------------------------------------------------------







In addition, we are subject to the provisions of Section 203
of the Delaware General Corporation Law, which limits business combination transactions with stockholders of 15% or more of our
outstanding voting stock that our board of directors has not approved. These provisions and other similar provisions make it more
difficult for stockholders or potential acquirers to acquire us without negotiation. These provisions may apply even if some stockholders
may consider the transaction beneficial to them.



As a result, these provisions could limit the price that investors
are willing to pay in the future for shares of our common stock. These provisions might also discourage a potential acquisition
proposal or tender offer, even if the acquisition proposal or tender offer is at a premium over the then current market price for
our common stock.

43







Our officers and directors have significant voting power
and may take actions that may not be in the best interests of other stockholders.



Our executive officers and directors currently
beneficially own 15% of our common stock. If these stockholders act together, they will be able to exert significant control over
our management and affairs requiring stockholder approval, including approval of significant corporate transactions. This concentration
of ownership may have the effect of delaying or preventing a change in control and might adversely affect the market price of our
common stock. This concentration of ownership may not be in the best interests of all of our stockholders.



We do not anticipate paying dividends in the foreseeable
future.



We currently intend to retain our future
earnings to support operations and to finance expansion and, therefore, we do not anticipate paying any cash dividends on our capital
stock in the foreseeable future. Additionally, under our term loan, we may not pay cash dividends on our common stock without the
consent of the lender. You should not buy our stock if you are expecting to receive cash dividends.







ITEM
2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.



None



ITEM
3. DEFAULTS UPON SENIOR SECURITIES.



None



ITEM
4. MINE SAFETY DISCLOSURES



None



ITEM
5. OTHER INFORMATION.



None



ITEM
6. EXHIBITS.



|Exhibit No. |  | Description                                                                                        
|----------- |  | ---------------------------------------------------------------------------------------------------
|31.1        |  | Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                    
|31.2        |  | Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                    
|32.1        |  | Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|            |  |                                                                                                    
|32.2        |  | Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.





44







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.



|                        | KIT DIGITAL, INC. |                                                              
|----------------------- | ----------------- | -------------------------------------------------------------
|                        |                   |                                                              
|Dated:  August 14, 2012 | By:               | /s/ Barak Bar-Cohen                                          
|                        |                   | Barak Bar-Cohen                                              
|                        |                   | Chief Executive Officer
        (principal executive officer)





|Dated:  August 14, 2012 | By: | /s/ Fabrice Hamaide                                                          | 
|----------------------- | --- | ---------------------------------------------------------------------------- | 
|                        |     | Fabrice Hamaide                                                              | 
|                        |     | Chief Financial Officer
        (principal financial and accounting officer)





45