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 March 31, 2010





OR




 ̈
            TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the transition period from __________ to __________





Commission file number
001-34437




KIT digital,
Inc.


(Exact
Name of Registrant as Specified in Its Charter)




Delaware
            11-3447894(State
      or Other Jurisdiction of
            (I.R.S.
      EmployerIncorporation
      or Organization)
            Identification
      No.)205 Hudson Street, Suite
      802, New York, New York
            10013(Address
      of Principal Executive Offices)
            (Zip
      Code)





+1 (212)
661-4111


(Registrant’s
Telephone Number, Including Area Code)




Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x
  No  ̈





Indicate
by check mark whether the registrant 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).    Yes    ̈
  No  ̈ (not
required)




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
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):




Large
      Accelerated Filer  ̈
            Accelerated
      Filer  ̈Non-accelerated
      Filer  ̈
            Smaller
      Reporting Company x





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


Yes  ̈
  No x





As of May
17, 2010, there were 23,106,183 shares of the registrant’s common stock
outstanding.












KIT
digital, Inc.




TABLE OF
CONTENTS





PagePART
      I - FINANCIAL INFORMATIONItem
      1.
                Financial
      Statements
                2Consolidated
      Balance Sheets - As of March 31, 2010 (unaudited) and December 31,
      2009
                2Consolidated
      Statements of Operations and Comprehensive Income (Loss) - For the three
      ended March 31, 2010 and 2009 (unaudited)
                3Consolidated
      Statements of Stockholders’ Equity - For the three months ended March 31,
      2010 (unaudited)
                4Consolidated
      Statements of Cash Flows - For the three months ended March 31, 2010 and
      2009 (unaudited)
                5Notes
      to Consolidated Financial Statements (unaudited)
                7Item
2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
                20Item 3.
                Quantitative
      and Qualitative Disclosures About Market Risk
                25Item 4T.
                Controls
      and Procedures
                25PART II - OTHER INFORMATIONItem 1.
                Legal
      Proceedings
                26Item 1A.
                Risk
      Factors
                26Item 2.
                Unregistered
      Sales of Equity Securities and Use of Proceeds
                26Item 3.
                Defaults
      Upon Senior Securities
                26Item 4.
                Reserved
                26Item 5.
                Other
      Information
                26Item 6.
                Exhibits
                26SIGNATURES
                27












PART
I - FINANCIAL INFORMATION


Item
1.  Financial Statements




KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


(Amounts in Thousands, Except Share
Data)





March
      31, 2010
                                    
                                    
                                    December
      31, 2009 (A)(Unaudited)Assets:Current
      assets:Cash
      and cash equivalents
                                    
                                    $
                                    37,823
                                    
                                    
                                    $
                                    6,791Investments
                                    
                                    
                                    986
                                    
                                    
                                    
                                    217Accounts
      receivable, net
                                    
                                    
                                    24,253
                                    
                                    
                                    
                                    17,258Unbilled
      revenue
                                    
                                    
                                    2,336
                                    
                                    
                                    
                                    2,960Inventory
                                    
                                    
                                    641
                                    
                                    
                                    
                                    708Other
      current assets
                                    
                                    
                                    2,574
                                    
                                    
                                    
                                    2,205Total
      current assets
                                    
                                    
                                    68,613
                                    
                                    
                                    
                                    30,139Property
      and equipment, net
                                    
                                    
                                    6,632
                                    
                                    
                                    
                                    5,697Software,
      net
                                    
                                    
                                    3,282
                                    
                                    
                                    
                                    3,436Customer
      list, net
                                    
                                    
                                    5,880
                                    
                                    
                                    
                                    4,650Goodwill
                                    
                                    
                                    57,022
                                    
                                    
                                    
                                    36,492Total
      assets
                                    
                                    $
                                    141,429
                                    
                                    
                                    $
                                    80,414Liabilities
      and Stockholders' Equity:Current
      liabilities:Bank
      overdraft
                                    
                                    $
                                    1,199
                                    
                                    
                                    $
                                    1,623Capital
      lease and other obligations
                                    
                                    
                                    1,231
                                    
                                    
                                    
                                    1,218Secured
      loans payable
                                    
                                    
                                    266
                                    
                                    
                                    
                                    1,321Accounts
      payable
                                    
                                    
                                    12,550
                                    
                                    
                                    
                                    6,647Accrued
      expenses
                                    
                                    
                                    9,701
                                    
                                    
                                    
                                    8,501Income
      tax payable
                                    
                                    
                                    308
                                    
                                    
                                    
                                    312Deferred
      tax liability
                                    
                                    
                                    580
                                    
                                    
                                    
                                    580Acquisition
      liability – Visual
                                    
                                    
                                    1,075
                                    
                                    
                                    
                                    1,075Derivative
      liability
                                    
                                    
                                    6,760
                                    
                                    
                                    
                                    21,314Warrant
      buyback liability
                                    
                                    
                                    22,232
                                    
                                    
                                    
                                    -Other
      current liabilities
                                    
                                    
                                    2,957
                                    
                                    
                                    
                                    3,455Total
      current liabilities
                                    
                                    
                                    58,859
                                    
                                    
                                    
                                    46,046Capital
      lease and other obligations, net of current
                                    
                                    
                                    441
                                    
                                    
                                    
                                    377Total
      liabilities
                                    
                                    
                                    59,300
                                    
                                    
                                    
                                    46,423Equity:Stockholders'
      equity:Common
      stock, $0.0001 par value: authorized 30,000,000 shares; issued and
      outstanding 17,615,946 and 10,844,853, respectively
                                    
                                    
                                    2
                                    
                                    
                                    
                                    1Additional
      paid-in capital
                                    
                                    
                                    195,205
                                    
                                    
                                    
                                    128,263Accumulated
      deficit
                                    
                                    
                                    (112,385
                                    )
                                    
                                    
                                    (93,943
                                    )Accumulated
      other comprehensive loss
                                    
                                    
                                    (693
                                    )
                                    
                                    
                                    (330
                                    )Total
      stockholders' equity
                                    
                                    
                                    82,129
                                    
                                    
                                    
                                    33,991Total
      liabilities and stockholders’ equity
                                    
                                    $
                                    141,429
                                    
                                    
                                    $
                                    80,414




(A) -
Reference is made to the Company’s Annual Report on Form 10-K for the year ended
December 31, 2009, filed with the U.S. Securities and Exchange Commission on
April 5, 2010.




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





2




KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)


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


(Unaudited)





Three
      months endedMarch
      31,2010
                                      
                                      
                                      2009Revenue
                                      
                                      $
                                      17,364
                                      
                                      
                                      $
                                      9,624Variable
      and direct third party costs:Cost
      of goods and services
                                      
                                      
                                      4,352
                                      
                                      
                                      
                                      3,478Hosting,
      delivery and reporting
                                      
                                      
                                      1,074
                                      
                                      
                                      
                                      282Content
      costs
                                      
                                      
                                      235
                                      
                                      
                                      
                                      461Direct
      third party creative production costs
                                      
                                      
                                      890
                                      
                                      
                                      
                                      805Total
      variable and direct third party costs
                                      
                                      
                                      6,551
                                      
                                      
                                      
                                      5,026Gross
      profit
                                      
                                      
                                      10,813
                                      
                                      
                                      
                                      4,598General
      and administrative expenses:Compensation,
      travel and associated costs (including non-cash stock-based compensation
      of $552 and $280, respectively)
                                      
                                      
                                      5,650
                                      
                                      
                                      
                                      3,693Legal,
      accounting, audit and other professional service fees
                                      
                                      
                                      690
                                      
                                      
                                      
                                      270Office,
      marketing and other corporate costs
                                      
                                      
                                      2,064
                                      
                                      
                                      
                                      717Merger
      and acquisition and investor relations expenses
                                      
                                      
                                      1,219
                                      
                                      
                                      
                                      378Depreciation
      and amortization
                                      
                                      
                                      1,654
                                      
                                      
                                      
                                      683Restructuring
      charges
                                      
                                      
                                      3,693
                                      
                                      
                                      
                                      119Integration
      expenses
                                      
                                      
                                      2,921
                                      
                                      
                                      
                                      244Total
      general and administrative expenses
                                      
                                      
                                      17,891
                                      
                                      
                                      
                                      6,104Loss
      from operations
                                      
                                      
                                      (7,078
                                      )
                                      
                                      
                                      (1,506
                                      )Interest
      income
                                      
                                      
                                      1
                                      
                                      
                                      
                                      1Interest
      expense
                                      
                                      
                                      (92
                                      )
                                      
                                      
                                      (139
                                      )Amortization
      of deferred financing costs and debt discount
                                      
                                      
                                      -
                                      
                                      
                                      
                                      (164
                                      )Derivative
      (expense) income
                                      
                                      
                                      (11,443
                                      )
                                      
                                      
                                      10,176Other
      income
                                      
                                      
                                      184
                                      
                                      
                                      
                                      29Net
      income (loss) before income taxes
                                      
                                      
                                      (18,428
                                      )
                                      
                                      
                                      8,397Income
      tax expense
                                      
                                      
                                      (14
                                      )
                                      
                                      
                                      (3
                                      )Net
      income (loss) available to common shareholders
                                      
                                      $
                                      (18,442
                                      )
                                      
                                      $
                                      8,394Basic
      net income (loss) per common share
                                      
                                      $
                                      (1.33
                                      )
                                      
                                      $
                                      1.96Diluted
      net income (loss) per common share
                                      
                                      $
                                      (1.33
                                      )
                                      
                                      $
                                      1.88Basic
      weighted average common shares outstanding
                                      
                                      
                                      13,878,912
                                      
                                      
                                      
                                      4,289,630Diluted
      weighted average common shares outstanding
                                      
                                      
                                      13,878,912
                                      
                                      
                                      
                                      4,473,679Comprehensive
      income (loss):Net
      income (loss)
                                      
                                      $
                                      (18,442
                                      )
                                      
                                      $
                                      8,394Foreign
      currency translation
                                      
                                      
                                      (432
                                      )
                                      
                                      
                                      (37
                                      )Change
      in unrealized gain on investments, net
                                      
                                      
                                      69
                                      
                                      
                                      
                                      -Comprehensive
      income (loss):
                                      
                                      $
                                      (18,805
                                      )
                                      
                                      $
                                      8,357




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


3





KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY


(Amounts in Thousands, Except Share
Data)




Common
                          Stock
                        
                        
                        Common
                          Stock
                          Par
      Value
                        
                        
                        Additional
                          Paid-in
                          CapitalBalance
      – December 31, 2009
                        
                        
                        10,844,853
                        
                        
                        $
                        1
                        
                        
                        $
                        128,263Issue
      of stock in public offerings, net
                        
                        
                        5,102,868
                        
                        
                        
                        1
                        
                        
                        
                        48,486Issue
      of stock for exercise of stock options
                        
                        
                        7,622
                        
                        
                        
                        —
                        
                        
                        
                        41Issue
      of stock for exercise of warrants
                        
                        
                        308,007
                        
                        
                        
                        —
                        
                        
                        
                        4,056Issue
      of stock for acquisitions
                        
                        
                        1,312,034
                        
                        
                        
                        —
                        
                        
                        
                        13,120Issue
      of warrants for services
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        451Issue
      of stock for compensation
                        
                        
                        16,500
                        
                        
                        
                        —
                        
                        
                        
                        190Issue
      of stock for services
                        
                        
                        24,062
                        
                        
                        
                        —
                        
                        
                        
                        236Stock-based
      compensation
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        362Foreign
      currency translation adjustment
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Fair
      market value adjustment for available for sale securities
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Net
      loss
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —Balance
      – March 31, 2010
                        
                        
                        17,615,946
                        
                        
                        $
                        2
                        
                        
                        $
                        195,205




Accumulated
                          (Deficit)
                        
                        
                        Accumulated
                          Other
                          Comprehensive
                          Income
                          (Loss)
                        
                        
                        Total
                          Shareholders’
                          EquityBalance
      – December 31, 2009
                        
                        $
                        (93,943
                        )
                        
                        $
                        (330
                        )
                        
                        $
                        33,991Issue
      of stock in public offerings, net
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        48,487Issue
      of stock for exercise of stock options
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        41Issue
      of stock for exercise of warrants
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        4,056Issue
      of stock for acquisitions
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        13,120Issue
      of warrants for services
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        451Issue
      of stock for compensation
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        190Issue
      of stock for services
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        236Stock-based
      compensation
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        362Foreign
      currency translation adjustment
                        
                        
                        —
                        
                        
                        
                        (432
                        )
                        
                        
                        (432
                        )Fair
      market value adjustment for available for sale securities
                        
                        
                        —
                        
                        
                        
                        69
                        
                        
                        
                        69Net
      loss
                        
                        
                        (18,442
                        )
                        
                        
                        —
                        
                        
                        
                        (18,442
                        )Balance
      – March 31, 2010
                        
                        $
                        (112,385
                        )
                        
                        $
                        (693
                        )
                        
                        $
                        82,129




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





4





KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Amounts
in Thousands)


(Unaudited)







Three
      months ended March 31,2010
                              
                              
                              2009Operating
      Activities:Net
      (loss) income
                              
                              $
                              (18,442
                              )
                              
                              $
                              8,394Adjustments
      to reconcile net (loss) income to net cash used by operating
      activities:Provision
      for doubtful accounts
                              
                              
                              84
                              
                              
                              
                              57Depreciation
                              
                              
                              927
                              
                              
                              
                              279Amortization
      of intangible assets
                              
                              
                              727
                              
                              
                              
                              404Amortization
      of deferred financing costs
                              
                              
                              -
                              
                              
                              
                              26Amortization
      of debt discount
                              
                              
                              -
                              
                              
                              
                              138Derivative
      expense (income)
                              
                              
                              11,443
                              
                              
                              
                              (10,176
                              )Non-cash
      stock based compensation
                              
                              
                              552
                              
                              
                              
                              407Non-cash
      warrants for services
                              
                              
                              451
                              
                              
                              
                              -Non-cash
      stock for services
                              
                              
                              235
                              
                              
                              
                              -Changes
      in assets and liabilities:Accounts
      receivable
                              
                              
                              (6,828
                              )
                              
                              
                              (799
                              )Unbilled
      revenue
                              
                              
                              553
                              
                              
                              
                              -Inventories
                              
                              
                              49
                              
                              
                              
                              1,042Other
      assets
                              
                              
                              (181
                              )
                              
                              
                              (1,430
                              )Accounts
      payable
                              
                              
                              4,439
                              
                              
                              
                              874Accrued
      expenses
                              
                              
                              1,030
                              
                              
                              
                              1,207Income
      tax payable
                              
                              
                              (11
                              )
                              
                              
                              -Other
      liabilities
                              
                              
                              (967
                              )
                              
                              
                              (1,585
                              )Total
      adjustments
                              
                              
                              12,503
                              
                              
                              
                              (9,556
                              )Net
      cash used by operating activities - forward
                              
                              
                              (5,939
                              )
                              
                              
                              (1,162
                              )Investing
      Activities:Release
      of restricted cash
                              
                              
                              -
                              
                              
                              
                              -Cash
      paid into investment
                              
                              
                              (700
                              )
                              
                              
                              (200
                              )Cash
      paid in acquisition of Visual
                              
                              
                              -
                              
                              
                              
                              (180
                              )Cash
      paid in acquisition of Multicast
                              
                              
                              (4,746
                              )
                              
                              
                              -Cash
      received in acquisition of Multicast
                              
                              
                              396
                              
                              
                              
                              -Purchase
      of equipment
                              
                              
                              (310
                              )
                              
                              
                              (1,512
                              )Net
      cash used by investing activities - forward
                              
                              $
                              (5,360
                              )
                              
                              $
                              (1,892
                              )





5




KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS (continued)


(Amounts
in Thousands)


(Unaudited)




Three
      months ended March 31,2010
                              
                              
                              2009Net
      cash used by operating activities - forwarded
                              
                              $
                              (5,939
                              )
                              
                              $
                              (1,162
                              )Net
      cash used by investing activities - forward
                              
                              
                              (5,360
                              )
                              
                              
                              (1,892
                              )Financing
      Activities:Proceeds
      from public offering, net
                              
                              
                              48,487
                              
                              
                              
                              -Proceeds
      from exercise of stock options
                              
                              
                              41
                              
                              
                              
                              25Proceeds
      from exercise of warrants
                              
                              
                              1,448
                              
                              
                              
                              -Payments
      for warrant buybacks
                              
                              
                              (1,158
                              )
                              
                              
                              -Bank
      overdraft and other obligations
                              
                              
                              (386
                              )
                              
                              
                              (2
                              )Payments
      of Secured Notes
                              
                              
                              (1,020
                              )
                              
                              
                              (67
                              )Repayments
      of Notes Payable
                              
                              
                              (4,500
                              )
                              
                              
                              -Payment
      on capital leases
                              
                              
                              (261
                              )
                              
                              
                              (126
                              )Net
      cash (used) provided by financing activities
                              
                              
                              42,651
                              
                              
                              
                              (170
                              )Effect
      of exchange rate changes on cash
                              
                              
                              (320
                              )
                              
                              
                              (129
                              )Net
      increase (decrease) in cash and cash equivalents
                              
                              
                              31,032
                              
                              
                              
                              (3,353
                              )Cash
      and cash equivalents - beginning of period
                              
                              
                              6,791
                              
                              
                              
                              5,878Cash
      and cash equivalents - end of period
                              
                              $
                              37,823
                              
                              
                              $
                              2,525Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Income
      taxes
                              
                              $
                              -
                              
                              
                              $
                              -Interest
                              
                              $
                              92
                              
                              
                              $
                              139





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)
Basis of Presentation




KIT
digital, Inc. ("we," "us," "our," the "Company" or "KIT digital"), through our
operating subsidiaries, provides enterprise clients an end-to-end technology
platform for managing Internet Protocol (“IP”)-based video assets across the
browser, mobile device and IPTV set-top box-enabled television set. We offer
creative interface design, branding, strategic planning and technical
integration services to complement our “VX”-branded software platform. Our
solutions includes the delivery of IP video software solutions, including
software-as-a-service (“SaaS”) fees, enterprise license fees, software usage
fees, set-up/support services, storage, hardware components, content delivery,
content syndication, and advertising-based monetization. Our solutions also
include technical integration services, interface design, branding, strategic
planning, creative production, online marketing, media planning and
analytics.





On March
6, 2009, we filed a certificate of amendment of our certificate of incorporation
to (i) effect a 1-for-35 reverse stock split of our common stock; (ii) decrease
the total number of shares of common stock authorized to be issued from
500,000,000 shares to 30,000,000 shares; and (iii) eliminate the authorization
of a class of preferred stock.  The changes made by the certificate of
amendment were effective on March 9, 2009, and per share amounts in the
accompanying financial statements have been adjusted for the reverse stock
split.  On August 13, 2009, our common stock began trading on the
NASDAQ Global Market exchange under the ticker symbol “KITD.” Previously, our
ticker symbol was “KDGL”, as quoted on the OTC Bulletin Board.





The
accompanying unaudited consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and the instructions to Form 10-Q and Article 8 of Regulation S-X.
Accordingly, they do not include all information and footnotes required by
general accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring adjustments)
necessary to present fairly the financial position at March 31, 2010 and the
results of operations and comprehensive income (loss), stockholders’ equity and
cash flows for all periods presented. The consolidated results of operations for
the three months ended March 31, 2010 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2010. These
interim consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto of the Company included
in our annual report on Form 10-K for the year ended December 31,
2009.







(2)
Summary of Significant Accounting Policies





Principles of
Consolidation - Our consolidated financial statements include the
accounts of KIT digital, Inc., and all its wholly-owned and majority-owned
subsidiaries. All significant intercompany transactions have been eliminated in
consolidation.





Management
Estimates - The preparation of financial statements in conformity with
U.S. generally accepted accounting principles requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, disclosure of contingent assets and liabilities at the date of the
financial statements, and the reported amounts of revenues and expenses during
the reporting period. Certain amounts included in the financial statements are
estimated based on currently available information and management's judgment as
to the outcome of future conditions and circumstances. Changes in the status of
certain facts or circumstances could result in material changes to the estimates
used in the preparation of financial statements and actual results could differ
from the estimates and assumptions. Management makes estimates and assumptions
for, but not limited to, allowance for doubtful accounts, revenue recognition,
purchase price allocation, inventory reserves, tax assets and liabilities,
depreciation and amortization lives, stock-based compensation, fair value of
derivative liabilities, impairment of tangible and intangible assets and other
contingencies.





Foreign Currency
Translation - Assets and liabilities of KIT digital’s foreign
subsidiaries are translated at period end exchange rates and related revenues
and expenses are translated at average exchange rates in effect during the
periods. Resulting translation adjustments are recorded as a component of
accumulated other comprehensive income (loss) in stockholders' equity. Foreign
currency transaction gains and losses are recorded in other income (expense),
net.




7





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




Fair Value of
Financial Instruments - On January 1, 2008, we adopted the standard that
defines fair value, establishes a framework for measuring fair value in GAAP and
expands disclosure about fair value measurements. This standard defines fair
value as 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. It 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 active quoted market prices (Level
1). See Note 3 for fair value hierarchy on the Derivative
Liabilities.





Risk
Concentrations - 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, and from time to time,
obtain collateral for our accounts where we deem prudent and is feasible. We
believe no significant concentration of credit risk exists with respect to these
investments. The amount of held in foreign currencies as of March 31, 2010 and
December 31, 2009 was $1,283 and $2,272, respectively. The amount of cash in
excess of FDIC insured amounts as of March 31, 2010 and December 31, 2009, was
$37,073 and $6,541, 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 March 31, 2010, four customers accounted for approximately 46.8%
of our trade accounts receivable. As of December 31, 2009, three customers
accounted for approximately 39.6% of our trade accounts receivable. We routinely
assess the financial strength of customers and, based upon factors concerning
credit risk, we establish an allowance for doubtful accounts. Management
believes that accounts receivable credit risk exposure beyond such allowance is
limited.





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. The 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. In 2009 and 2008,
we did not record any goodwill impairment charges.





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.





We also
compared the sum of the estimated fair values of the reporting units to our
total enterprise value as implied by the market value of our equity securities.
This comparison indicated that, in total, our assumptions and estimates were not
unreasonable.





8





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited )





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.





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. As of March 31, 2010, the Company had $2,032 of cash equivalents in
an account that pays interest at LIBOR plus 150 basis points. This account is
guaranteed and backed by liquid collateral instruments, and can be redeemed with
14 days written notice.





Investments
– Investments include an investment in a limited partnership fund which
invests, on a hedged basis, primarily in the U.S. equity markets. This initial
investment was made in March 2009 and a subsequent investment was made in
February 2010 and is recorded at a fair value of $986.





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 March
31, 2010 and December 31, 2009 was $959 and $874, respectively.





Inventory
- Inventories are valued at the lower of cost (first-in, first-out method) or
market and are 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
March 31, 2010 and December 31, 2009, our reserves for excess and obsolete
inventory were $137 and $136, respectively.





Property and
Equipment - Property and equipment are stated at cost less accumulated
depreciation. Depreciation is provided for using the straight-line and declining
balance methods of accounting over the estimated useful lives of the assets
which range from one year to twenty years. Leasehold improvements are amortized
over the shorter of its useful life or lease term. Routine maintenance and
repair costs are charged to expense as incurred and renewals and improvements
that extend the useful life of the assets are capitalized. Upon sale or
retirement, the cost and related accumulated depreciation are eliminated from
the respective accounts and any resulting gain or loss is reported in the
statement of operations.





Income Taxes
- We account for income taxes under the asset and liability method, which
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of events that have been included in the financial
statements. Under this method, deferred tax assets and liabilities are
determined based on the differences between the financial statements and tax
basis of assets and liabilities using enacted tax rates in effect for the year
in which the differences are expected to reverse. The effect of a change in tax
rates on deferred tax assets and liabilities is recognized in income in the
period that includes the enactment date.





We record
net deferred tax assets to the extent we believe these assets will more likely
than not be realized. In making such determination, we consider all available
positive and negative evidence, including future reversals of existing taxable
temporary differences, projected future taxable income, tax planning strategies
and recent financial operations. In the event we were to determine that we would
be able to realize our deferred income tax assets in the future in excess of
their net recorded amount, we would make an adjustment to the valuation
allowance which would reduce the provision for income taxes.





9





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




Derivative
Financial Instruments - Upon the adoption of a new standard effective
January 1, 2009, certain of our financial instruments with “down-round”
protection features are no longer considered indexed to our Company’s stock for
purposes of determining whether they meet the first part of the scope exception.
As such, these instruments no longer meet the conditions to obtain equity
classification and are required to be carried as derivative liabilities, at fair
value with changes in fair value reflected as income (expense). The fair value
of the warrants issued was $15,736, $21,314 and $6,760 on January 1, 2009,
December 31, 2009 and March 31, 2010, respectively. See Note 3, “Derivative
Liabilities” for further information.





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.  Revenues are derived principally from the delivery of
digital media solutions and professional services. Our revenues include fees
charged for software-as-a-service (“SaaS”), enterprise licenses, software usage,
storage, software set-up/support services, hardware components, content
delivery, content syndication fees, advertising-based monetization and
professional services.  Revenue is recognized when the product and/or
service has been provided to the customer. We may enter into agreements whereby
we guarantee a minimum service level, or a minimum number of impressions,
click-throughs or other criteria on our software platform’s points of
distribution for a specified period. To the extent these guarantees are not met,
we may defer recognition of the corresponding revenue until guaranteed delivery
levels are achieved. For software related multiple-element arrangements, we have
applied the residual method to determine the amount of license revenues to be
recognized. Under the residual method, if fair value exists for undelivered
elements in a multiple-element arrangement, such fair value of the undelivered
elements is deferred with the remaining portion of the arrangement consideration
recognized upon delivery of the software license or services arrangement. We
allocate the fair values of each element of a software related multiple-element
arrangement based upon its fair value as determined by our vendor specific
objective evidence, with any remaining amount allocated to the software
license.





Research
and Development - Costs incurred in research and development are expensed
as incurred and are included in the consolidated statement of operations and
comprehensive loss in compensation, travel and associated costs and office,
marketing and other corporate costs. Software development costs are required to
be capitalized when a product’s technological feasibility has been established
through the date the product is available for general release to customers. We
do not capitalize any software development costs, as technological feasibility
is generally not established until a working model is completed, at which time
substantially all development is complete.





Stock-Based
Compensation - We record compensation expense for share-based awards
issued to employees and directors in exchange for services provided. The amount
of the compensation expense is based on the estimated fair value of the awards
on their grant dates and is recognized over the requisite service periods. Our
share-based awards include stock options, warrants and restricted stock awards.
We use the Black-Scholes-Merton option-pricing model (“Black-Scholes”) to
measure fair value of these share-based awards. The Black-Scholes model requires
us to make significant judgments regarding the assumptions used within the
model, the most significant of which are the expected stock price volatility,
the expected life of the option award, the risk-free rate of return and
dividends during the expected term.





Net Income (Loss)
Per Share - We compute net income (loss) per common share under
the provisions of the accounting standard which establishes standards for
computing and presenting earnings per share. It requires us to report both basic
net (loss) income per share, which is based on the weighted average number of
common shares outstanding during the period, and diluted net (loss) income per
share, which is based on the weighted average number of common shares
outstanding plus all potentially dilutive common shares outstanding. All
equivalent shares underlying options and warrants 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.





10





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




Recent Accounting
Pronouncements –    In October 2009, the FASB issued Accounting
Standards Update on Multiple-Deliverable Revenue Arrangements, which addresses
the accounting for multiple-deliverable arrangements and requires that the
overall arrangement consideration be allocated to each deliverable in a revenue
arrangement based on an estimated selling price when vendor specific objective
evidence or third-party evidence of fair value is not available. This guidance
also eliminates the residual method of allocation and requires that arrangement
consideration be allocated to all deliverables using the relative selling price
method. This update is effective for fiscal years beginning on or after June 15,
2010 and early adoption is permitted.  The Company is currently
evaluating the impact of adoption of this update.





In
October 2009, the FASB issued Accounting Standards Update on Certain Revenue
Arrangements That Include Software Elements, which changes the accounting model
for revenue arrangements that include both tangible products and software
elements. Tangible products containing both software and non-software components
that function together to deliver the product’s essential functionality will no
longer be within the scope of Software Revenue Recognition. This update is
effective for fiscal years beginning on or after June 15, 2010 and early
adoption is permitted. We do not expect the adoption of this to have a
material impact.





(2)
Acquisitions





In late
March 2010, we acquired Multicast Media Technologies, Inc., a United States
company engaged in live event broadcasting, internet video and targeted
multimedia communications (“Multicast”), in exchange for 2,379,714 shares of our
common stock and approximately $4,750 in cash (the “Cash Consideration”). The
share consideration issuable to Multicast stockholders was reduced to 1,312,034
shares of KIT digital common stock (the “Merger Shares”), after giving effect to
adjustments for assumption by KIT digital of existing indebtedness and other
liabilities of Multicast in the amount of approximately $5,927.  The
merger consideration is subject to adjustment upwards or downwards to the extent
that the closing working capital of Multicast is greater or less than zero and
subject to the final fair valuation of Merger Shares. The Cash Consideration and
Merger Shares were delivered as follows: (i) $4,000 in cash and 842,500 shares
of our stock promptly following the closing; and (ii) a “holdback amount” of an
additional $746 in cash and 469,534 shares of KIT digital common stock, less any
amount used by KIT digital to offset negative working capital and satisfy
indemnity claims as described below, will be delivered to such stockholders not
later than one year after the closing or such later date as all indemnity claims
have been resolved. Of the total “holdback amount,” $712 in cash and 196,798
Merger Shares will be used to offset any negative working capital balance of
Multicast as of the effective date of the merger. The remaining $34 in cash and
272,736 Merger Shares being held back by KIT digital will be used to indemnify
KIT digital against any breaches of representations, warranties and covenants by
Multicast, as well as against certain additional specified liabilities The
Company has allocated the aggregate cost of the acquisition to Multicast’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 to goodwill.





11





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(2) Acquisitions
(continued)





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





Current
      assets
                        
                        $
                        612Property
      and equipment
                        
                        
                        1,548Intangible
      assets – developed software
                        
                        
                        200Intangible
      assets - customer list
                        
                        
                        1,600Goodwill
                        
                        
                        20,530Total
      assets acquired
                        
                        
                        24,490Current
      liabilities and assumed debt
                        
                        
                        (7,025)Net assets acquired
                        
                        $
                        17,465





The
results of operations of Multicast in March were not material but have
been included in the consolidated statements of operations and comprehensive
loss.




Selected
      unaudited pro forma combined results of operations for the three months
      ended March 31, 2009, assuming the Multicast acquisition occurred on
      January 1, 2009 using actual unaudited figures from the entity prior to
      acquisition, are presented as
follows:
  Total
      revenue
                  
                  $
                  12,700Net
      income
                  
                  $
                  7,671
  Selected
      unaudited pro forma combined results of operations for the three months
      ended March 31, 2010, assuming the Multicast acquisition occurred on
      January 1, 2010 using actual unaudited figures from the entity prior to
      acquisition, are presented as
follows:
  Total
      revenue
                      
                      $
                      20,255Net
      (loss)
                      
                      $
                      (18,987
                      )




The
acquisitions of Nunet AG and The FeedRoom, Inc. from October 2009 are not
presented above in the proforma combined results of operations for the three
months ended March 31, 2009 as management believes that these businesses
have significantly changed after acquisition.




12





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(3)
Derivative Liabilities





In June
2008, the Financial Accounting Standards Board issued a new accounting standard.
Under this standard, instruments which contain full ratchet anti-dilution
provisions will no longer be considered indexed to a company’s own stock for
purposes of determining whether it meets the first part of the scope exception.
The adoption required us to (1) evaluate our instrument’s contingent exercise
provisions and (2) evaluate the instrument’s settlement provisions. Based upon
applying this approach to instruments within the scope of the consensus, we have
determined that certain of our warrants which were classified in stockholders’
equity on December 31, 2008, no longer meet the definition of Indexed to a
Company’s Own Stock provided in the Consensus. Accordingly, effective on January
1, 2009, we were required to reclassify those warrants, at their fair value,
into liabilities. 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. The difference
between the amount the warrants were originally recorded in the financial
statements and the fair value of the instruments on January 1, 2009 was
considered a cumulative effect of a change in accounting principle and required
an adjustment to the opening balance of retained earnings and a reduction in
additional paid-in capital in the amount of $8,498 and $24,235, respectively.
The derivative liability as of January 1, 2009 was $15,736. These amounts have
been adjusted for the errors noted in fair value computations. See Note 8
“Correction of errors” for further details. The common shares indexed to the
derivative financial instruments used in the calculation of the fair value and
recorded as liabilities at January 1, 2009, December 31, 2009 and March 31, 2010
were 5,806,230, 4,794,400 and 972,197, respectively. The number of shares for
the determination of liability have been computed based on the effective
exercise price used in the valuation. The actual number of common shares indexed
to the warrants at January 1, 2009, December 31, 2009 and March 31, 2010 were
2,886,038, 4,794,400 and 972,197, 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-Merton (“BSM”) option valuation technique, 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 BSM) 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 estimates and assumption changes. Under the terms of the new
accounting standard, increases in the trading price of the company’s 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 the company’s common stock and decreases in trading fair value during a
given financial quarter result in the application of non-cash derivative
income.





13





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




The
following tables summarize the components of derivative liabilities as of March
31, 2010, December 31, 2009 and the re-measurement date, January 1,
2009:





March
      31, 2010
                                      
                                      
                                      December
                                        31, 2009
                                      
                                      
                                      Re-measurement
                                        date
                                        January 1, 2009Fair
      value of warrants with anti-dilution provisions
                                      
                                      $
                                      (6,760
                                      )
                                      
                                      $
                                      (21,314
                                      )
                                      
                                      $
                                      (15,736
                                      )Significant
      assumptions (or ranges):Trading
      market values  (1)
                                      
                                      $
                                      12.88
                                      
                                      
                                      $
                                      11.00
                                      
                                      
                                      
                                      5.25Term
      (years)
                                      
                                      
                                      3.11
                                      
                                      
                                      3.35
      to 4.00
                                      
                                      
                                      $
                                      4.35
      to 5.00Volatility   (1)
                                      
                                      
                                      58.36
                                      %
                                      
                                      
                                      61.98
                                      %
                                      
                                      
                                      101.98
                                      %Risk-free
      rate   (2)
                                      
                                      
                                      1.60
                                      %
                                      
                                      
                                      1.70
                                      %
                                      
                                      
                                      1.55
                                      %Effective
      Exercise price  (3)
                                      
                                      $
                                      7.00
                                      
                                      
                                      $
                                      7.00
                                      
                                      
                                      $
                                      5.92





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 March 31, 2010
and 2009 was $(11,443) and $10,176, respectively. Included in the $(11,443)
expense for the three months ended March 31, 2010 is a loss on settlement of
$(3,037) related to the repurchase of warrants.




See Note
9 “Correction of errors”, for a description of the correction of an error
related to the derivative liability for the three months ended March 31,
2009.





On March
7, 2010, our Board of Directors approved the repurchase of certain outstanding
warrants with exercise prices below the then-current market price from certain
warrant holders (who had acquired the warrants in prior private placement
financings), including KIT Media, an entity controlled by Kaleil Isaza Tuzman,
our Chairman and Chief Executive Officer and Wellington Management Company
(“Wellington”), an entity with greater than a 10% holding in KIT digital’s
outstanding common shares at the time of the transaction. KIT Media and
Wellington are considered related parties of the company. The terms of the
warrant repurchase were identical for KIT Media and Wellington, and the
negotiation of such terms was led by Wellington. The company offered to purchase
and cancel these warrants at 133% of the intrinsic value of the warrants
(intrinsic value being based on a 20-day trailing volume weighted average price
of the underlying common stock).  These warrants with anti-ratchet
dilution provisions totaling 3,030,747 were cancelled effective on March 31,
2010. These warrants were included in the warrant buyback liability as at March
31, 2010 and were paid after such date. We also repurchased and cancelled
another 347,835 warrants with anti-ratchet dilution provisions during the
quarter ended March 31, 2010, at varying prices, from parties other than KIT
Media and Wellington for $1,141.





14







KIT DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(4)
Stock-Based Compensation





On March
17, 2008, the Board of Directors adopted an incentive compensation plan (the
“2008 Incentive Stock Plan”). The 2008 Incentive Stock Plan currently has
reserved 857,143 shares of common stock for issuance. The 2004 Stock Option Plan
has reserved 342,858 shares of common stock for issuance. In November 2009, our
board of directors voted unanimously to increase the number of shares which may
be issued under the 2008 Incentive Plan by 2,642,857 to an aggregate of
3,500,000 shares of common stock subject to ratification by our stockholders at
our next Annual General Meeting of shareholders.





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
granted and recognizes compensation costs ratably over the requisite service
period, net of estimated forfeitures.





For the
three months ended March 31, 2010 and 2009, we recognized $552 and $280,
respectively, of non-cash stock-based compensation expense in the consolidated
statements of operations. Included in the 2010 amount of $552, is $190 of stock
issued for compensation. Also included in non-cash stock-based compensation are
warrants to purchase 34,286 shares of common stock with an exercise price of
$4.655 issued on March 30, 2008, that vest over three years from the issue date.
During the three months ended March 31, 2010, a total of 2,857 of these warrants
vested with 22,857 vested and 11,429 unvested as of March 31, 2010. The
intrinsic value as of March 31, 2010 of these outstanding warrants and
exercisable warrants are $282 and $188, respectively.





As of
March 31, 2010, there was approximately $2,702 of total unrecognized
compensation cost related to unvested share-based compensation grants, which is
expected to be amortized over a weighted-average period of 2.9
years.





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:




Three
      Months Ended March
                    31, 2010
                  
                  
                  Three
                    Months
      Ended March
                    31, 2009Expected
      life (in years)
                  
                  5.00
                  
                  
                  
                  5.00Risk-free
      interest rate
                  
                  2.35
                  %
                  
                  
                  1.88
                  %Volatility
                  
                  31.50
                  %
                  
                  
                  105.61
                  %Dividend
      yield
                  
                  
                  0
                  
                  
                  
                  0








15




KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(4)
Stock-Based Compensation (continued)








A summary
of the status of stock option awards and changes during the three months ended
March 31, 2010 are presented below:





Shares
                      
                      
                      Weighted
                        Average
                        Exercise
                        Price
                      
                      
                      Weighted
                        Average
                        Remaining
                        Contractual
                        Life (Years)
                      
                      
                      Intrinsic
                        ValueOutstanding
      at December 31, 2009
                      
                      
                      877,973
                      
                      
                      
                      7.14Granted
                      
                      
                      21,683
                      
                      
                      
                      10.45Exercised
                      
                      
                      (7,622
                      )
                      
                      
                      5.41Cancelled,
      expired, or forfeited
                      
                      
                      (4,628
                      )
                      
                      
                      8.23Outstanding
      at March 31, 2010
                      
                      
                      887,406
                      
                      
                      
                      7.23
                      
                      
                      
                      3.81
                      
                      
                      $
                      5,016Exercisable
      at March 31, 2010
                      
                      
                      368,735
                      
                      
                      
                      6.86
                      
                      
                      
                      3.58
                      
                      
                      $
                      2,220





The
weighted-average grant-date fair value of option awards granted during the three
months ended March 31, 2010 was $3.33.





16







KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(5)
Stock Issuances





During
the quarter ended March 31, 2010, we issued 6,771,093 shares of common stock. Of
this amount, we issued 2,980,000 shares in the January 2010 public offering,
350,000 shares in the February 2010 over-allotment, 1,541,624 shares in the
March 2010 public offering, 231,244 shares in the March 2010
over-allotment,  1,312,034 shares for the acquisition of Multicast,
308,007 shares for the exercise of warrants with proceeds of $1,448, 7,622
shares for the exercise of options with proceeds of $41,16,500 shares for
compensation valued at $190 and 24,062 shares for services valued at
$236.





On
January 26, 2010, we completed an underwritten public offering of 2,980,000
shares of our common stock, pursuant to our shelf registration statement on Form
S-3 (No. 333-162325), which was originally filed and declared effective in
October 2009, and related prospectus supplement dated January 21,
2010.  We sold such shares in the offering at a price of $10.50 per
share and received $31,290 in gross proceeds and approximately $28,890 in net
proceeds, after deducting underwriting discounts, commissions, legal fees and
other estimated offering expenses.  The impact of the public offering
increased our total stockholders’ equity by $28,890.  As part of the
offering, we granted the underwriters an over-allotment option to purchase an
additional 447,000 shares of common stock at the same price per share through
February 20, 2010.  We subsequently sold 350,000 additional shares of
common stock pursuant to the over-allotment option on February 23, 2010, and
received $3,675 in gross proceeds and approximately $3,433 in net
proceeds.





On March
9, 2010, we completed an underwritten public offering of 1,541,624 shares of our
common stock, pursuant to our shelf registration statement on Form S-3 (No.
333-164655), which was originally filed and declared effective in February 2010,
and related prospectus supplement dated March 4, 2010.  We sold such
shares in the offering at a price of $9.73 per share and received $15,000 in
gross proceeds and approximately $14,075 in net proceeds, after deducting
underwriting discounts, commissions, legal fees and other estimated offering
expenses. The impact of the public offering increased our total stockholders’
equity by $14,075. We subsequently sold 231,244 additional shares of common
stock pursuant to an underwriters’ over-allotment option on March 22, 2010, and
received $2,250 in gross proceeds and approximately $2,087 in net
proceeds.





KIT Media
Ltd., an entity controlled by Kaleil Isaza Tuzman, our Chairman and Chief
Executive Officer (“KIT Media”) purchased $1,750 of common stock (179,856
shares) in the March 9, 2010 offering, at the same price and on the same terms
as the other investors in this offering.





As of
March 31, 2010, the outstanding warrants (excluding the warrants included in the
derivative liability of 972,197 and stock-based compensation of 34,286) are
755,896 with a weighted average exercise price of $44.10. As of December 31,
2009, the outstanding warrants (excluding the warrants included in the
derivative liability of 4,794,400 and stock-based compensation of 34,286) are
510,639 with a weighted average exercise price of $51.36.





17





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





(6)
Restructuring Charges





In the
first quarter of 2010, management approved restructuring plans for all
entities acquired since September 2009. Management expects to complete the
restructuring by the end of the year. Restructuring charges include the costs of
future employee terminations, contract settlements and facility closing
costs.





The
following table summarizes the restructuring charges for the three months ended
March 31, 2010:





Employee
      termination costs
                    
                    $
                    2,632Contract
      settlements
                    
                    
                    41Facility
      closing costs
                    
                    
                    1,020Total
      restructuring charges
                    
                    $
                    3,693





The
following table summarizes the restructuring activity for the three months ended
March 31, 2010:





Employee
      Termination Costs
                      
                      
                      Contract
      Settlements
                      
                      
                      Facility
      Closing Costs
                      
                      
                      TotalBalance
      as of December 31, 2009
                      
                      $
                      -
                      
                      
                      $
                      -
                      
                      
                      $
                      829
                      
                      
                      $
                      829Additions
                      
                      
                      2,632
                      
                      
                      
                      41
                      
                      
                      
                      1,020
                      
                      
                      
                      3,693Cash
      payments
                      
                      
                      (6
                      )
                      
                      
                      -
                      
                      
                      
                      (446
                      )
                      
                      
                      (452
                      )Balance
      as of March 31, 2010
                      
                      $
                      2,626
                      
                      
                      $
                      41
                      
                      
                      $
                      1,403
                      
                      
                      $
                      4,070





The
accrued restructuring of $829 and $4,070 is included in accrued expenses in the
consolidated balance sheets as of December 31, 2009 and March 31, 2010,
respectively.





The
Company recorded restructuring charges of $119 in the quarter ended March 31,
2009. This amount is comprised of employee termination costs related to the
reorganization of the Company of $47 and facility closing costs of $72 related
to the closing of one of the Melbourne, Australia offices and one of the Dubai
offices.





(7)
Integration Expenses





The
Company has recorded integration charges of $3,171 in the quarter ended March
31, 2010 related to the redundancy in staff and consultants during
reorganization, corporate rebranding related to the reorganization, and the
integration of acquired companies and assets.





The
Company has recorded integration charges of $244 in the quarter ended March 31,
2009 related to the redundancy in staff and consultants for the transition of
technology infrastructure during reorganization due to the centralizing of
resources in Prague.





(8)
Segment Reporting





We have
presented geographical location for revenue and assets below. We have presented
operating segments in the past for Digital Media Solutions and Professional
Services but since Professional services represents less than 10% of total
assets and total revenues and we expect this segment to continue to decrease, we
are not presenting financial information for operating segments..





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


Three
      months endedMarch 31,2010
                            
                            
                            2009Revenue:EMEA
                            
                            $
                            12,043
                            
                            
                            $
                            6,836AsiaPac
                            
                            
                            2,817
                            
                            
                            
                            2,278Americas
                            
                            
                            2,504
                            
                            
                            
                            510Total
      revenue
                            
                            $
                            17,364
                            
                            
                            $
                            9,624March
      31,2010Assets:EMEA
                            
                            $
                            29,315AsiaPac
                            
                            
                            3,466Americas
                            
                            
                            7,429Corporate
      (includes goodwill and intangible assets)
                            
                            
                            101,219Total
      assets
                            
                            $
                            141,429





18





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(9)
Correction of Errors





Our
previously issued financial statements have been corrected for the
following;





An
adjustment was made on September 30, 2009 for an increase in the common shares
indexed to the financial instruments for both warrants that were mistakenly not
included and for a change in the calculation of the fair value for the
anti-dilution provision that increases the common shares indexed to the
financial instruments. As of January 1, 2009, the effect of the correction
increased the derivative liability by $10,066 to $15,736, decreased retained
earnings by $6,082 and decreased additional paid-in capital by $3,984. As of
March 31, 2009, the effect of the correction decreased the derivative liability
by $8,226 and increased the derivative income by $8,226, in addition to the
corrections above as of January 1, 2009 to the consolidated balance sheet. As of
March 31, 2009, the corrected consolidated balance sheet has a derivative
liability of $5,560 and total liabilities of $26,050. In the three months ended
March 31, 2009, the corrected consolidated statement of operations has a
derivative income of $10,176 and the net income available to common shareholders
of $8,394, with a basic net income per common share of $1.96 and diluted net
income per common share of $1.88.




The
derivative income (expense) reflected in the consolidated statement of
operations and comprehensive income (loss) for the three months ended March 31,
2009 is based on changes in the fair values, adjusted for the correction of the
above mentioned errors.





(10)
Related Party Transactions





In
December 2007, we entered into an agreement with KIT Capital, Ltd., (“KIT
Capital”) a company beneficially controlled and led by Kaleil Isaza Tuzman,
our Chairman and Chief Executive Officer, under which KIT Capital has provided
us managerial services. The total amount paid to KIT Capital and included in our
results of operations in the three months ended March 31, 2010 and 2009 were
$108 and $126, respectively.





KIT Media
purchased $1,750 of common stock (179,856 shares) in the March 9, 2010 offering,
at the same price and on the same terms as the other investors in this
offering.




See Note
3, “Derivative Liabilities,” for a description of warrant repurchase from KIT
Media and Wellington.





(11)
Subsequent Events





In April
2010, the company repurchased and cancelled a warrant to purchase 47,143 shares
from Robin Smyth, our Chief Financial Officer. The terms of the warrant
repurchase were identical to Wellington and KIT Media, the negotiation of which
terms was led by Wellington.





On April
27, 2010, we completed an underwritten public offering of 4,230,770 shares of
our common stock, pursuant to our shelf registration statement on Form S-3 (No.
333-164655), which was originally filed and declared effective in February 2010,
and related prospectus supplement dated April 22, 2010. We sold such shares in
the offering at a price of $13.00 per share and received $55,000 in gross
proceeds and approximately $50,300 in net proceeds, after deducting underwriting
discounts, commissions, legal fees and other estimated offering expenses. The
impact of the public offering was essentially be to increase our total
stockholders’ equity by approximately $50,300. We subsequently sold 634,615
additional shares of common stock pursuant to an underwriters’ over-allotment
option, on May 6, 2010, and received $8,250 in gross proceeds and approximately
$7,600 in net proceeds. We intend to use the net proceeds from the sale of the
shares in the offering to acquire and invest in competitive and complementary
businesses as a part of our growth strategy.





KIT
Capital purchased $1,300 of common stock (100,000 shares) in the April 27, 2010
offering, at the same price and on the same terms as the other investors in this
offering.




On May 8,
2010, our Board of Directors authorized the issuance of 2,252,700 stock options
pursuant to the 2008 Incentive Stock Plan, at a strike price of $12.36 per share
(reflecting the previous trading day’s closing price), pursuant to approval by a
majority of the company’s shareholders at the next Annual General Meeting. These
stock options carry a 4-year quarterly vesting term and a 5-year exercise term.
In aggregate, as of May 17, 2010, shares underlying the company’s total issued
employee stock options represent less than 14% of the company’s outstanding
common shares. The Board of Directors had not authorized a substantial issuance
of stock options since June 2008. The Board of Directors authorized the issuance
of the 2,252,700 stock options to (a) account for the addition of over 200 staff
members since the last authorized options issuance, (b) incentivize all staff
for future performance, and (c) adjust existing employees’ options levels to
account for dilution in the company’s total shares outstanding that has occurred
over time. Kaleil Isaza Tuzman, Gavin Campion and Robin Smyth did not receive
any new options as part of this issuance.





On May
14, 2010, we executed and closed on the share purchase agreement to acquire
privately-held Benchmark Broadcast Systems Pte. Ltd.(“Benchmark”), based in
Singapore. Benchmark is a leading video asset management provider and broadcast
video systems integrator, serving clients in 12+ countries through six regional
offices throughout Asia. Benchmark expects to generate at least $10 million in
revenues during the next 12 months. In consideration for 100% of Benchmark's
shares, the transaction includes guaranteed payments of approximately $9,500
directly to the company over time (comprised of $4,500 in cash and $5,000 in KIT
digital common stock) plus approximately $1,100 paid to employees over two
years. The transaction also includes corporate performance-based contingent
considerations at the first and second anniversary of the
transaction.





19


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 devices and IPTV networks. Our core digital
asset management software suite, marketed under the “KIT VX” brand, includes
online and mobile video players, ingestion and trans-coding video content for
Internet and mobile devices, IPTV set-top box development, IPTV recording and
editing suite deployment, video content localization and syndication, digital
rights management, hosting, storage,  content delivery and content
syndication. We currently provide IP video solutions internationally through our
offices in Atlanta, Beijing, Buenos Aires, Chennai, Cologne, Delhi, Dubai,
Kolkata, Melbourne (Australia), Mumbai, Prague, Toronto, Stockholm, New York,
London, Cairo and Singapore. To support IPTV enablement, we provide technical
integration and integrated marketing solutions, including interface design
services, branding, online marketing, data management and
analytics.





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 months ended March 31, 2010 and 2009. 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.





As a
component of our management’s review of the financial statements, our management
recently reviewed and modified the categorization of costs in the Consolidated
Statements of Operations. Management believes these changes in classifications
present additional information to the readers of the financial statements and
previously reported amounts were re-categorized to conform to the current
presentation.





Results
of Operations - Three Months Ended March 31, 2010 Compared to Three Months Ended
March 31, 2009





Revenue. Consolidated revenue
increased by $7,740 from $9,624 for the three months ended March 31, 2009 to
$17,364 for the three months ended March 31, 2010, an increase of 80%. This
increase in primarily due an increase in customers, increased spending by
existing customers, and revenue from the acquired companies not included in
prior period results.







20





Variable
and Direct Third Party Costs





Cost of Goods and Services.
Cost of goods and services increased by $874 from $3,478 for the three months
ended March 31, 2009 to $4,352 for the three months ended March 31, 2010, an
increase of 25%. These costs represent the costs of equipment and services for
the supply of digital media and IPTV solutions, services and components. The
increase is due to an increase in revenue for the supply of digital media and
IPTV solutions, services and components.





Hosting, Delivery and
Reporting. These costs increased by $792 from $282 for the three months
ended March 31, 2009 to $1,074 for the three months ended March 31, 2010, an
increase of 281%. These costs increased primarily due to the recent acquisitions
in October 2009 and March 2010.





Content Costs. Content costs
decreased by $226 from $461 for the three months ended March 31, 2009 to $235
for the three months ended March 31, 2010, a decrease of 49%. The decrease is
primarily due to the elimination of monthly minimum guarantees with many
content providers and the reduction in content providers.





Direct Third Party Creative
Production Costs. Direct third party creative production costs increased
by $85 from $805 for the three months ended March 31, 2009 to $890 for the three
months ended March 31, 2010, an increase of 11% 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 $1,957 from $3,693 for the three months ended March 31, 2009 to
$5,650 for the three months ended March 31, 2010, an increase of 53%. The
increase was primarily due to the recent acquisitions in October 2009 and March
2010 and the increase in non-cash stock-based compensation of $272.





Legal, Accounting, Audit and Other
Professional Services Fees. These expenses increased by $420 from $270
for the three months ended March 31, 2009 to $690 for the three months ended
March 31, 2010, primarily due to the increase in audit and other legal
fees.





Office, Marketing and Other Corporate
Costs. These expenses increased by $1,347 from $717 for the three months
ended March 31, 2009 to $2,064 for the three months ended March 31, 2010. The
increase was primarily due to the increases related to recent acquisitions in
October 2009 and March 2010.





Merger and Acquisition and Investor
Relation Expenses. Merger and acquisition and certain investor relation
expenses increased by $841 from $378 for the three months ended March 31, 2009
to $1,219 for the three months ended March 31, 2010. The increase is primarily
due the acquisition of Multicast in March 2010 and investor relation
expenses.





Depreciation and Amortization.
Depreciation and amortization expense increased 142% by $971 from $683 for the
three months ended March 31, 2009 to $1,654 for the three months ended March 31,
2010. The increase is primarily attributed to the amortization of intangible
assets and depreciation of long lived assets acquired as part of the
acquisitions of Nunet and Feedroom in October 2009.





Restructuring Charges.
Restructuring charges increased by $3,574, from $119 for the three months ended
March 31, 2009 to $3,693 for the three months ended March 31, 2010.
Restructuring charges consist of employee termination costs, contract
settlements and facility closing costs. These charges increased primarily due to
the increase in facility closing costs and contract settlements.





Integration expenses.
Integration expenses increased by $2,677 from $244 for the three months ended
March 31, 2009 to $2,921 for the three months ended March 31, 2010. Integration
expenses consist of IT overlap, recruiting costs, relocation of headquarters,
corporate rebranding activities due to acquisitions and relocations during the
year.





21





Interest Expense. Interest
expense decreased by $47 from $139 for the three months ended March 31, 2009 to
$92 for the three months ended March 31, 2010. This decrease was primarily due
to the decrease in debt.




Amortization of Deferred Financing
Costs and Debt Discount. Amortization of deferred financing costs and
debt discount were $164 for the three months ended March 31, 2009. These costs
resulted from the issuance of $1,500 of a senior secured note in November 2008
which was repaid in August 2009.





Derivative expense. Derivative
expense was $11,443 for the three months ended March 31, 2010 as compared to
derivative income of $10,176 for the three months ended March 31, 2009. The
company recorded an increase in the fair value of warrants containing reset
provisions.





Other Income/(Expense). Other
expense decreased by $155. Other expense was $29 for the three months ended
March 31, 2009 as compared to other expense of $184 for the three months
ended March 31, 2010.




Net Loss Available to Common
Shareholders. As a result of the factors described above, we reported net
loss available to common shareholders of $18,442 for the three months ended
March 31, 2010 compared to net income of $8,394 for the three months ended March
31, 2009, an increase in net loss of $26,836.








Liquidity and Capital
Resources





As of
March 31, 2010, we had cash and cash equivalents of $37,823 and working capital
of approximately $9,754. During the quarter ended March 31 2010, we have
received net proceeds of $48,487 in public offerings, repurchased warrants for
$1,158 and paid cash of $8,850 related to the acquisition of Multicast including
the extinguishment of their notes payable. Since March 31, 2010 until the date
of this report we have sold 4,865,385 shares of common stock in public offerings
and have received approximately $57,900 in net proceeds from these sales (see
subsequent events). We have also paid the warrant buyback liability amounting to
$22,232. We plan to primarily use net proceeds of the most recent equity
offering to finance the costs of acquiring or investing in competitive and
complementary businesses, products and technologies as a part of our growth
strategy. Management anticipates that going-forward, KIT digital will generate
sufficient cash flows from its operating activities to meet its capital
requirements. We believe that we have sufficient liquidity to finance our
operational and acquisition plan for the next twelve months.





Net cash
used by operating activities was $5,939 for the three months ended March 31,
2010, compared to $1,162 for the three months ended March 31, 2009, a decrease
of $4,777. The increase in net cash used in operating activities is primarily
related to the increase in receivables attributable to an increase in revenues
and a couple slower paying major clients, an increase in merger and acquisition
and investor relations expenses and restructuring and integration expenses
offset by the accrual for these in the three months ended March 31,
2010.





Net cash
used by investing activities was $5,360 for the three months ended March 31,
2010, compared to $1,892 for the three months ended March 31, 2009, a decrease
in net cash used in investing activities of $3,468. In 2010, this consisted of
cash paid in the acquisition of Multicast of $4,746 offset by cash received of
$396, cash paid into investment of $700 and purchase of equipment of
$310. In 2009, this primarily consisted of cash paid into investment of
$200, cash paid in the acquisition of Visual of $180 and the purchase of
software of $1,500.





22





Net cash
provided by financing activities was $42,651 for the three months ended March
31, 2010, compared to net cash used by financing activities of $17,195 for the
three months ended March 31, 2009. In 2010, this primarily consisted of the
proceeds from public offerings of $48,487 offset by payments of notes related to
the Multicast acquisition of $4,500 and payments of other notes, capital leases
and other obligations for $1,667. In 2009, this primarily consisted payments of
capital leases of $94.





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.





Impact
of Inflation





We
believe that inflation has not had a material impact on our results of
operations for the three months ended March 31, 2010 and 2009. We cannot assure
you that future inflation will not have an adverse impact on our operating
results and financial condition.





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, our management cautions that future events
rarely develop as forecast, and that best estimates may routinely require
adjustment.





The SEC
has issued cautionary advice to elicit more precise disclosure about accounting
policies management believes are most critical in portraying our financial
results and in requiring management’s most difficult subjective or complex
judgments.





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. 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.  Revenues are
derived principally from the delivery of digital media solutions and
professional services. Our revenues include fees charged for
software-as-a-service (“SaaS”), enterprise licenses, software usage, storage,
software set-up/support services, hardware components, content delivery, content
syndication fees, advertising-based monetization and professional
services.  Revenue is recognized when the product and/or service has
been provided to the customer. We may enter into agreements whereby we guarantee
a minimum service level, or a minimum number of impressions, click-throughs or
other criteria on our software platform’s points of distribution for a specified
period. To the extent these guarantees are not met, we may defer recognition of
the corresponding revenue until guaranteed delivery levels are achieved. For
software related multiple-element arrangements, we have applied the residual
method to determine the amount of license revenues to be recognized. Under the
residual method, if fair value exists for undelivered elements in a
multiple-element arrangement, such fair value of the undelivered elements is
deferred with the remaining portion of the arrangement consideration recognized
upon delivery of the software license or services arrangement. We allocate the
fair values of each element of a software related multiple-element arrangement
based upon its fair value as determined by our vendor specific objective
evidence, with any remaining amount allocated to the software
license.





23





Inventories.
  Inventories are valued at the lower of cost (first-in, first-out
method) or market and are 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.
Our estimates of future product demand may not be accurate and we may understate
or overstate the provision required for excess and obsolete inventory.
Accordingly, any significant unanticipated changes in demand could have a
significant impact on the value of our inventory and results of
operations.  As of March 31, 2010 and December 31, 2009, our reserves
for excess and obsolete inventory were $137 and $136, respectively.





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 March 31, 2010 and December 31, 2009 was $959 and $874, 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 Standards Codification (“ASC”) 350, 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. In 2010 and 2009,
we did not record any goodwill impairment charges.





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.





We also
compared the sum of the estimated fair values of the reporting units to our
total enterprise value as implied by the market value of our equity securities.
This comparison indicated that, in total, our assumptions and estimates were not
unreasonable.





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.





Derivative Financial
Instruments. Upon the adoption of a new standard effective January 1,
2009, certain of our financial instruments with “down-round” protection features
are no longer considered indexed to our Company’s stock for purposes of
determining whether they meet the first part of the scope exception. As such,
these instruments no longer meet the conditions to obtain equity classification
and are required to be carried as derivative liabilities, at fair value with
changes in fair value reflected as income (expense). The fair value of the
warrants issued was $15,736, $21,314 and $6,760 on January 1, 2009, December 31,
2009 and March 31, 2010, respectively. See Note 3, “Derivative Liabilities” for
further information.





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, 2009.  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.




24





ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





We
conduct our operations in the following primary functional currencies: the
United States dollar, the British pound, the Australian dollar, the Swedish
krona and the Czech koruna. 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 client revenues with associated client
delivery costs. We invoice our international customers primarily in U.S.
dollars, British pounds, Australian dollars, Euros, Swedish kronor, Czech koruna
and Australian dollars.




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 place our cash and cash equivalents with high credit quality institutions to
limit credit exposure, and from time to time, obtain collateral for our accounts
where we deem prudent and is feasible. We believe that no significant
concentration of 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
4T. 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 effective 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. 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.





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.







25


PART
II - OTHER INFORMATION





ITEM
1. LEGAL PROCEEDINGS.





None





ITEM
1A. RISK FACTORS.





There are
no material changes in the risk factors previously disclosed in our annual
report on Form 10-K for the year ended December 31, 2009.





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




None





ITEM
3. DEFAULTS UPON SENIOR SECURITIES.





None





ITEM
4. RESERVED




None





ITEM
5. OTHER INFORMATION.




None




ITEM
6. EXHIBITS.





Exhibit No.
                
                Description31.1
                
                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 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2
                
                Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.





26





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:  May
      18, 2010
              By:
              /s/
      Kaleil Isaza TuzmanKaleil
      Isaza TuzmanChairman
      and Chief Executive Officer
                (principal
      executive officer)





Dated:  May
      18, 2010
              By:
              /s/
      Robin SmythRobin
      SmythChief
      Financial Officer
                (principal
      financial and accounting
officer)




27