UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form
10-Q





(Mark
One)




x
            QUARTERLY
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For
the quarterly period ended September 30, 2009





OR




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


For
the transition period from __________ to __________





Commission file number
000-25659




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.)168 Fifth Avenue, Suite 301, New York, New York
                10010(Address
      of Principal Executive Offices)
                (Zip
      Code)





+1 (212)
661-4111


(Registrant’s
Telephone Number, Including Area Code)




Check
whether the issuer (1) filed all reports required to be filed by Section 13 or
15(d) of the Exchange Act during the past 12 months (or for such shorter period
that the 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
November 18, 2009, there were 10,719,934 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 September 30, 2009 (unaudited) and December 31,
      2008
                  2Consolidated
      Statements of Operations and Comprehensive Income (Loss) - For the three
      and nine months ended September 30, 2009 and 2008
      (unaudited)
                  3Consolidated
      Statements of Stockholders’ Equity - For the nine months ended September
      30, 2009 (unaudited)
                  4Consolidated
      Statements of Cash Flows - For the nine months ended September 30, 2009
      and 2008 (unaudited)
                  5Notes
      to Consolidated Financial Statements (unaudited)
                  7Item
      2.
                  Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
                  21Item
      3.
                  Quantitative
      and Qualitative Disclosures About Market Risk
                  28Item
      4T.
                  Controls
      and Procedures
                  28PART
      II - OTHER INFORMATIONItem
      1.
                  Legal
      Proceedings
                  29Item
      1A.
                  Risk
      Factors
                  29Item
      2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  29Item
      3.
                  Defaults
      Upon Senior Securities
                  29Item
      4.
                  Submission
      of Matters to a Vote of Security Holders
                  29Item
      5.
                  Other
      Information
                  29Item
      6.
                  Exhibits
                  29SIGNATURES
                  30







PART
I - FINANCIAL INFORMATION


Item
1.  Financial Statements




KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


(Amounts
in Thousands, Except Share Data)









September30, 2009
                  
                  
                  December31, 2008 (A)(Unaudited)Assets:Current
      assets:Cash
      and cash equivalents
                  
                  $
                  13,451
                  
                  
                  $
                  5,878Investments
                  
                  
                  215
                  
                  
                  
                  -Receivable
      from FeedRoom
                  
                  
                  4,636
                  
                  
                  
                  -Accounts
      receivable, net
                  
                  
                  18,602
                  
                  
                  
                  8,331Inventory,
      net
                  
                  
                  1,300
                  
                  
                  
                  2,130Other
      current assets
                  
                  
                  1,698
                  
                  
                  
                  1,539Total
      current assets
                  
                  
                  39,902
                  
                  
                  
                  17,878Property
      and equipment, net
                  
                  
                  2,791
                  
                  
                  
                  2,928Deferred
      tax assets
                  
                  
                  81
                  
                  
                  
                  64Software,
      net
                  
                  
                  3,097
                  
                  
                  
                  2,265Customer
      list, net
                  
                  
                  2,597
                  
                  
                  
                  2,988Domain
      names, net
                  
                  
                  11
                  
                  
                  
                  19Goodwill
                  
                  
                  16,559
                  
                  
                  
                  15,167Total
      assets
                  
                  $
                  65,038
                  
                  
                  $
                  41,309Liabilities
      and Stockholders' Equity:Current
      liabilities:Bank
      overdraft
                  
                  $
                  717
                  
                  
                  $
                  1,456Capital
      lease and other obligations
                  
                  
                  263
                  
                  
                  
                  395Secured
      notes payable
                  
                  
                  1,603
                  
                  
                  
                  966Senior
      secured notes payable, net of debt discount
                  
                  
                  -
                  
                  
                  
                  950Accounts
      payable
                  
                  
                  5,739
                  
                  
                  
                  5,775Accrued
      expenses
                  
                  
                  7,246
                  
                  
                  
                  2,240Income
      tax payable
                  
                  
                  193
                  
                  
                  
                  160Acquisition
      liability - Kamera
                  
                  
                  2,583
                  
                  
                  
                  3,000Acquisition
      liability - Visual
                  
                  
                  1,075
                  
                  
                  
                  2,218Derivative
      liability
                  
                  
                  13,503
                  
                  
                  
                  -Other
      current liabilities
                  
                  
                  2,274
                  
                  
                  
                  3,818Total
      current liabilities
                  
                  
                  35,196
                  
                  
                  
                  20,978Capital
      lease and other obligations, net of current
                  
                  
                  398
                  
                  
                  
                  949Secured
      notes payable, net of current
                  
                  
                  -
                  
                  
                  
                  236Acquisition
      liability - Visual, net of current
                  
                  
                  -
                  
                  
                  
                  1,075Total
      liabilities
                  
                  
                  35,594
                  
                  
                  
                  23,238Equity:Stockholders'
      equity:Common
      stock, $0.0001 par value: authorized 30,000,000 shares; issued and
      outstanding 8,891,623 and 4,183,280, respectively
                  
                  
                  1
                  
                  
                  
                  -Additional
      paid-in capital
                  
                  
                  108,145
                  
                  
                  
                  101,057Accumulated
      deficit
                  
                  
                  (78,351
                  )
                  
                  
                  (82,499
                  )Accumulated
      other comprehensive (loss) income
                  
                  
                  (351
                  )
                  
                  
                  (250
                  )Total
      stockholders' equity
                  
                  
                  29,444
                  
                  
                  
                  18,308Non-controlling
      interest
                  
                  
                  
                  
                  
                  
                  (237
                  )Total
      equity
                  
                  
                  29,444
                  
                  
                  
                  18,071Total
      liabilities and equity
                  
                  $
                  65,038
                  
                  
                  $
                  41,309




(A) - Reference is made to the
Company’s Annual Report on Form 10-K for the year ended December 31, 2008, filed
with the U.S. Securities and Exchange Commission on April 15,
2009.




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)










Threemonthsended
                              
                              
                              NinemonthsendedSeptember30,
                              
                              
                              September30,2009
                              
                              
                              2008
                              
                              
                              2009
                              
                              
                              2008Revenue
                              
                              $
                              11,036
                              
                              
                              $
                              5,381
                              
                              
                              $
                              31,154
                              
                              
                              $
                              14,368Variable
      and direct third party costs:Cost
      of goods and services
                              
                              
                              4,550
                              
                              
                              
                              -
                              
                              
                              
                              11,662Hosting,
      delivery and reporting
                              
                              
                              331
                              
                              
                              
                              499
                              
                              
                              
                              1,027
                              
                              
                              
                              1,601Content
      costs
                              
                              
                              287
                              
                              
                              
                              866
                              
                              
                              
                              1,105
                              
                              
                              
                              1,685Direct
      third party creative production costs
                              
                              
                              583
                              
                              
                              
                              759
                              
                              
                              
                              2,541
                              
                              
                              
                              2,732Total
      variable and direct third party costs
                              
                              
                              5,751
                              
                              
                              
                              2,124
                              
                              
                              
                              16,335
                              
                              
                              
                              6,018Gross
      profit
                              
                              
                              5,285
                              
                              
                              
                              3,257
                              
                              
                              
                              14,819
                              
                              
                              
                              8,350General
      and administrative expenses:Compensation,
      travel and associated costs (including non-cash stock-based compensation
      of $536, $188, $1,088 and $4,262, respectively)
                              
                              
                              3,846
                              
                              
                              
                              3,889
                              
                              
                              
                              11,020
                              
                              
                              
                              16,370Legal,
      accounting, audit and other professional service fees
                              
                              
                              154
                              
                              
                              
                              291
                              
                              
                              
                              584
                              
                              
                              
                              905Office,
      marketing and other corporate costs
                              
                              
                              894
                              
                              
                              
                              834
                              
                              
                              
                              2,507
                              
                              
                              
                              2,600Merger
      and acquisition and investor relations expenses
                              
                              
                              522
                              
                              
                              
                              -
                              
                              
                              
                              1,251
                              
                              
                              
                              -Depreciation
      and amortization
                              
                              
                              977
                              
                              
                              
                              434
                              
                              
                              
                              2,570
                              
                              
                              
                              1,033Restructuring
      charges
                              
                              
                              340
                              
                              
                              
                              162
                              
                              
                              
                              654
                              
                              
                              
                              3,053Other
      non-recurring charges
                              
                              
                              641
                              
                              
                              
                              200
                              
                              
                              
                              1,632
                              
                              
                              
                              845Impairment
      of property and equipment
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              228Total
      general and administrative expenses
                              
                              
                              7,374
                              
                              
                              
                              5,810
                              
                              
                              
                              20,218
                              
                              
                              
                              25,034Loss
      from operations
                              
                              
                              (2,089
                              )
                              
                              
                              (2,553
                              )
                              
                              
                              (5,399
                              )
                              
                              
                              (16,684
                              )Interest
      income
                              
                              
                              27
                              
                              
                              
                              37
                              
                              
                              
                              31
                              
                              
                              
                              127Interest
      expense
                              
                              
                              (124
                              )
                              
                              
                              (31
                              )
                              
                              
                              (441
                              )
                              
                              
                              (85
                              )Amortization
      of deferred financing costs and debt discount
                              
                              
                              (562
                              )
                              
                              
                              -
                              
                              
                              
                              (1,175
                              )
                              
                              
                              -Derivative
      (expense) income
                              
                              
                              (8,449
                              )
                              
                              
                              -
                              
                              
                              
                              2,233
                              
                              
                              
                              -Other
      expense
                              
                              
                              65
                              
                              
                              
                              8
                              
                              
                              
                              405
                              
                              
                              
                              140Net
      loss before income taxes
                              
                              
                              (11,132
                              )
                              
                              
                              (2,539
                              )
                              
                              
                              (4,346
                              )
                              
                              
                              (16,502
                              )Income
      tax expense
                              
                              
                              (2
                              )
                              
                              
                              (1
                              )
                              
                              
                              (4
                              )
                              
                              
                              (2
                              )Net
      loss
                              
                              
                              (11,134
                              )
                              
                              
                              (2,540
                              )
                              
                              
                              (4,350
                              )
                              
                              
                              (16,504
                              )Plus:
      Net income attributable to the non-controlling interest
                              
                              
                              -
                              
                              
                              
                              (15
                              )
                              
                              
                              -
                              
                              
                              
                              (8
                              )Net
      loss available to common shareholders
                              
                              $
                              (11,134
                              )
                              
                              $
                              (2,555
                              )
                              
                              $
                              (4,350
                              )
                              
                              $
                              (16,512
                              )Basic
      and diluted net loss per common share
                              
                              $
                              (1.65
                              )
                              
                              $
                              (0.78
                              )
                              
                              $
                              (0.82
                              )
                              
                              $
                              (7.33
                              )Basic
      and diluted weighted average common shares outstanding
                              
                              
                              6,739,934
                              
                              
                              
                              3,273,079
                              
                              
                              
                              5,278,472
                              
                              
                              
                              2,254,159Comprehensive
      loss:Net
      loss
                              
                              $
                              (11,134
                              )
                              
                              $
                              (2,555
                              )
                              
                              $
                              (4,350
                              )
                              
                              $
                              (16,512
                              )Foreign
      currency translation
                              
                              
                              (530
                              )
                              
                              
                              (219
                              )
                              
                              
                              (116
                              )
                              
                              
                              (240
                              )Change
      in unrealized gain on investments, net
                              
                              
                              15
                              
                              
                              
                              -
                              
                              
                              
                              15
                              
                              
                              
                              -Comprehensive
      loss
                              
                              $
                              (11,649
                              )
                              
                              $
                              (2,774
                              )
                              
                              $
                              (4,451
                              )
                              
                              $
                              (16,752
                              )





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, 2008
                  
                  
                  4,183,280
                  
                  
                  $
                  —
                  
                  
                  $
                  101,057Cumulative
      adjustment for derivative liabilities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (24,235
                  )Balance
      – January 1, 2009
                  
                  
                  4,183,280
                  
                  
                  
                  —
                  
                  
                  
                  76,822Issue
      of stock in public offering
                  
                  
                  4,004,000
                  
                  
                  
                  1
                  
                  
                  
                  26,089Issue
      of stock for repayment of loans
                  
                  
                  34,733
                  
                  
                  
                  —
                  
                  
                  
                  278Issue
      of stock for exercise of stock options
                  
                  
                  9,568
                  
                  
                  
                  —
                  
                  
                  
                  27Issue
      of stock for cashless exercise of warrants
                  
                  
                  8,960
                  
                  
                  
                  —
                  
                  
                  
                  —Issue
      of stock for acquisitions
                  
                  
                  641,847
                  
                  
                  
                  —
                  
                  
                  
                  4,363Acquisition
      of non-controlling interest
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  (867
                  )Debt
      discount on notes
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  517Issue
      of stock for services
                  
                  
                  9,235
                  
                  
                  
                  —
                  
                  
                  
                  89Stock-based
      compensation
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  827Foreign
      currency translation adjustment
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Fair
      market value adjustment for available for sale securities
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Net
      loss
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  —Balance
      – September 30, 2009
                  
                  
                  8,891,623
                  
                  
                  $
                  1
                  
                  
                  $
                  108,145




Accumulated
                  (Deficit)
                
                
                Accumulated
                  Other
                  Comprehensive
                  Income
                  (Loss)
                
                
                Total
                  Shareholders’
                  EquityBalance
      – December 31, 2008
                
                $
                (82,499
                )
                
                $
                (250
                )
                
                $
                18,308Cumulative
      adjustment for derivative liabilities
                
                
                8,498
                
                
                
                —
                
                
                
                (15,737
                )Balance
      – January 1, 2009
                
                
                (74,001
                )
                
                
                (250
                )
                
                
                2,571Issue
      of stock in public offering
                
                
                —
                
                
                
                —
                
                
                
                26,090Issue
      of stock for repayment of loans
                
                
                
                
                
                
                
                
                
                
                278Issue
      of stock for exercise of stock options
                
                
                —
                
                
                
                —
                
                
                
                27Issue
      of stock for exercise of warrants
                
                
                —
                
                
                
                —
                
                
                
                —Issue
      of stock for acquisitions
                
                
                —
                
                
                
                —
                
                
                
                4,363Acquisition
      of non-controlling interest
                
                
                —
                
                
                
                —
                
                
                
                (867
                )Debt
      discount on notes
                
                
                —
                
                
                
                —
                
                
                
                517Issue
      of stock for services
                
                
                —
                
                
                
                —
                
                
                
                89Stock-based
      compensation
                
                
                —
                
                
                
                —
                
                
                
                827Foreign
      currency translation adjustment
                
                
                —
                
                
                
                (116
                )
                
                
                (116
                )Fair
      market value adjustment for available for sale securities
                
                
                —
                
                
                
                15
                
                
                
                15Net
      loss
                
                
                (4,350
                )
                
                
                —
                
                
                
                (4,350
                )Balance
      – September 30, 2009
                
                $
                (78,351
                )
                
                $
                (351
                )
                
                $
                29,444




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)










Nine months ended September
    30,2009
                    
                    
                    2008Operating
      Activities:Net
      loss
                    
                    $
                    (4,350
                    )
                    
                    $
                    (16,512
                    )Adjustments
      to reconcile net loss to net cash used by operating
      activities:Provision
      for doubtful accounts
                    
                    
                    205
                    
                    
                    
                    95Depreciation
                    
                    
                    951
                    
                    
                    
                    393Amortization
      of intangible assets
                    
                    
                    1,619
                    
                    
                    
                    641Amortization
      of deferred financing costs
                    
                    
                    108
                    
                    
                    
                    -Amortization
      of debt discount
                    
                    
                    1,067
                    
                    
                    
                    -Loss
      on impairment of property and equipment
                    
                    
                    -
                    
                    
                    
                    228Derivative
      income
                    
                    
                    (2,235
                    )
                    
                    
                    -Non-cash
      stock based compensation
                    
                    
                    1,088
                    
                    
                    
                    4,262Non-cash
      warrants for settlement of separation agreements
                    
                    
                    -
                    
                    
                    
                    1,038Non-cash
      stock for services
                    
                    
                    89
                    
                    
                    
                    -Gain
      on bargain purchase
                    
                    
                    (26
                    )
                    
                    
                    -Non-controlling
      interest
                    
                    
                    -
                    
                    
                    
                    8Changes
      in assets and liabilities:Accounts
      receivable
                    
                    
                    (10,175
                    )
                    
                    
                    (559
                    )Inventories
                    
                    
                    830
                    
                    
                    
                    -Other
      assets
                    
                    
                    (177
                    )
                    
                    
                    (84
                    )Accounts
      payable
                    
                    
                    (843
                    )
                    
                    
                    (1,273
                    )Accrued
      expenses
                    
                    
                    5,008
                    
                    
                    
                    921Income
      tax payable
                    
                    
                    -
                    
                    
                    
                    6Other
      liabilities
                    
                    
                    (1,667
                    )
                    
                    
                    (253
                    )Total
      adjustments
                    
                    
                    (4,156
                    )
                    
                    
                    5,423Net
      cash used by operating activities - forward
                    
                    
                    (8,506
                    )
                    
                    
                    (11,089
                    )Investing
      Activities:Relaease
      of restricted cash
                    
                    
                    -
                    
                    
                    
                    100Cash
      paid into investment
                    
                    
                    (200
                    )
                    
                    
                    -Cash
      paid in advance of Feedroom merger
                    
                    
                    (4,636
                    )
                    
                    
                    -Cash
      received in acquisition of Narrowstep
                    
                    
                    279
                    
                    
                    
                    -Cash
      paid for completion of acquisition of Sputnik
                    
                    
                    -
                    
                    
                    
                    (4,563
                    )Cash
      paid in acquisition of Visual
                    
                    
                    (480
                    )
                    
                    
                    -Cash
      paid in acquisition of Kamera
                    
                    
                    -
                    
                    
                    
                    (4,229
                    )Cash
      paid in acquisition of Morpheum
                    
                    
                    -
                    
                    
                    
                    (649
                    )Cash
      paid in acquisition of Juzou
                    
                    
                    (150
                    )
                    
                    
                    -Purchase
      of software
                    
                    
                    (1,500
                    )
                    
                    
                    -Proceeds
      from sale of equipment
                    
                    
                    -
                    
                    
                    
                    33Purchase
      of equipment
                    
                    
                    (153
                    )
                    
                    
                    (774
                    )Net
      cash used by investing activities - forward
                    
                    $
                    (6,840
                    )
                    
                    $
                    (10,082
                    )


5






KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS (continued)


(Amounts
in Thousands)


(Unaudited)







NinemonthsendedSeptember30,2009
                
                
                2008Net
      cash used by operating activities - forwarded
                
                $
                (8,506
                )
                
                $
                (11,089
                )Net
      cash used by investing activities - forward
                
                
                (6,840
                )
                
                
                (10,082
                )Financing
      Activities:Proceeds
      from public offering, net
                
                
                26,090
                
                
                
                -Proceeds
      from private placement, net
                
                
                -
                
                
                
                14,710Proceeds
      from exercise of stock options
                
                
                27
                
                
                
                21Bank
      overdraft and other obligations
                
                
                (739
                )
                
                
                58Proceeds
      from issuance of Secured Notes
                
                
                849
                
                
                
                -Payments
      of Secured Notes
                
                
                (557
                )
                
                
                -Payments
      of Senior Secured Note
                
                
                (1,500
                )
                
                
                -Proceeds
      from issuance of Convertible Notes Payable
                
                
                3,700
                
                
                
                -Repayments
      of Convertible Notes Payable
                
                
                (3,700
                )
                
                
                -Liability
      to KIT Media, Ltd.
                
                
                -
                
                
                
                2,500Payment
      on capital leases
                
                
                (778
                )
                
                
                (94
                )Net
      cash provided by financing activities
                
                
                23,392
                
                
                
                17,195Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (473
                )
                
                
                (144
                )Net
      increase (decrease) in cash and cash equivalents
                
                
                7,573
                
                
                
                (4,120
                )Cash
      and cash equivalents - beginning of period
                
                
                5,878
                
                
                
                10,189Cash
      and cash equivalents - end of period
                
                $
                13,451
                
                
                $
                6,069Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Interest
                
                $
                441
                
                
                $
                84





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
business is divided into two segments: Digital Media Solutions and Professional
Services (formerly “Agency Services”). Digital Media 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. Professional Services 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)
considered necessary in order to make the interim financial statements not
misleading have been included. The consolidated results of operations for the
three and nine months ended September 30, 2009 are not necessarily indicative of
the results that may be expected for the year ending December 31, 2009. These
interim consolidated financial statements should be read in conjunction with the
consolidated financial statements and footnotes thereto of the Company and
management’s discussion and analysis of financial condition and results of
operations included in the our annual report on Form 10-K for the year ended
December 31, 2008.




During
the third quarter ended September 30, 2009, we identified certain errors in the
fair valuation of derivative liabilities and accounting for acquisition of
noncontrolling interests related to prior interim periods in fiscal year 2009.
We have adjusted the opening balances to correct these errors and present
correct amounts for the three months and nine months ended September 30, 2009.
See Note 6 “Derivative liabilities” and Note. 13, “Correction of errors” for
further details. These errors have no impact on the consolidated balance sheet
and statement of operations and comprehensive income (loss) for the year ended
December 31, 2008.


We
evaluated events or transactions which occurred subsequent to the balance sheet
date but prior to November 19, 2009, the issuance date of the financial
statements, for recognition or disclosure.





(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.





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 on the following major items; allowance for
doubtful accounts, revenue recognition, fair value of derivative liabilities and
impairment of tangible and intangible assets.


7





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







Foreign Currency
Translation - Assets and liabilities of KIT digital’s foreign
subsidiaries are translated at current 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.





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 6 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. From time to time, we obtain collateral for our
cash and cash equivalent 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 cash beyond insured amounts as of September 30, 2009
was $13,201.




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. The allowance for doubtful accounts as of September 30, 2009 was $892.
As of September 30, 2009, three customers accounted for approximately 43% 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.





Impairment of
Long-Lived Assets - We review our long-lived assets and identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. When such factors
and circumstances exist, we compare the projected undiscounted future cash flows
associated with the future use and disposal of the related asset or group of
assets to their respective carrying amounts. Impairment, if any, is measured as
the excess of the carrying amount over the fair value based on market value
(when available) or discounted expected cash flows of those assets, and is
recorded in the period in which the determination is made.





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 September 30, 2009, we had $2,023 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.


8





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited )









Investments
– Investments include an investment in a limited partnership fund which
invests, on a hedged basis, primarily in the U.S. equity markets. This
investment was made in March 2009 and is recorded at a fair value of
$215.





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.





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
- Income tax expense (or benefit) for the year is the sum of deferred tax
expense (or benefit) and income taxes currently payable (or refundable).
Deferred tax expense (or benefit) is the change during the year in a company's
deferred tax liabilities and assets. Deferred tax liabilities and assets are
determined based on differences between financial reporting and tax bases of
assets and liabilities, and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to
reverse.





Intangible Assets
- Amortizable intangible assets of the Company are recorded at cost less
accumulated amortization. Amortization is computed using the straight-line
method over the estimated useful lives of the assets, with periods of up to five
years. Goodwill is reviewed for impairment at least annually and all other
intangible assets are reviewed for impairment if events or circumstances
indicate that carrying amounts may not be recoverable.





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. 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
September 30, 2009 and December 31, 2008, our reserves for excess and obsolete
inventory were $145 and $157, respectively.




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 and $13,503 on January 1, 2009 and September
30, 2009, respectively. See Note 6, “Derivative Liabilities” and Note 13 “Correction of
errors”, for further
information.


9


KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







Research and
Development - Costs incurred in research and development are expensed as
incurred. 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.





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.





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 required service periods. Our
share-based awards include stock options, warrants and restricted stock
awards.





We
adopted the accounting standard using the modified prospective transition
method, which requires the application of the accounting standard to all
share-based awards issued on or after January 1, 2006 and any outstanding
share-based awards that were issued but not vested as of January 1, 2006. For
the nine months ended September 30, 2009 and 2008, we recognized $1,088 and
$4,262, respectively, of stock-based compensation expense in the consolidated
statements of operations. Included in the 2009 amount is $261 for employees who
have agreed to be issued stock in lieu of compensation and is included in
accrued expenses as of September 30, 2009.





The
estimated fair value underlying our calculation of compensation expense for
stock options is based on the Black-Scholes-Merton pricing model. This
accounting standard requires forfeitures of share-based awards to be estimated
at the time of grant and revised, if necessary, in subsequent periods if
estimates change based on the actual amount of forfeitures
experienced.





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. Under the 2008 Incentive
Stock Plan, options may be granted which are intended to qualify as Incentive
Stock Options under Section 422 of the Internal Revenue Code of 1986 or which
are not intended to qualify as Incentive Stock Options thereunder. In addition,
direct grants of stock or restricted stock may be awarded.


10





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







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




Nine Months
                                  Ended
                                  September 30,
                                  2009Expected
      life (in years)
                                
                                
                                5.00Risk-free
      interest rate
                                
                                
                                2.83
                                %Volatility
                                
                                
                                77.55
                                %Dividend
      yield
                                
                                
                                0





A summary
of the status of stock option awards and changes during nine months ended
September 30, 2009 are presented below:





Shares
                        
                        
                        Weighted
                          Average
                          Exercise
                          Price
                        
                        
                        Weighted
                          Average
                          Remaining
                          Contractual
                          Life (Years)
                        
                        
                        Intrinsic
                          ValueOutstanding
      at January 1, 2009
                        
                        
                        501,613
                        
                        
                        $
                        5.25Granted
                        
                        
                        465,584
                        
                        
                        
                        7.53Exercised
                        
                        
                        (9,566
                        )
                        
                        
                        2.80Cancelled,
      expired, or forfeited
                        
                        
                        (100,772
                        )
                        
                        
                        7.59Outstanding
      at September 30, 2009
                        
                        
                        856,859
                        
                        
                        
                        7.11
                        
                        
                        
                        4.26
                        
                        
                        $
                        2,398Exercisable
      at September 30, 2009
                        
                        
                        305,422
                        
                        
                        
                        6.52
                        
                        
                        
                        3.94
                        
                        
                        $
                        1,036





The
weighted-average grant-date fair value of option awards granted during the nine
months ended September 30, 2009 was $4.43.





Also
included in non-cash 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 36 months from the issue date. During the nine months ended September
30, 2009, a total of 8,571 warrants vested with 17,143 warrants unvested as of
September 30, 2009.The intrinsic value of the outstanding warrants and
exercisable warrants are $180 and $90, respectively.





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.





Reclassification
- Certain prior period amounts have been reclassified to conform to the
current presentation.


11





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





Recent Accounting
Pronouncements –    In December 2007, the FASB issued a new
accounting standard, which establishes accounting and reporting standards for
the noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. It clarifies that a noncontrolling interest in a subsidiary, which
is sometimes referred to as minority interest, is an ownership interest in the
consolidated entity that should be reported as equity in the consolidated
financial statements. Among other requirements, this standard requires
consolidated net income to be reported at amounts that include the amounts
attributable to both the parent and the noncontrolling interest. It also
requires disclosure, on the face of the consolidated income statement, of the
amounts of consolidated net income attributable to the parent and to the
noncontrolling interest. We adopted the provisions of this new accounting
standard on January 1, 2009. We implemented these changes, which led to changes
in the presentation of prior period results.





In April
2009, the FASB issued new requirements for interim disclosures about fair value
of financial instruments, which increase the frequency of fair value disclosures
to a quarterly basis instead of annually. The requirements relate to fair value
disclosures for any financial instruments that are not currently reflected on
the balance sheet at fair value. Prior to these changes, fair values for these
assets and liabilities were only disclosed annually. We adopted the provisions
of these accounting standards on June 30, 2009. The newly required interim
disclosures, which we included in Note 2, had no impact on our consolidated
financial position or results of operations.





In April
2009, the FASB issued new guidance on the recognition and presentation of
other-than-temporary impairments, which segregate credit and noncredit
components of impaired debt securities that are not expected to be sold.
Impairments will still have to be measured at fair value in other comprehensive
income. These accounting standards also require some additional disclosures
regarding expected cash flows, credit losses, and an aging of securities with
unrealized losses. We adopted the new guidance on June 30, 2009; the adoption of
which had no impact on our consolidated financial position or results of
operations





In May
2009, the FASB issued a new accounting standard on subsequent events, which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. This accounting standard establishes: 1) the period
after the balance sheet date during which management of a reporting entity
should evaluate events or transactions that may occur for potential recognition
or disclosure in the financial statements; 2) the circumstances under which an
entity should recognize events or transactions occurring after the balance sheet
date in its financial statements; and 3) the disclosures that an entity should
make about events or transactions that occurred after the balance sheet date.
This accounting standard also requires disclosure of the date through which an
entity has evaluated subsequent events. We adopted the provisions of this
accounting standard on June 30, 2009. In connection with the adoption of this
accounting standard, we have included disclosure in Note 1 to address the date
through which we evaluated subsequent events.





In June
2009, the FASB issued the accounting standard “The FASB Accounting Standards
CodificationTM and the Hierarchy of Generally Accepted Accounting Principles—a
replacement of FASB Statement No. 162”, which establishes the FASB Accounting
Standards CodificationTM (“Codification”) as the source of authoritative U.S.
Generally Accepted Accounting Principles (GAAP) recognized by the FASB to be
applied by nongovernmental entities. Rules and interpretive releases of the
Securities and Exchange Commission (“SEC”) under authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. We adopted the
provisions of this accounting standard for the interim period
ended September 30, 2009. The implementation of this accounting standard
did not have any impact on our consolidated financial position and results of
operations upon adoption.





In April 2009, the FASB
also issued new guidelines on the initial recognition and measurement,
subsequent measurement and accounting, and disclosure of assets and liabilities
arising from contingencies in a business combination which provides that an
acquirer shall recognize an asset acquired or a liability assumed in a business
combination that arises from a contingency at fair value, at the acquisition
date, if the acquisition-date fair value of that asset or liability can be
determined during the measurement period. New guidance is also provided in the
event that the fair value of an asset acquired or liability assumed cannot be
determined during the measurement period. An acquirer shall also develop a
systematic and rational basis for subsequently measuring and accounting for
assets and liabilities arising from contingencies and also provides for the
disclosure requirements. We
adopted the provisions of the new accounting standards on business combinations
on January 1, 2009; acquisitions after this are accounted for using this
standard.





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.


12





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





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 are currently assessing the impact of
adoption of this update.





(3)
Notes Payable





On May 1,
2009, we issued a convertible interim promissory note up to a maximum of $5,000
to KIT Media, Ltd. of which we received gross proceeds of $2,250 in the quarter
ended June 30, 2009 and $1,100 in the quarter ended September 30, 2009. Interest
is payable monthly in arrears at 8% and matures on April 30, 2010. Interest
of $51 was calculated through conversion and paid. The principal was due at
maturity. A debt discount of $442 was recorded related to this debt and was
amortized through the repayment date of August 18, 2009. As of August 18,
2009, these notes were repaid from the proceeds of the public
offering.





On April
8, 2009, we received gross proceeds of $350 related to the issuance of a
convertible note to Granahan McCourt Capital, LLC. The note was interest
free.  The principal was due at maturity. A debt discount of $75 was
recorded related to this debt and was amortized through June 30, 2009. As of
August 18, 2009, these notes were repaid from the proceeds of the public
offering.





In November 2008, we received $1,500 in
gross proceeds from the issuance of a non-convertible note to Genesis Merchant
Partners, LP. Interest is payable monthly in arrears at 14.5% and matures on
December 31, 2009.  The principal is repayable in monthly installments
of $75 beginning in May 2009, with the remainder of the principal due at
maturity.  The note is secured by the company’s property, including
accounts receivable and inventory, but excludes any security interests in Visual
and Reality Group or assets of these subsidiaries.  In conjunction
with the borrowing, we issued to Genesis Merchant Partners, LP a warrant
entitling it to purchase, for $11.90 per share, 139,286 shares of our common
stock through October 31, 2013. A debt discount of $642 was recorded related to
this debt and is being amortized over fourteen months which is the life of the
note. On August 18, 2009,
we repaid the entire principal balance of the non-convertible note of $1,275
owed to Genesis Merchant Partners, LP and wrote off the unamortized amount of
debt discount as of that date.





(4)
Acquisitions





On March
6, 2009, we acquired the remaining 49% outstanding share capital that we did not
previously own in subsidiary Reality Group Pty. Ltd., in consideration of
issuing the sellers 90,073 shares of our common stock for a total purchase price
of $631 which is recorded as a reduction to additional paid-in capital. The
remaining balance of the non-controlling interest of $236 is recorded as part of
the acquisition and recorded as additional paid-in capital. The total of
$867 was originally recorded as goodwill, see Note 13 “Correction of Errors.”
Reality Group’s activities are part of the Professional Services segment of our
business.





On April
8, 2009, we acquired certain of the operating assets and
assumed specified liabilities of Narrowstep, Inc. (“Narrowstep”) in an
asset purchase agreement, in exchange for 25,000 shares of restricted common
stock valued at $213. The Company has allocated the aggregate cost of the
acquisition to net tangible and identifiable intangible assets based on their
estimated fair values.





The
following table summarizes the estimated fair values of the assets acquired and
liabilities assumed at the date of the Narrowstep acquisition (April 8, 2009).


Current
      assets
                                    
                                    $
                                    670Property
      and equipment
                                    
                                    
                                    296Intangible
      assets - customer lists
                                    
                                    
                                    313Total
      assets acquired
                                    
                                    
                                    1,279Current
      liabilities
                                    
                                    
                                    1,040Total
      liabilities assumed
                                    
                                    
                                    1,040Net assets acquired
                                    
                                    $
                                    239Gain
      on bargain purchase
                                    
                                    $
                                    26





A gain on bargain purchase of $26 was
recorded to other income in the three months ended June 30,
2009.




13




KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







In
November 2008, we purchased specified assets of Extreme Mobile Services Limited
(also known as Juzou), a company formed under the laws of the United
Kingdom.  Juzou’s business involves content management and web
services with live streaming capabilities.  Under an Asset Purchase
Agreement, dated November 15, 2008, we acquired the Juzou trademark and system
and ongoing client and other operating contracts.  The total purchase
price of the assets was $800, payable in shares of our common stock based on
meeting specified financial and operating targets over the ensuing two-year
period, which has subsequently been amended in August 2009 to
$570.  At closing, we issued 13,715 shares of our common stock to
Juzou valued at $120 against the total purchase price of which $104 was
recorded as software. In September 2009, we paid $150 in cash and issued 10,559
shares valued at $90, which was recorded as software. We have not recorded the
contingent liability of $210 in consideration that is payable 12, 18 and 24
months from closing as it is not certain that the performance criteria will be
met.





(5)
Acquisition Liabilities





On March
9, 2009, we issued 300,539 shares of our common stock in satisfaction of a
$1,500 acquisition liability incurred in connection with the acquisition of
Kamera Content AB (“Kamera”) in 2008, which is included in goodwill. In
September 2009, we recorded an additional liability of $1,083 as a result of an
amendment to the underling share purchase agreement for full and final
settlement of all future/potential earn-out payments. This has been recorded as
additional goodwill in the consolidated balance sheet as of September 30, 2009.
The liability included in the consolidated balance sheet in “Acquisition
liability - Kamera” is $2,583 as of September 30, 2009. In October 2009, we paid
$1,700 and 110,805 shares valued at $883 to settle this liability.





In
January 2009, we paid $180 in cash to the former shareholders of Visual
Connection a.s. (“Visual”), pursuant to the Visual Share Purchase Agreement
dated October 5, 2008 (“Visual SPA”). In March 2009, we issued 163,044 shares of
our common stock to the former shareholders of Visual, pursuant to the Visual
SPA, in satisfaction of a $1,500 earn out liablility, which is included in
goodwill. In September 2009, we issued 52,632 shares valued at $430 and $300 in
cash to the former shareholders of Visual pursuant to an amendment to the Visual
SPA and in satisfaction of the earn-out 12 months after closing and is included
in goodwill. The liability included in the consolidated balance sheet in
“Acquisition liability – Visual” is $1,075 as of September 30, 2009. We have not
recorded the contingent liability of $1,075 in consideration that is payable 18
and 24 months from closing as it is not certain that the performance criteria
will be met.





(6)
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 13 “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 and September 30, 2009 were 5,806,230 and
4,906,265, 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 increased from
2,886,038 to 4,906,265.


14





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







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 estimate 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. 
 The
application of the new accounting standard resulted in a non-cash derivative
expense of $8,449 in the third quarter of 2009. The application of the new
accounting standard adjustment resulted in an offsetting $10,176 and $506
of derivative income in the first and second quarters of 2009, respectively,
which will be reported in the 2009 annual financial reports. Taking into account
the aggregate amounts that would have been recorded in the first and second
quarters of 2009 for this adjustment, the company had an accumulated amount of
$2,233 in non-cash derivative income for the nine months ending September 30,
2009.  See Note 13 (“Correction of errors”) for further
details.





The
following tables summarize the components of derivative liabilities as of
September 30, 2009 and the re-measurement date, January 1, 2009:





September
                  30, 2009
                
                
                Re-measurement
                  date
                  January 1, 2009Fair
      value of warrants with anti-dilution provisions
                
                $
                (13,503
                )
                
                $
                (15,736
                )Significant
      assumptions (or ranges):Trading
      market values  (1)
                
                $
                9.91
                
                
                $
                5.25Term
      (years)
                
                
                3.61
      to 4.25
                
                
                
                4.35
      to 5.00Volatility   (1)
                
                
                42.23
                %
                
                
                101.98
                %Risk-free
      rate   (2)
                
                
                1.45
      to 2.31
                %
                
                
                1.55
                %Effective
      Exercise price  (3)
                
                $
                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 and nine months ended
September 30, 2009 was $(8,449) and $2,233, respectively.




See Note
13 “Correction of errors”, for a
description the correction of an error related to the derivative
liability.


15





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







(7)
Stock Issuances





During
the quarter ended March 31, 2009, we issued 562,476 shares of common stock. Of
this amount we issued 8,820 shares from the exercise of stock options and
received $25 in gross proceeds. In addition, we issued 90,073 shares for the
acquisition of Reality, 300,539 shares for the acquisition of Kamera and 163,044
shares for the acquisition of Visual.





During
the quarter ended June 30, 2009, we issued 65,623 shares of common stock. Of
this amount, we issued 748 shares from the exercise of stock options and
received $2 in gross proceeds. In addition, we issued 25,000 shares for the
asset purchase agreement with Narrowstep, 34,733 shares for the repayment of
loans and 5,142 shares for services.





During
the quarter ended September 30, 2009, we issued 4,080,244 shares of common
stock. Of this amount, we issued 4,004,000 shares in the public offering in
August 2009, 52,632 shares for the acquisition of Visual, 10,559 shares for the
assets acquired from Juzou, 8,960 shares for exercise of warrants and 4,093
shares for services.





In August
2009, we completed the sale of 4,554,000 shares of our common stock at a price
of $7.00 per share in a public offering, 4,004,000 shares were sold by us and
550,000 shares were sold by certain existing, unaffiliated stockholders. The
gross proceeds of the common stock sold by us were $28,028. We did not receive
any proceeds from the sale of shares by the selling stockholders. We issued to
the underwriters 44,067 warrants to purchase shares of common stock with an
exercise price of $8.40 per share exercisable for a period of five years and
were valued under the Black-Scholes-Merton method as $181. In connection with
the public offering, we received net cash proceeds of approximately $26,090
after underwriting discounts, commissions and fees, legal fees and expenses, and
other fees.





KIT
Media, Ltd., our largest single stockholder, controlled by Kaleil Isaza Tuzman,
our Chairman and Chief Executive Officer, has purchased $4,004 of common stock
(572,000 shares) in this August 18, 2009 offering, in part through the
conversion into common stock of an interim note payable by us in the amount of
$3,350. All shares sold to KIT Media were at the same price and on the same
terms as the other investors in this offering. Gavin Campion, our President, is
also an investor in KIT Media, as are several members of our board of
directors.





(8)
Restructuring Charges





The
Company recorded restructuring charges of $654 in the nine months ended
September 30, 2009. This amount is comprised of employee termination costs
related to the reorganization of the Company of $271 and facility closing costs
of $382 related to the closing of one of the Melbourne, Australia offices and
one of the Dubai, UAE offices.





The
Company recorded restructuring charges of $3,053 in the nine months ended
September 30, 2008. This amount is comprised of employee termination costs
related to the reorganization of the Company of $2,716, contract settlement and
facility closing costs of $337 related to the closing of the Clifton Park, New
York office and the closing of one of the Melbourne, Australia offices, and
vendor settlements related to the reorganization. Included in the employee
termination costs are $2,397 related to the settlement of separation
agreements.





(9)
Other Non-Recurring Charges





The
Company has recorded other non-recurring charges of $1,632 in the nine months
ended September 30, 2009 related to the redundancy in staff and consultants
during reorganization, corporate rebranding related to the reorganization,
integration of acquired companies and assets, and legal and consulting fees
related to potential fund raising.





The
Company has recorded other non-recurring charges of $845 in the nine months
ended September 30, 2008 related to the redundancy in staff and consultants for
the transition of technology infrastructure during reorganization due to the
centralizing of resources in Toronto, recruiting costs for the centralizing of
resources in Toronto, legal fees for the acquisitions of Kamera and Sputnik, and
corporate rebranding related to the reorganization.


16





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







(10)
Impairment of Property and Equipment





In March
2008, we decided to downsize our office in London and move to another location
to reduce costs. This included removing and abandoning the leasehold
improvements and furniture and fixtures in the former London office. Due to this
office relocation, we recorded an impairment charge for certain property and
equipment, which totaled $228, during the nine months ended September 30, 2008.
This amount was recorded as a loss on impairment of property and equipment in
the Statement of Operations.





(11)
Segment Reporting





We have
presented the operating segments for revenue, operating loss or income and
assets and geographical location for revenue and assets below. We derive our
revenue from two operating segments. These operating segments are presented on a
worldwide basis and include: Digital Media Solutions and Professional
Services.





Digital
Media Solutions includes the comprehensive delivery of IP video software
solutions, including SaaS fees, enterprise license fees, software usage fees,
storage, set-up/support services, hardware components, content delivery, content
syndication, and advertising-based monetization. Our IP digital asset management
platform, branded as “VX”, allows for management of IP video assets for
consumption on the computer browser, mobile devices and the IPTV set-top box
enabled television set. Our software is generally hosted in our facilities, and
delivered as a service, but we occasionally sell upfront enterprise licenses
which allow for hosting and deployment of our VX suite at the client
site.





Professional
Services is designed to support and complement the Digital Media Solutions
segment of our business, and includes technical integration services, interface
design, branding, strategic planning, creative production, sponsorships, online
marketing, media planning, data management and analytics.





The
emphasis of our business is the Digital Media Solutions segment. As our
operations continue to evolve, the Company will continue to regularly review the
business to determine if there is a need to make changes to these reported
segments.





The
following table provides revenue and segment income (loss) from operations for
each of the segments. Segment income (loss) from operations, as shown below, is
the performance measure used by management to assess segment performance and
excludes the effects of: stock-based compensation, amortization of intangible
assets and corporate expenses. Corporate expenses consist of those costs not
directly attributable to a segment, and include: salaries and benefits for our
corporate executives, corporate governance costs, fees for professional service
providers including audit, legal, tax, insurance, and other corporate
expenses.


17





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





Three months ended
                                  
                                  Nine months endedSeptember 30,
                                  
                                  September 30,2009
                                  
                                  
                                  2008
                                  
                                  2009
                                  
                                  
                                  2008Revenue:Digital
      Media Solutions
                                  
                                  $
                                  10,180
                                  
                                  
                                  $
                                  3,977
                                  
                                  
                                  $
                                  27,954
                                  
                                  
                                  $
                                  9,830Professional
      Services
                                  
                                  
                                  856
                                  
                                  
                                  
                                  1,404
                                  
                                  
                                  
                                  3,200
                                  
                                  
                                  
                                  4,538Total
      revenue
                                  
                                  $
                                  11,036
                                  
                                  
                                  $
                                  5,381
                                  
                                  
                                  $
                                  31,154
                                  
                                  
                                  $
                                  14,368Operating
      (loss) income:Digital
      Media Solutions
                                  
                                  $
                                  551
                                  
                                  
                                  $
                                  (1,440
                                  )
                                  
                                  $
                                  (637
                                  )
                                  
                                  $
                                  (7,046
                                  )Professional
      Services
                                  
                                  
                                  (39
                                  )
                                  
                                  
                                  63
                                  
                                  
                                  
                                  (92
                                  )
                                  
                                  
                                  252Corporate
                                  
                                  
                                  (2,601
                                  )
                                  
                                  
                                  (1,176
                                  )
                                  
                                  
                                  (4,670
                                  )
                                  
                                  
                                  (9,890
                                  )Total
      operating (loss) income
                                  
                                  $
                                  (2,089
                                  )
                                  
                                  $
                                  (2,553
                                  )
                                  
                                  $
                                  (5,399
                                  )
                                  
                                  $
                                  (16,684
                                  )September
      30,
                                  
                                  
                                  
                                  
                                  
                                  December
      31,2009
                                  
                                  
                                  
                                  
                                  
                                  2008Assets:Digital
      Media Solutions
                                  
                                  $
                                  25,202
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  15,901Professional
      Services
                                  
                                  
                                  1,121
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  836Corporate
                                  
                                  
                                  38,715
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  24,572Total
      assets
                                  
                                  $
                                  65,038
                                  
                                  
                                  
                                  
                                  
                                  
                                  $
                                  41,309





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





Three months ended
                                    
                                    Nine months endedSeptember 30,
                                    
                                    September 30,2009
                                    
                                    
                                    2008
                                    
                                    2009
                                    
                                    
                                    2008Revenue:EMEA
                                    
                                    $
                                    7,802
                                    
                                    
                                    $
                                    1,917
                                    
                                    
                                    $
                                    21,411
                                    
                                    
                                    $
                                    4,156AsiaPac
                                    
                                    
                                    2,626
                                    
                                    
                                    
                                    2,740
                                    
                                    
                                    
                                    8,052
                                    
                                    
                                    
                                    8,695Americas
                                    
                                    
                                    608
                                    
                                    
                                    
                                    724
                                    
                                    
                                    
                                    1,691
                                    
                                    
                                    
                                    1,517Total
      revenue
                                    
                                    $
                                    11,036
                                    
                                    
                                    $
                                    5,381
                                    
                                    
                                    $
                                    31,154
                                    
                                    
                                    $
                                    14,368September
      30,
                                    
                                    
                                    
                                    
                                    
                                    December
      31,2009
                                    
                                    
                                    
                                    
                                    
                                    2008Assets:EMEA
                                    
                                    $
                                    19,887
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    9,831AsiaPac
                                    
                                    
                                    3,793
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    2,786Americas
                                    
                                    
                                    2,643
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    4,120Corporate
                                    
                                    
                                    38,715
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    24,572Total
      assets
                                    
                                    $
                                    65,038
                                    
                                    
                                    
                                    
                                    
                                    
                                    $
                                    41,309


18





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







(12)
Software license agreement





In the
first quarter of 2009, we sold a non-exclusive, perpetual, non-transferable,
non-assignable and non-sublicenseable, worldwide license to use our technology
for the sole purpose of providing online video services to this non-related
party’s customers for a license fee of $1,500. We also are charging an annual
maintenance fee of 18% of the license fee. The license fee was recorded in the
income statement as “Revenue” in the first quarter of 2009 and the maintenance
fee is being recognized in revenue on a monthly basis. In the first quarter of
2009, we purchased a non-exclusive, perpetual, non-transferable, non-assignable
and non-sublicenseable, license to use the software from this same non-related
party to power search and related videos within our VX Application and player of
our owned and licensed video content or our customer’s video content for a
license fee of $1,500 and an annual support and maintenance fee of $270. The
license fee was recorded in the balance sheet in “Software, net” and is being
amortized over two years. The annual support and maintenance fee is being
recorded in the income statement as expense on a monthly basis.





(13)
Correction of Errors





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





The
acquisition of the remaining 49% non-controlling interest in March 2009 was
accounted for using purchase method and $867 was recorded as goodwill as of
March 31, 2009 and June 30, 2009. The acquisition of the non-controlling
interest should have been recorded as an equity transaction as a reduction in
additional paid in capital which has now been corrected as of September 30,
2009 in the consolidated balance sheets.





An
adjustment has been 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 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.  As of June 30, 2009, the correction
increased the derivative liability by $1,120 and increased the derivative
expense by $1,120, in addition to the corrections above as of January 1, 2009
and March 31, 2009 to the consolidated balance sheets. As of June 30, 2009, the
corrected consolidated balance sheet has derivative liability of $5,054 and
total liabilities of $30,892. In the three months ended June 30, 2009, the
corrected consolidated statement of operations has a derivative income of
$506 and the net loss available to common shareholders of $1,610, with a basic
and diluted net loss per common share of $(0.37). In the
six months ended June 30, 2009, the corrected consolidated statement of
operations has a derivative income of $10,682 and the net income available to
common shareholders of $6,784, with a basic and diluted net income per common
share of $1.50. Taking into account the aggregate derivative income (loss)
adjustments that would have been recorded in the three months ended March 31,
2009 and June 30, 2009, the derivative income for the nine months ended
September 30, 2009 is $2,233.




The
derivative income (expense) for the three and nine months ended September 30,
2009 is based on changes in the fair values, adjusted for the correction of
above mentioned errors. Management believes these correction of errors are not
material to the financial position for the nine months ended September 30,
2009.
  19





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)







(14)
Related Party Transactions





In
December 2007, we entered into an agreement with 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 nine months ended September 30, 2009 and 2008 were
$390 and $438, respectively.





On May 1,
2009, we issued a convertible interim promissory note up to a maximum of $5,000
to KIT Media, Ltd. of which we received gross proceeds of $2,250 in the quarter
ended June 30, 2009 and $1,100 in the quarter ended September 30, 2009. Interest
is payable monthly in arrears at 8% and matures on April 30, 2010. Interest
of $51 was calculated and paid. The principal was due at maturity. A debt
discount of $442 was recorded related to this debt and was amortized through
the repayment date of August 18, 2009. As of August 18, 2009, these notes
were repaid from the proceeds of the public offering.





KIT
Media, Ltd., our largest single stockholder, controlled by Kaleil Isaza Tuzman,
our Chairman and Chief Executive Officer, has purchased $4,004 of common stock
(572,000 shares) in this August 18, 2009 offering, in part through the repayment
of an interim note payable by us in the amount of $3,350. All shares sold to KIT
Media were at the same price and on the same terms as the other investors in
this offering. Gavin Campion, our President, is also an investor in KIT Media,
as are several members of our board of directors.





(15)
Subsequent Events





On
September 30, 2009, KIT digital, KIT Acquisition Corporation, a Delaware
corporation and wholly-owned subsidiary of KIT digital,  The FeedRoom,
Inc., a Delaware corporation (“FeedRoom”) and certain stockholders of FeedRoom,
entered into a definitive Agreement and Plan of Merger (the “Merger
Agreement”).  Under the Merger Agreement, KIT Acquisition Corporation
merged with and into FeedRoom and as a result of such merger KIT digital became
the sole stockholder of FeedRoom as of the effective date of October 1,
2009.  FeedRoom stockholders received in exchange for their capital
stock in FeedRoom 1,312,000 shares of KIT digital common stock (the “Merger
Shares”), which reflects 948,636 shares of KIT digital common stock issued for
the acquisition of FeedRoom and an additional 363,636 shares of KIT digital
common stock issued in exchange for a $4,000 indirect investment in KIT digital
through the purchase of FeedRoom Series F Preferred Stock by certain
stockholders of FeedRoom immediately prior to the closing of the
merger.  The KIT digital common stock was sold to such stockholders at
an effective price of $11.00 per share.  In accordance with the Merger
Agreement, the Merger Shares were delivered as follows: (i) 937,398 shares
of KIT common stock delivered to the stockholders of FeedRoom; and (ii) a
“holdback amount” of 374,602 shares of KIT common stock, which will be used by
KIT digital to satisfy any indemnity claims in accordance with the Merger
Agreement, the balance of which will be payable by KIT digital one year after
the closing. Included
in “Receivable from FeedRoom” in the consolidated balance sheet is $4,736 which
represents the payment of FeedRoom’s debt in advance of the
closing.





On
October 5, 2009, KIT digital and International Management Group GmbH (“IMG”), a
company organized under the laws of Germany, entered into a definitive Share
Purchase Agreement (the “Share Purchase Agreement”).  Under the Share
Purchase Agreement, at the closing on October 9, 2009, KIT digital acquired all
of the issued and outstanding shares of capital stock of Nunet AG, a stock
corporation organized under the laws of Germany, for an aggregate purchase price
of EUR 7,647, consisting of: a cash payment of EUR 5,400 paid at closing; a
convertible promissory note of EUR 1,663 due March 31, 2011; and another
convertible promissory note of EUR 584 due June 30, 2010. These convertible
promissory notes have since been converted into 339,540 shares of common stock
and purchased by an independent investor. An additional EUR 300 was paid to IMG
at closing to cover brokers, introducing parties, management incentives and
other transaction-related costs.


20





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 Dubai, Melbourne (Australia), Prague, Toronto, Stockholm, New York,
London, Cairo, Singapore, Buenos Aires and Bogotá. 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 and nine months ended September 30, 2009 and 2008. 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 September 30, 2009 Compared to Three Months
Ended September 30, 2008





Revenue . Consolidated revenue
increased by $5,655 from $5,381 for the three months ended September 30, 2008 to
$11,036 for the three months ended September 30, 2009, an increase of
105%.





Digital
Media Solutions segment revenue increased by $6,203 from $3,977 for the three
months ended September 30, 2008 to $10,180 for the three months ended September
30, 2009, an increase of 156%. The increase was principally due to
an increase in customers, increased spending by existing customers and
revenue from the acquired companies not included in prior period
results.





Professional
Services segment revenue decreased by $548 from $1,404 for the three months
ended September 30, 2008 to $856 for the three months ended September 30, 2009,
a decrease of 39%. The decrease was primarily due to a greater emphasis on
the growth in the Digital Media Solutions segment and a decrease in spending by
existing clients.


21





Variable
and Direct Third Party Costs





Cost of Goods and Services .
Cost of goods and services of $4,550 represents the costs for the supply of IPTV
solutions, services and components; no expenses were classified as such prior to
the acquisition of Visual in October 2008.





Hosting, Delivery and
Reporting . These costs decreased by $168 from $499 for the three months
ended September 30, 2008 to $331 for the three months ended September 30, 2009,
a decrease of 34%. These costs decreased primarily due to a decrease in the cost
of delivering content.





Content Costs . Content costs
decreased by $579 from $866 for the three months ended September 30, 2008 to
$287 for the three months ended September 30, 2009, a decrease of 67%. 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 decreased
by $176 from $759 for the three months ended September 30, 2008 to $583 for the
three months ended September 30, 2009, a decrease of 23% attributable to lower
costs in the Professional Services segment associated with the decrease in the
revenue of that segment.





General
and Administrative Expenses





Compensation, Travel and Associated
Costs (Exclusive of Non-Cash Stock-Based Compensation) . These costs
decreased by $391 from $3,701 for the three months ended September 30, 2008 to
$3,310 for the three months ended September 30, 2009, a decrease of 11%. The
decrease was primarily due to the broad cost cutting measures that have been
implemented during 2008 and 2009 which included a reduction in headcount and
salary levels offset in part by increases due to our business
acquisitions.





Non-Cash Stock-Based
Compensation . Non-cash stock-based compensation expense increased 185%
by $348, from $188 for the three months ended September 30, 2008 to $536 for the
three months ended September 30, 2009. This increase is due to more options
being issued subsequent to September 2008.





Legal, Accounting, Audit and Other
Professional Services Fees . These expenses decreased by $137 from $291
for the three months ended September 30, 2008 to $154 for the three months ended
September 30, 2009, a decrease of 47%, primarily due to lower legal
fees.





Office, Marketing and Other Corporate
Costs . These expenses increased by $60 from $834 for the three months
ended September 30, 2008 to $894 for the three months ended September 30, 2009,
a increase of 7%. The increase was primarily due to the increases related to the
acquisition of Visual in October 2008.





Merger and Acquisition and Investor
Relation Expenses . Merger and acquisition and certain investor relation
expenses were $522 for the three months ended September 30, 2009 and there were
no such expenses in the three months ended September 30, 2008, which is
primarily due to the new accounting pronouncement.





Depreciation and Amortization
.. Depreciation and amortization expense increased 125% by $543 from $434 for the
three months ended September 30, 2008 to $977 for the three months ended
September 30, 2009. The increase is primarily attributed to the amortization of
intangible assets and depreciation of long lived assets acquired as part of the
acquisitions of Kamera in May 2008 and Visual in October 2008.





Restructuring Charges .
Restructuring charges increased 110% by $178, from $162 for the three months
ended September 30, 2008 to $340 for the three months ended September 30, 2009.
These charges increased primarily due to the increase in facility closing costs
and contract settlements.





Other Non-Recurring Charges .
Other non-recurring charges increased 221% by $441 from $200 for the three
months ended September 30, 2008 to $641 for the three months ended September 30,
2009. These charges have increased primarily due to the inclusion of costs for
the integration of systems and operations in 2009.


22


Interest Income . Interest
income decreased by $10 from $37 for the three months ended September 30, 2008
to $27 for the three months ended September 30, 2009, a decrease of
27%.





Interest Expense . Interest
expense increased by $93 from $31 for the three months ended September 30, 2008
to $124 for the three months ended September 30, 2009. This increase was
primarily due to the issuance of a $1,500 senior secured note in November 2008
and the addition of debt and capital lease obligations acquired in the
acquisition of Visual in October 2008




Amortization of Deferred Financing
Costs and Debt Discount . Amortization of deferred financing costs and
debt discount were $562 for the three months ended September 30, 2009. These
costs resulted from the issuance of $1,500 of a senior secured note in November
2008 and interim convertible promissory notes payable of $3,350 to KIT Media
Ltd. and $350 to Granahan McCourt Capital, LLC during the quarters ended June
30, 2009 and September 30, 2009. The convertible promissory notes were repaid
from the proceeds of the public offering in August 2009 and hence any remaining
deferred financing costs or debt discount was written off.





Derivative expense .
Derivative expense was $8,449 for the three months ended September 30, 2009. The
company recorded an increase in the fair value of warrants containing reset
provisions in the three months ended September 30, 2009.





Other Income/(Expense) . Other
income decreased by $57. Other income was $8 for the three months ended
September 30, 2008 as compared to other income of $65 for the three months
ended September 30, 2009. This increase was primarily due to foreign
currency gain.




Net Loss Available to Common
Shareholders . As a result of the factors described above, we reported
net loss available to common shareholders of $11,134 for the three months ended
September 30, 2009 compared to net loss of $2,555 for the three months ended
September 30, 2008, an increase in net loss of $8,579, or 336%. The increase was
primarily due to the effect of the derivative expense which was not in the
September 30, 2008 amounts.





Results
of Operations - Nine Months Ended September 30, 2009 Compared to Nine Months
Ended September 30, 2008





Revenue . Consolidated revenue
increased by $16,786 from $14,368 for the nine months ended September 30, 2008
to $31,154 for the nine months ended September 30, 2009, an increase of
117%.





Digital
Media Solutions segment revenue increased by $18,124 from $9,830 for the nine
months ended September 30, 2008 to $27,954 for the nine months ended September
30, 2009, an increase of 184%. The increase was principally due to
an increase in customers, increased spending by existing customers,
and revenue from the acquired companies not included in prior period
results.





Professional
Services segment revenue decreased by $1,338 from $4,538 for the nine months
ended September 30, 2008 to $3,200 for the nine months ended September 30, 2009,
a decrease of 29%. The decrease was primarily due to a greater emphasis on
the growth in the Digital Media Solutions segment and a decrease in spending by
existing clients.


23





Variable
and Direct Third Party Costs





Cost of Goods and Services .
Cost of goods and services of $11,662 represents the costs for the supply of
IPTV solutions, services and components; no expenses were classified as such
prior to the acquisition of Visual in October 2008.





Hosting, Delivery and
Reporting . These costs decreased by $574 from $1,601 for the nine months
ended September 30, 2008 to $1,027 for the nine months ended September 30, 2009,
a decrease of 36%. These costs decreased primarily due to a decrease in the cost
of delivering content and the establishment of an internal datacenter which
reduced our reliance on third party suppliers.





Content Costs . Content costs
decreased by $580 from $1,685 for the three months ended September 30, 2008 to
$1,105 for the three months ended September 30, 2009, a decrease of 34%. 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 decreased
by $191 from $2,732 for the nine months ended September 30, 2008 to $2,541 for
the nine months ended September 30, 2009, a decrease of 7% attributable to lower
costs in the Professional Services segment associated with the decrease in the
revenue of that segment.





General
and Administrative Expenses





Compensation, Travel and Associated
Costs (Exclusive of Non-Cash Stock-Based Compensation) . These costs
decreased by $2,176 from $12,108 for the nine months ended September 30, 2008 to
$9,932 for the nine months ended September 30, 2009, a decrease of 18%. The
decrease was primarily due to the broad cost cutting measures that have been
implemented during 2008 and 2009 which included a reduction in headcount and
salary levels offset in part by increases due to our business
acquisitions.





Non-Cash Stock-Based
Compensation . Non-cash stock-based compensation expense decreased 74% by
$3,174, from $4,262 for the nine months ended September 30, 2008 to $1,088 for
the nine months ended September 30, 2009.





Legal, Accounting, Audit and Other
Professional Services Fees . These expenses decreased by $321 from $905
for the nine months ended September 30, 2008 to $584 for the nine months ended
September 30, 2009, a decrease of 35%, primarily due to lower legal
fees.





Office, Marketing and Other Corporate
Costs . These expenses decreased by $93 from $2,600 for the nine months
ended September 30, 2008 to $2,507 for the nine months ended September 30, 2009,
a decrease of 4%. The decrease was primarily due to the broad cost cutting
measures begun in the first quarter of 2008 and includes a reduction in
marketing related expenses.




Merger and Acquisition and Investor
Relation Expenses . Merger and acquisition and certain investor relation
expenses were $1,251 for the nine months ended September 30, 2009 and there were
no such expenses in the nine months ended September 30, 2008, primarily due to
the new accounting pronouncement.





Depreciation and Amortization
.. Depreciation and amortization expense increased 149% by $1,537 from $1,033 for
the nine months ended September 30, 2008 to $2,570 for the nine months ended
September 30, 2009. These costs have increased primarily due to the increases
related to the assets acquired in the acquisitions of Kamera in May 2008 and
Visual in October 2008.




Restructuring Charges .
Restructuring charges decreased 79% by $2,399, from $3,053 for the nine months
ended September 30, 2008 to $654 for the nine months ended September 30, 2009.
The decrease is primarily due to the termination costs of $2,397 related to the
settlement of separation agreements in 2008.





Other Non-Recurring Charges .
Other non-recurring charges increased 93% by $787 from $845 for the nine months
ended September 30, 2008 to $1,632 for the nine months ended September 30, 2009.
These charges have increased primarily due to the inclusion of costs for the
integration of systems and operations in 2009.


24


Impairment of Property and
Equipment . Impairment of property and equipment was $228 for the nine
months ended September 30, 2008. In 2008, the impairment related to the
abandonment of assets due to the downsizing of our London office.




Interest Income . Interest
income decreased by $96 from $127 for the nine months ended September 30, 2008
to $31 for the nine months ended September 30, 2009, a decrease of 76%. This
decrease was primarily due to the average level of cash and cash equivalents and
lower interest rates.





Interest Expense . Interest
expense increased by $356 from $85 for the nine months ended September 30, 2008
to $441 for the nine months ended September 30, 2009. This increase was
primarily due to the issuance of a $1,500 senior secured note in November 2008
and the addition of debt and capital lease obligations acquired in the
acquisition of Visual in October 2008




Amortization of Deferred Financing
Costs and Debt Discount . Amortization of deferred financing costs and
debt discount were $1,175 for the nine months ended September 30, 2009. These
costs result from the issuance of $1,500 of a senior secured note in November
2008 and interim convertible promissory notes payable of $3,350 to KIT Media
Ltd. and $350 to Granahan McCourt Capital, LLC during the quarters ended June
30, 2009 and September 30, 2009. The convertible promissory notes were repaid
from the proceeds of the public offering in August 2009 and hence any remaining
deferred financing costs or debt discount was written off.





Derivative income . Derivative
income was $2,233 for the nine months ended September 30, 2009. The company
recorded an increase in the fair value of warrants containing reset provisions
in the nine months ended September 30, 2009.





Other Income/(Expense) . Other
income increased by $265. Other income was $140 for the nine months ended
September 30, 2008 as compared to other income of $405 for the nine months ended
September 30, 2009. This increase was primarily due to the gain on settlement of
a non-operating liability and a gain on the bargain purchase of
Narrowstep.




Net Loss Available to Common
Shareholders . As a result of the factors described above, we reported
net loss available to common shareholders of $4,350 for the nine months ended
September 30, 2009 compared to net loss of $16,512 for the nine months ended
September 30, 2008, an improvement of $12,162, or 74%.





Liquidity
and Capital Resources





As of
September 30, 2009, we had cash and cash equivalents of $13,451 and a working
capital of approximately $4,706, which if adjusted for the derivative liability
which has a non-cash valuation of $13,503, becomes working capital of $18,209.
Management anticipates that going-forward, KIT digital will generate sufficient
cash flows from its operating activities to meet its capital requirements. In
August 2009, we received net proceeds of approximately $26,090 from a public
offering of 4,004,000 shares of common stock and will use these proceeds
primarily to finance acquisitions, with a limited portion allocated to repay
certain outstanding debts and for general corporate purposes. 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 $8,506 for the nine months ended September 30,
2009, compared to $11,089 for the nine months ended September 30, 2008, a
decrease of $2,583, or 23%. The decrease in net cash used in operating
activities is primarily related to an increase in revenues from clients, and the
reduction in general and administrative costs due to the broad cost cutting
measures that have been implemented during 2008 and 2009 which included a
reduction in headcount and salary levels offset in part by increases due to our
business acquisitions.





Net cash
used by investing activities was $6,840 for the nine months ended September 30,
2009, compared to $10,082 for the nine months ended September 30, 2008, a
decrease in net cash used in investing activities of $3,242. In 2009, this
primarily consisted of cash paid in advance of Feedroom merger of $4,636, cash
paid into an investment of $200, cash paid in acquisition of Visual of $480,
purchase of software of $1,500 and purchase of property and equipment of
$153.  In 2008, this primarily consisted of the release of restricted
cash of $100, cash paid for the completion of acquisition of Sputnik of $4,563,
cash paid in acquisition of Kamera of $4,500 less cash received of $271, cash
paid in acquisition of Morpheum of $790 less cash received of $141, and purchase
of property and equipment of $774.


25


Net cash
provided by financing activities was $23,392 for the nine months ended September
30, 2009, compared to net cash provided by financing activities of $17,195 for
the nine months ended September 30, 2008. In 2009, this primarily consisted of
proceeds from the public offering in August 2009 of $26,090, proceeds from
issuance of secured notes of $849 less cash used in bank overdraft of $739,
payments of senior secured note of $1,500, payments of senior secured notes of
$557 and payments on capital leases of $778. In 2008, this primarily consisted
of proceeds from the May 2008 private placement of $14,710, proceeds from
liability to KIT Media, Ltd. of $2,500, cash provided by bank overdraft of $58,
and payment 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 and nine months ended September 30, 2009 and 2008. 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 and their application places the most
significant demands on our management’s judgment 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 that management believes are most critical in portraying financial
results and that require 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. 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.


26


Inventories . We value
inventories 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 September 30, 2009, our reserve for excess and obsolete
inventory was $145.




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. 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 feasible. We believe that no significant concentration of credit risk exists
with respect to these investments.





Allowance for Doubtful
Accounts . We maintain an allowance for doubtful accounts for estimated
losses resulting from our customers not making their required payments. 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. The
allowance for doubtful accounts is reviewed monthly and changes to the allowance
are updated based on actual collection experience. We use a combination of the
specific identification method and analysis of the aging of accounts receivable
to establish an allowance for losses on accounts receivable. The allowance for
doubtful accounts as of September 30, 2009 was $892.





Tangible and Intangible Asset
Impairment . We review our long-lived assets and identifiable intangibles
for impairment at least annually and whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. When such
factors and circumstances exist, we compare the projected undiscounted future
cash flows associated with the future use and disposal of the related asset or
group of assets to their respective carrying amounts. Impairment, if any, is
measured as the excess of the carrying amount over the fair value based on
market value (when available) or discounted expected cash flows of those assets,
and is recorded in the period in which the determination is made. In assessing
the recoverability of our goodwill, we review goodwill for impairment at each
reporting period to determine whether events and circumstances continue to
support the indefinite useful life of the asset. We then perform the first step
of the goodwill impairment test which compares the fair value of the reporting
unit with its carrying value, including goodwill. The fair value of the
reporting unit is based on expected future cash flows associated with the group
of assets. This valuation method is used if quoted market prices are not
available. If the fair value of the reporting unit exceeds the carrying amount,
goodwill is not impaired. If the carrying amount of a reporting unit exceeds its
fair value, the second step of the goodwill impairment test shall be performed.
The second step, used to measure the amount of impairment loss, compares the
implied fair value of reporting unit goodwill with the carrying amount of that
goodwill. If the carrying amount of the reporting unit goodwill exceeds the
implied fair value of that goodwill, an impairment loss is recognized in an
amount equal to the excess.




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 (Level1). The next highest
priority is given to inputs other than quoted prices included 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.


27


SPECIAL
NOTE ON FORWARD-LOOKING STATEMENTS




This
report contains forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934. These forward-looking statements are based
largely on our expectations and are subject to a number of risks and
uncertainties, certain of which are beyond our control. Actual results could
differ materially from these forward-looking statements as a result of, among
other factors, risks related to our history of net losses and accumulated
deficits; integration of acquired businesses; future capital requirements;
competition and technical advances; dependence on the market for digital
advertising; and other risks. In light of these risks and uncertainties, there
can be no assurance that the forward-looking information contained in this
report will in fact occur.




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.


28


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, 2008.





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




None





ITEM
3. DEFAULTS UPON SENIOR SECURITIES.





None





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.




None





ITEM
5. OTHER INFORMATION.




None




ITEM
6. EXHIBITS.





Exhibit No.
                
                Description31.1
                
                Certification
      by Chief Executive Officer, required by Rule 13a-14(a) or Rule 15d-14(a)
      of the Exchange Act.31.2
                
                Certification
      by Chief Financial Officer, required by Rule 13a-14(a) or Rule 15d-14(a)
      of the Exchange Act.32.1
                
                Certification
      by Chief Executive Officer, required by Rule 13a-14(b) or Rule 15d-14(b)
      of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the
      United States Code.32.2
                
                Certification
      by Chief Financial Officer, required by Rule 13a-14(b) or Rule 15d-14(b)
      of the Exchange Act and Section 1350 of Chapter 63 of Title 18 of the
      United States Code.


29


SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.




KIT
      DIGITAL, INC.Dated:  November
      19, 2009
              By:
              /s/
      Kaleil Isaza TuzmanKaleil
      Isaza TuzmanChairman
      and Chief Executive Officer
                (principal
      executive officer)





Dated:  November
      19, 2009
              By:
              /s/
      Robin SmythRobin
      SmythChief
      Financial Officer
                (principal
      financial and accounting
officer)


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