UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington, D.C. 20549





Form
10-Q





(Mark
One)




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


For
the quarterly period ended September 30, 2010





OR




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


For
the transition period from __________ to __________





Commission file number
001-34437




KIT digital,
Inc.


(Exact
Name of Registrant as Specified in Its Charter)




Delaware
                        11-3447894(State
      or Other Jurisdiction of
                        (I.R.S.
      EmployerIncorporation
      or Organization)
                        Identification
      No.)168
      Fifth Avenue, Suite
      302, New York, New York
                        10010(Address
      of Principal Executive Offices)
                        (Zip
      Code)





+1 (212)
661-4111


(Registrant’s
Telephone Number, Including Area Code)




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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files).    Yes    ̈
  No  ̈ (not
required)




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
definition of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):




Large
      accelerated Filer  ̈
            Accelerated
      filer  ̈Non-accelerated
      filer  ̈
            Smaller
      reporting company x





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


Yes  ̈
  No x





As of
November 21, 2010, there were 23,939,714 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, 2010 (unaudited) and December 31,
      2009
                  2Consolidated
      Statements of Operations and Comprehensive Income (Loss) - For the three
      and nine months ended September 30, 2010 and 2009
      (unaudited)
                  3Consolidated
      Statements of Stockholders’ Equity - For the nine months ended September
      30, 2010 (unaudited)
                  4Consolidated
      Statements of Cash Flows - For the nine months ended September 30, 2010
      and 2009 (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
                  26Item
      4T.
                  Controls
      and Procedures
                  26PART
      II - OTHER INFORMATIONItem
      1.
                  Legal
      Proceedings
                  27Item
      1A.
                  Risk
      Factors
                  27Item
      2.
                  Unregistered
      Sales of Equity Securities and Use of Proceeds
                  27Item
      3.
                  Defaults
      Upon Senior Securities
                  27Item
      4.
                  Reserved
                  27Item
      5.
                  Other
      Information
                  27Item
      6.
                  Exhibits
                  27SIGNATURES
                  28








PART
I - FINANCIAL INFORMATION


Item
1.  Financial Statements





KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


(Amounts in Thousands, Except Share
Data)




September 30,
                    2010
                  
                  
                  December 31,
                    2009 (A)(Unaudited)Assets:Current
      assets:Cash
      and cash equivalents
                  
                  $
                  50,052
                  
                  
                  $
                  6,791Restricted
      cash
                  
                  
                  2,035
                  
                  
                  
                  -Investments
                  
                  
                  1,008
                  
                  
                  
                  217Accounts
      receivable, net
                  
                  
                  35,666
                  
                  
                  
                  17,258Unbilled
      revenue
                  
                  
                  2,113
                  
                  
                  
                  2,960Inventory
                  
                  
                  1,920
                  
                  
                  
                  708Other
      current assets
                  
                  
                  5,704
                  
                  
                  
                  2,205Total
      current assets
                  
                  
                  98,498
                  
                  
                  
                  30,139Property
      and equipment, net
                  
                  
                  6,813
                  
                  
                  
                  5,697Software,
      net
                  
                  
                  2,887
                  
                  
                  
                  3,436Customer
      list, net
                  
                  
                  13,284
                  
                  
                  
                  4,650Goodwill
                  
                  
                  90,226
                  
                  
                  
                  36,492Total
      assets
                  
                  $
                  211,708
                  
                  
                  $
                  80,414Liabilities
      and Stockholders' Equity:Current
      liabilities:Bank
      overdraft
                  
                  $
                  1,940
                  
                  
                  $
                  2,944Capital
      lease and other obligations
                  
                  
                  894
                  
                  
                  
                  1,218Secured
      notes payable
                  
                  
                  1,188
                  
                  
                  
                  -Accounts
      payable
                  
                  
                  14,786
                  
                  
                  
                  6,647Accrued
      expenses
                  
                  
                  8,521
                  
                  
                  
                  8,501Income
      tax payable
                  
                  
                  322
                  
                  
                  
                  312Deferred
      tax liability
                  
                  
                  580
                  
                  
                  
                  580Acquisition
      liability
                  
                  
                  2,753
                  
                  
                  
                  1,075Derivative
      liability
                  
                  
                  3,869
                  
                  
                  
                  21,314Other
      current liabilities
                  
                  
                  8,966
                  
                  
                  
                  3,455Total
      current liabilities
                  
                  
                  43,819
                  
                  
                  
                  46,046Capital
      lease and other obligations, net of current
                  
                  
                  539
                  
                  
                  
                  377Secured
      notes payable, net of current and debt discount
                  
                  
                  4,631
                  
                  
                  
                  -Acquisition
      liability, net of current
                  
                  
                  9,160
                  
                  
                  
                  -Deferred
      tax liability, net of current
                  
                  
                  1,295
                  
                  
                  
                  -Total
      liabilities
                  
                  
                  59,444
                  
                  
                  
                  46,423Equity:Stockholders'
      equity:Common
      stock, $0.0001 par value: authorized 80,000,000 shares; issued and
      outstanding 23,914,052 and 10,844,853, respectively
                  
                  
                  2
                  
                  
                  
                  1Additional
      paid-in capital
                  
                  
                  272,231
                  
                  
                  
                  128,263Accumulated
      deficit
                  
                  
                  (120,701
                  )
                  
                  
                  (93,943
                  )Accumulated
      other comprehensive income (loss)
                  
                  
                  732
                  
                  
                  
                  (330
                  )Total
      stockholders' equity
                  
                  
                  152,264
                  
                  
                  
                  33,991Total
      liabilities and stockholders' equity
                  
                  $
                  211,708
                  
                  
                  $
                  80,414




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




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


2





KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)


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


(Unaudited)





Three months ended
                      
                      
                      Nine months endedSeptember 30,
                      
                      
                      September 30,2010
                      
                      
                      2009
                      
                      
                      2010
                      
                      
                      2009Revenue
                      
                      $
                      27,746
                      
                      
                      $
                      11,036
                      
                      
                      $
                      68,165
                      
                      
                      $
                      31,154Variable
      and direct third party costs:Cost
      of goods and services
                      
                      
                      11,472
                      
                      
                      
                      4,550
                      
                      
                      
                      22,190
                      
                      
                      
                      11,662Hosting,
      delivery and reporting
                      
                      
                      671
                      
                      
                      
                      331
                      
                      
                      
                      3,035
                      
                      
                      
                      1,027Content
      costs
                      
                      
                      262
                      
                      
                      
                      287
                      
                      
                      
                      746
                      
                      
                      
                      1,105Direct
      third party creative production costs
                      
                      
                      1,074
                      
                      
                      
                      583
                      
                      
                      
                      2,620
                      
                      
                      
                      2,541Total
      variable and direct third party costs
                      
                      
                      13,479
                      
                      
                      
                      5,751
                      
                      
                      
                      28,591
                      
                      
                      
                      16,335Gross
      profit
                      
                      
                      14,267
                      
                      
                      
                      5,285
                      
                      
                      
                      39,574
                      
                      
                      
                      14,819General
      and administrative expenses:Compensation,
      travel and associated costs (including non-cash stock-based compensation
      of $1,273, $536, $2,910 and $1,088, respectively)
                      
                      
                      7,359
                      
                      
                      
                      3,846
                      
                      
                      
                      21,545
                      
                      
                      
                      11,020Legal,
      accounting, audit and other professional service fees
                      
                      
                      425
                      
                      
                      
                      154
                      
                      
                      
                      1,645
                      
                      
                      
                      584Office,
      marketing and other corporate costs
                      
                      
                      3,341
                      
                      
                      
                      894
                      
                      
                      
                      7,718
                      
                      
                      
                      2,507Merger
      and acquisition and investor relations expenses
                      
                      
                      1,306
                      
                      
                      
                      522
                      
                      
                      
                      3,411
                      
                      
                      
                      1,251Depreciation
      and amortization
                      
                      
                      2,407
                      
                      
                      
                      977
                      
                      
                      
                      6,110
                      
                      
                      
                      2,570Restructuring
      charges
                      
                      
                      (93
                      )
                      
                      
                      340
                      
                      
                      
                      3,481
                      
                      
                      
                      654Integration
      expenses
                      
                      
                      4,535
                      
                      
                      
                      641
                      
                      
                      
                      10,834
                      
                      
                      
                      1,632Total
      general and administrative expenses
                      
                      
                      19,280
                      
                      
                      
                      7,374
                      
                      
                      
                      54,744
                      
                      
                      
                      20,218Loss
      from operations
                      
                      
                      (5,013
                      )
                      
                      
                      (2,089
                      )
                      
                      
                      (15,170
                      )
                      
                      
                      (5,399
                      )Interest
      income
                      
                      
                      5
                      
                      
                      
                      27
                      
                      
                      
                      33
                      
                      
                      
                      31Interest
      expense
                      
                      
                      (223
                      )
                      
                      
                      (124
                      )
                      
                      
                      (563
                      )
                      
                      
                      (441
                      )Amortization
      of deferred financing costs and debt discount
                      
                      
                      (19
                      )
                      
                      
                      (562
                      )
                      
                      
                      (33
                      )
                      
                      
                      (1,175
                      )Derivative
      income (expense)
                      
                      
                      (1,451
                      )
                      
                      
                      (8,449
                      )
                      
                      
                      (10,526
                      )
                      
                      
                      2,233Other
      (expense) income
                      
                      
                      (1,263
                      )
                      
                      
                      65
                      
                      
                      
                      (475
                      )
                      
                      
                      405Net
      loss before income taxes
                      
                      
                      (7,964
                      )
                      
                      
                      (11,132
                      )
                      
                      
                      (26,734
                      )
                      
                      
                      (4,346
                      )Income
      tax expense (benefit)
                      
                      
                      (10
                      )
                      
                      
                      (2
                      )
                      
                      
                      (24
                      )
                      
                      
                      (4
                      )Net
      loss available to common shareholders
                      
                      $
                      (7,974
                      )
                      
                      $
                      (11,134
                      )
                      
                      $
                      (26,758
                      )
                      
                      $
                      (4,350
                      )Basic
      and diluted net loss per common share
                      
                      $
                      (0.34
                      )
                      
                      $
                      (1.65
                      )
                      
                      $
                      (1.37
                      )
                      
                      $
                      (0.82
                      )Basic
      and diluted weighted average common shares outstanding
                      
                      
                      23,355,298
                      
                      
                      
                      6,739,934
                      
                      
                      
                      19,581,084
                      
                      
                      
                      5,278,472Comprehensive
      income (loss):Net
      loss
                      
                      $
                      (7,974
                      )
                      
                      $
                      (11,134
                      )
                      
                      $
                      (26,758
                      )
                      
                      $
                      (4,350
                      )Foreign
      currency translation
                      
                      
                      3,022
                      
                      
                      
                      (530
                      )
                      
                      
                      971
                      
                      
                      
                      (116
                      )Change
      in unrealized gain on investments, net
                      
                      
                      75
                      
                      
                      
                      15
                      
                      
                      
                      91
                      
                      
                      
                      15Comprehensive
      loss:
                      
                      $
                      (4,877
                      )
                      
                      $
                      (11,649
                      )
                      
                      $
                      (25,696
                      )
                      
                      $
                      (4,451
                      )





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)


(Unaudited)




Common
                      Stock
                    
                    
                    Common
                      Stock
                      Par Value
                    
                    
                    Additional
                      Paid-in
                      CapitalBalance
      – December 31, 2009
                    
                    
                    10,844,853
                    
                    
                    $
                    1
                    
                    
                    $
                    128,263Issue
      of stock in public offerings, net
                    
                    
                    9,968,253
                    
                    
                    
                    1
                    
                    
                    
                    106,614Issue
      of stock for exercise of stock options
                    
                    
                    14,673
                    
                    
                    
                    —
                    
                    
                    
                    74Issue
      of stock for exercise of warrants
                    
                    
                    568,158
                    
                    
                    
                    —
                    
                    
                    
                    6,945Issue
      of stock for acquisitions
                    
                    
                    2,460,959
                    
                    
                    
                    —
                    
                    
                    
                    25,964Issue
      of warrants for services
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    840Debt
      discount on notes
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    210Issue
      of stock for compensation
                    
                    
                    16,500
                    
                    
                    
                    —
                    
                    
                    
                    190Issue
      of stock for services
                    
                    
                    40,656
                    
                    
                    
                    —
                    
                    
                    
                    412Stock-based
      compensation
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    2,719Foreign
      currency translation adjustment
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Fair
      market value adjustment for available for sale securities
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Net
      loss
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Balance
      – September 30, 2010
                    
                    
                    23,914,052
                    
                    
                    $
                    2
                    
                    
                    $
                    272,231




Accumulated
                  (Deficit)
                
                
                Accumulated
                  Other
                  Comprehensive
                  Income
                  (Loss)
                
                
                Total
                  Shareholders’
                  EquityBalance
      – December 31, 2009
                
                $
                (93,943
                )
                
                $
                (330
                )
                
                $
                33,991Issue
      of stock in public offerings, net
                
                
                —
                
                
                
                —
                
                
                
                106,615Issue
      of stock for exercise of stock options
                
                
                —
                
                
                
                —
                
                
                
                74Issue
      of stock for exercise of warrants
                
                
                —
                
                
                
                —
                
                
                
                6,945Issue
      of stock for acquisitions
                
                
                —
                
                
                
                —
                
                
                
                25,964Issue
      of warrants for services
                
                
                —
                
                
                
                —
                
                
                
                840Debt
      discount on notes
                
                
                —
                
                
                
                —
                
                
                
                210Issue
      of stock for compensation
                
                
                —
                
                
                
                —
                
                
                
                190Issue
      of stock for services
                
                
                —
                
                
                
                —
                
                
                
                412Stock-based
      compensation
                
                
                —
                
                
                
                —
                
                
                
                2,719Foreign
      currency translation adjustment
                
                
                —
                
                
                
                971
                
                
                
                971Fair
      market value adjustment for available for sale securities
                
                
                —
                
                
                
                91
                
                
                
                91Net
      loss
                
                
                (26,758
                )
                
                
                —
                
                
                
                (26,758)Balance
      – September 30, 2010
                
                $
                (120,701
                )
                
                $
                732
                
                
                $
                152,264




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 30,2010
                
                
                2009Operating
      Activities:Net
      loss
                
                $
                (26,758
                )
                
                $
                (4,350)Adjustments
      to reconcile net loss to net cash used by operating
      activities:Provision
      for doubtful accounts
                
                
                358
                
                
                
                205Depreciation
                
                
                3,243
                
                
                
                951Amortization
      of intangible assets
                
                
                2,867
                
                
                
                1,619Amortization
      of deferred financing costs
                
                
                3
                
                
                
                108Amortization
      of debt discount
                
                
                30
                
                
                
                1,067Loss
      on disposal of property and equipment
                
                
                111
                
                
                
                -Derivative
      expense (income)
                
                
                10,526
                
                
                
                (2,233
                )Less:
      merger and acquisition expenses
                
                
                1,387
                
                
                
                -Non-cash
      stock based compensation
                
                
                2,909
                
                
                
                1,088Non-cash
      warrants for services
                
                
                840
                
                
                
                -Non-cash
      stock for services
                
                
                412
                
                
                
                89Gain
      on bargain purchase
                
                
                -
                
                
                
                (26
                )Changes
      in assets and liabilities:Accounts
      receivable
                
                
                (13,926
                )
                
                
                (10,175
                )Unbilled
      revenue
                
                
                930
                
                
                
                -Inventory
                
                
                (579
                )
                
                
                830Other
      assets
                
                
                (716
                )
                
                
                (177
                )Accounts
      payable
                
                
                2,268
                
                
                
                (843
                )Accrued
      expenses
                
                
                (1,084
                )
                
                
                5,008Income
      tax payable
                
                
                (9
                )
                
                
                -Other
      liabilities
                
                
                (282
                )
                
                
                (1,667
                )Total
      adjustments
                
                
                9,290
                
                
                
                (4,156
                )Net
      cash used by operating activities – forward
                
                
                (17,468
                )
                
                
                (8,506
                )Investing
      Activities:Cash
      paid into restricted cash
                
                
                (2,035
                )
                
                
                -Cash
      paid into investment in limited partnership fund
                
                
                (700
                )
                
                
                (200
                )Cash
      received in acquisition of Narrowstep
                
                
                -
                
                
                
                279Cash
      paid in acquisition of Visual
                
                
                (2,900
                )
                
                
                (480
                )Cash
      paid in acquisition of Multicast
                
                
                (4,746
                )
                
                
                -Cash
      received in acquisition of Multicast
                
                
                396
                
                
                
                -Cash
      paid in acquisition of Benchmark
                
                
                (4,905
                )
                
                
                -Cash
      received in acquisition of Benchmark
                
                
                2,545
                
                
                
                -Cash
      paid in acquisition of Accela
                
                
                (2,936
                )
                
                
                -Cash
      received in acquisition of Accela
                
                
                337
                
                
                
                -Cash
      paid in acquisition of Megahertz
                
                
                (3,251
                )
                
                
                -Cash
      received in acquisition of Megahertz
                
                
                2,039
                
                
                
                -Cash
      paid in acquisition of Brickbox
                
                
                (7,600
                )
                
                
                -Cash
      received in acquisition of Brickbox
                
                
                1,264
                
                
                
                -Merger
      and acquisition expenses
                
                
                (1,387
                )
                
                
                -Cash
      paid in advance of Feedroom merger
                
                
                -
                
                
                
                (4,636
                )Cash
      paid in acquisition of Juzou
                
                
                -
                
                
                
                (150
                )Purchase
      of equipment
                
                
                (1,272
                )
                
                
                (1,653
                )Net
      cash used by investing activities - forward
                
                $
                (25,151
                )
                
                $
                (6,840
                )


5





KIT
DIGITAL, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS (continued)


(Amounts
in Thousands)


(Unaudited)





Nine months ended
                    September 30,2010
                  
                  
                  2009Net
      cash used by operating activities – forwarded
                  
                  $
                  (17,468
                  )
                  
                  $
                  (8,506
                  )Net
      cash used by investing activities – forwarded
                  
                  
                  (25,151
                  )
                  
                  
                  (6,840
                  )Financing
      Activities:Proceeds
      from public offering, net
                  
                  
                  106,615
                  
                  
                  
                  26,090Proceeds
      from exercise of stock options
                  
                  
                  74
                  
                  
                  
                  27Proceeds
      from exercise of warrants
                  
                  
                  3,030
                  
                  
                  
                  -Payments
      for warrant buybacks
                  
                  
                  (24,054
                  )
                  
                  
                  -Bank
      overdraft
                  
                  
                  209
                  
                  
                  
                  (739
                  )Proceeds
      from issuance of secured notes
                  
                  
                  5,762
                  
                  
                  
                  849Payments
      of secured notes
                  
                  
                  (1,020
                  )
                  
                  
                  (557
                  )Payments
      of senior secured note
                  
                  
                  -
                  
                  
                  
                  (1,500
                  )Proceeds
      from issuance of convertible notes payable
                  
                  
                  -
                  
                  
                  
                  3,700Repayments
      of convertible notes payable
                  
                  
                  -
                  
                  
                  
                  (3,700
                  )Repayments
      of notes payable
                  
                  
                  (4,500
                  )
                  
                  
                  -Payment
      on capital leases
                  
                  
                  (794
                  )
                  
                  
                  (778
                  )Net
      cash provided by financing activities
                  
                  
                  85,322
                  
                  
                  
                  23,392Effect
      of exchange rate changes on cash
                  
                  
                  558
                  
                  
                  
                  (473
                  )Net
      increase in cash and cash equivalents
                  
                  
                  43,261
                  
                  
                  
                  7,573Cash
      and cash equivalents - beginning of period
                  
                  
                  6,791
                  
                  
                  
                  5,878Cash
      and cash equivalents - end of period
                  
                  $
                  50,052
                  
                  
                  $
                  13,451Supplemental
      disclosures of cash flow information:Cash
      paid during the period for:Income
      taxes
                  
                  $
                  -
                  
                  
                  $
                  -Interest
                  
                  $
                  563
                  
                  
                  $
                  441Non-cash
      issuances of stock for acquisitions (2,460,959 and 641,847 shares issued,
      respectively)
                  
                  $
                  25,964
                  
                  
                  $
                  4,363





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


6





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(1) Nature of
Business and Nature of Presentation





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





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





Certain
information and footnote disclosures normally included in the Company’s annual
audited consolidated financial statements and accompanying notes have been
condensed or omitted in these interim financial statements. Accordingly, the
unaudited consolidated financial statements included herein should be read in
conjunction with the audited consolidated financial statements and accompanying
notes included in KIT digital’s annual report on Form 10-K for the year ended
December 31, 2009, filed with the U.S. Securities and Exchange
Commission.





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





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.





(2) Recent
Accounting Pronouncements





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





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. The Company adopted during the quarter ended September 30, 2010 and has
been applied retrospectively to January 1, 2010. The adoption of this standard
did not have a material impact on prior results.





The new
guidance changes the criteria required to (1) separate deliverables into
separate units of accounting when deliverables are sold in a bundled arrangement
and (2) to allocate the arrangement’s consideration to each unit in the
arrangement (such as, equipment, installation or commissioning services).
Entities are now required to determine an estimated selling price for each
separate deliverable following a hierarchy of evidence — Vendor-specific
Objective Evidence (“VSOE”), Third Party Evidence (“TPE”) and, if VSOE and TPE
do not exist, best estimate of selling price (“BESP”).


7





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(2) Recent
Accounting Pronouncements (continued)





The
Company’s material revenue streams are related to the delivery of IP video
software solutions, including software-as-a-service (“SaaS”) fees, software
usage fees, enterprise license fees, set-up/support services, storage, hardware
components, content delivery and content syndication. Our solutions also include
technical integration services, interface design, branding, strategic planning,
creative production, online marketing, media planning and analytics. The Company
enters into revenue arrangements that may consist of multiple deliverables of
components and services due to the needs of its customers. The Company
recognizes revenue when persuasive evidence of an arrangement exists, delivery
has occurred, the sales price is fixed or determinable, and collectability of
the sale price is reasonably assured. In addition to these general revenue
recognition criteria, the following specific revenue recognition policies are
followed:





Multiple-Element
Arrangements — Arrangements with customers may include multiple deliverables,
including any combination of  components and services. For the
Company’s multiple-element arrangements, deliverables are separated into more
than one unit of accounting when (i) the delivered element(s) have value to the
customer on a stand-alone basis, and (ii) delivery of the undelivered element(s)
is probable and substantially in the control of the Company. Based on the new
accounting guidance adopted July 1, 2010, revenue is then allocated to each unit
of accounting based on the estimated selling price determined using a hierarchy
of evidence based first on VSOE if it exists, based next on TPE if VSOE does not
exist, and finally, if both VSOE and TPE do not exist, based on
BESP.





Services
— Revenue for services is generally recognized at completion of the
contractually required services.





Hardware
Components — For hardware component sales (one deliverable only), revenue
recognition generally occurs when products or equipment have been shipped, risk
of loss has transferred to the customer, objective evidence exists that customer
acceptance provisions have been met, no significant obligations remain and an
allowance for discounts, returns and customer incentives can be reliably
estimated. Recorded revenues are reduced by these allowances. The Company bases
its estimates of these allowances on historical experience taking into
consideration the type of products sold, the type of customer, and the specific
type of transaction in each arrangement.





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





Contractually
stated prices in multiple-element arrangements are not presumed to represent
VSOE, TPE or BESP for an individual deliverable. An entity must develop its
estimate of selling prices using the hierarchy of evidence in the new
guidance.





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





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





(3)
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,
2010, the Company had $2,059 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 prior written
notice. As of September 30, 2010, the Company had $47,993 of additional cash in
low interest-bearing accounts in accordance with the Company's cash management
policy.


8





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited )




(4)
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 10 for fair value hierarchy on the Derivative
Liabilities.





Investments
include an investment in a limited partnership fund which invests, on a hedged
basis, primarily in the U.S. equity markets. This initial investment was made in
March 2009 and a subsequent investment was made in February 2010 and is recorded
at a fair value of $1,008 since we do not exercise control over this
fund.





(5)
Accounts Receivable





Trade
accounts receivable are stated net of allowances for doubtful accounts. Specific
customer provisions are made when a review of significant outstanding amounts,
customer creditworthiness and current economic trends, indicates that collection
is doubtful. In addition, provisions are made at differing amounts, based upon
the balance and age of the receivable and the Company’s historical collection
experience. Trade accounts are charged off against the allowance for doubtful
accounts or expense when it is probable the accounts will not be recovered. The
allowance for doubtful accounts as of September 30, 2010 and December 31, 2009
was $1,324 and $874, respectively.





(6)
Concentration of Credit Risk





Financial
instruments which potentially subject us to concentrations of credit risk
consist principally of cash and cash equivalents and trade accounts receivable.
We place our cash and cash equivalents with high credit quality institutions to
limit credit exposure, and from time to time, obtain collateral for our accounts
where we deem prudent and is feasible. We believe no significant concentration
of credit risk exists with respect to these investments. The amount held in
foreign currencies as of September 30, 2010 and December 31, 2009 was $5,844 and
$2,272, respectively. The amount of cash in excess of FDIC insured amounts as of
September 30, 2010 and December 31, 2009, was $48,802 and $6,541,
respectively.





Concentrations
of credit risk with respect to trade accounts receivable are limited due to the
nature of our customers who are dispersed across many industries and geographic
regions. As of September 30, 2010, one customer accounted for 11.1% of our trade
accounts receivable. As of December 31, 2009, three customers accounted for
approximately 39.6% of our trade accounts receivable. As of September 30, 2010,
one customer accounted for 10.0% of the quarterly revenue. As of December 31,
2009, no customer accounted for 10% or more of quarterly revenue. 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.





(7)
Inventory





Inventory
is valued at the lower of cost (first-in, first-out method) or market and is
comprised of finished goods. On a quarterly basis, we review inventory
quantities on hand and analyze the provision for excess and obsolete inventory
based primarily on product age in inventory and our estimated sales forecast,
which is based on sales history and anticipated future demand. As of September
30, 2010 and December 31, 2009, our reserves for excess and obsolete inventory
were $131 and $136, respectively.


9





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





(8)
Secured Notes Payable





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





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





(9)
Acquisitions





In late
March 2010, we acquired Multicast Media Technologies, Inc., a United States
company engaged in live event broadcasting, internet video and targeted
multimedia communications (“Multicast”), in exchange for 2,379,714 shares of our
common stock and approximately $4,750 in cash (the “Cash Consideration”). The
share consideration issuable to Multicast stockholders was reduced to 1,312,034
shares of KIT digital common stock (the “Merger Shares”) which was valued at
$13,120, after giving effect to adjustments for assumption by KIT digital of
existing indebtedness and other liabilities of Multicast in the amount of
approximately $5,927. The merger consideration was subject to adjustment upwards
or downwards to the extent that the closing working capital of Multicast was
greater or less than zero and subject to the final fair valuation of Merger
Shares. The Cash Consideration and Merger Shares were delivered as follows: (i)
$4,000 in cash and 842,500 shares of our stock promptly following the closing;
and (ii) a “holdback amount” of an additional $746 in cash and 469,534 shares of
KIT digital common stock, less any amount used by KIT digital to offset negative
working capital and satisfy indemnity claims as described below, will be
delivered to such stockholders not later than one year after the closing or such
later date as all indemnity claims have been resolved. Of the total “holdback
amount,” $712 in cash and 196,798 Merger Shares were used to offset any negative
working capital balance of Multicast as of the effective date of the merger. The
remaining $34 in cash and 272,736 Merger Shares being held back by KIT digital
will be used to indemnify KIT digital against any breaches of representations,
warranties and covenants by Multicast, as well as against certain additional
specified liabilities The Company has allocated the aggregate cost of the
acquisition to Multicast’s net tangible and identifiable intangible assets based
on their estimated fair values. The excess of the aggregate cost of the
acquisition over the net estimated fair value of the tangible and identifiable
intangible assets and liabilities assumed was recorded to goodwill.





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





Current
      assets
                  
                  $
                  612Property
      and equipment
                  
                  
                  1,548Intangible
      assets – developed software
                  
                  
                  562Intangible
      assets – customer list
                  
                  
                  3,087Goodwill
                  
                  
                  18,681Total
      assets acquired
                  
                  
                  24,490Current
      liabilities and assumed debt
                  
                  
                  (7,025
                  )Net assets acquired
                  
                  $
                  17,465


10





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(9)
Acquisitions (continued)





On May
14, 2010, we acquired Benchmark Broadcast Systems Pte. Ltd., a Singapore company
engaged in providing asset management solutions and integration of broadcast
video systems, and subsidiaries (“Benchmark”), in exchange for 353,744 shares of
our common stock valued at $4,775 and approximately $4,905 in cash (the “Cash
Consideration”) at the time of acquisition. The estimated aggregate cost of the
acquisition of Benchmark was $19,386. Additionally, the cost includes $1,119 for
the working capital due to the seller, $1,028 estimated to be due after one year
from closing based on a percentage of revenue and meeting earnings targets and
$7,560 estimated to be due after two years from closing based on a percentage of
revenue and meeting earnings targets. Of these amounts, $2,147 is included in
the Balance Sheet in “Acquisition liability” and $7,560 is in the Balance Sheet
in “Acquisition liability, net of current.” Pursuant to the agreement, we put
$2,000 into escrow for potential future obligations, which is included in
“Restricted Cash” in the Balance Sheet as of September 30, 2010. We have
allocated the aggregate cost of the acquisition to Benchmark’s net tangible and
identifiable intangible assets based on their estimated fair values. The excess
of the aggregate cost of the acquisition over the net estimated fair value of
the tangible and identifiable intangible assets and liabilities assumed was
recorded as goodwill.





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





Current
      assets
                  
                  $
                  2,523Property
      and equipment
                  
                  
                  166Intangible
      assets – customer list
                  
                  
                  200Intangible
      assets – backlog
                  
                  
                  1,100Goodwill
                  
                  
                  18,035Total
      assets acquired
                  
                  
                  22,024Current
      liabilities and assumed debt
                  
                  
                  (5,183
                  )Net assets acquired
                  
                  $
                  16,841





In June
2010, we paid $2,900 in cash and issued 122,911 shares of our common stock
valued at $1,250 to the former shareholders of Visual Connection a.s.
(“Visual”), pursuant to an amendment to the Visual Share Purchase Agreement
dated October 5, 2008 (“Visual SPA”) and in satisfaction of all remaining
earn-out provisions. We have recorded an increase of $3,075 to “Goodwill” in the
Balance Sheet as of September30, 2010 and a reduction of $1,075 of the
previously recorded contingent liability.





On
September 8, 2010, we acquired Accela Communications, Inc., a United States
company engaged in providing on-demand, video-based enablement and measurement
tools (“Accela”), in exchange for 332,764 shares of our common stock valued at
$3,085 and approximately $2,936 in cash at the time of acquisition, which
included $1,106 in cash paid to debtors of Accela. The estimated aggregate cost
of the acquisition of Accela was $5,913. Additionally, the cost includes an
offset of $108 due to KIT for the working capital adjustment, which is included
in the Balance Sheet in “Other current assets”. We have allocated the aggregate
cost of the acquisition to Accela’s net tangible and identifiable intangible
assets based on their estimated fair values. The excess of the aggregate cost of
the acquisition over the net estimated fair value of the tangible and
identifiable intangible assets and liabilities assumed was recorded as
goodwill.





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





Current
      assets
                  
                  $
                  880Property
      and equipment
                  
                  
                  172Intangible
      assets – customer list
                  
                  
                  2,000Goodwill
                  
                  
                  4,838Total
      assets acquired
                  
                  
                  7,890Current
      liabilities and assumed debt
                  
                  
                  (2,314
                  )Net assets acquired
                  
                  $
                  5,576


11





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(9)
Acquisitions (continued)





On
September 8, 2010, we acquired the assets of Megahertz Broadcast Systems, a
United Kingdom company engaged in providing broadcast video systems integration
(“Megahertz”), in exchange for $3,251 in cash at the time of acquisition. The
estimated aggregate cost of the acquisition of Megahertz was $3,840.
Additionally, the cost included an estimate of $589 due to the seller for the
working capital adjustment, which is included in the Balance Sheet in
“Acquisition liability”. We have allocated the aggregate cost of the acquisition
to Megahertz’s net tangible and identifiable intangible assets based on their
estimated fair values. The excess of the aggregate cost of the acquisition over
the net estimated fair value of the tangible and identifiable intangible assets
and liabilities assumed was recorded as goodwill.





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





Current
      assets
                  
                  $
                  1,110Property
      and equipment
                  
                  
                  165Intangible
      assets – customer list
                  
                  
                  1,000Goodwill
                  
                  
                  625Total
      assets acquired
                  
                  
                  2,900Current
      liabilities
                  
                  
                  (1,099
                  )Net assets acquired
                  
                  $
                  1,801





On
September 21, 2010, we acquired Brickbox Digital Media s.r.o., a Czech company
engaged in providing digital video asset management solutions, and its
international subsidiaries (“Brickbox”), in exchange for 339,476 shares of our
common stock valued at $3,734 and approximately $7,600 in cash at the time of
acquisition. The estimated aggregate cost of the acquisition of Brickbox was
$12,934. Additionally, the cost includes $1,600 estimated for future
consideration based on 10 percent of revenue and meeting earnings targets over a
four-year period after closing, which is included in the Balance Sheet in
“Acquisition liability”. We have allocated the aggregate cost of the acquisition
to Brickbox’s net tangible and identifiable intangible assets based on their
estimated fair values. The excess of the aggregate cost of the acquisition over
the net estimated fair value of the tangible and identifiable intangible assets
and liabilities assumed was recorded as goodwill.





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





Current
      assets
                  
                  $
                  2,598Property
      and equipment
                  
                  
                  874Intangible
      assets – customer list
                  
                  
                  3,000Goodwill
                  
                  
                  8,452Total
      assets acquired
                  
                  
                  14,924Current
      liabilities and assumed debt
                  
                  
                  (3,254
                  )Net assets acquired
                  
                  $
                  11,670


12





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(9)
Acquisitions (continued)




Selected
unaudited pro forma combined results of operations for the nine months ended
September 30, 2009, assuming the Multicast, Benchmark, Accela, Megahertz and
Brickbox acquisitions occurred on January 1, 2009 using actual unaudited figures
from each entity prior to acquisition, are presented as follows:





Total
      revenue
                  
                  $
                  77,703Net
      income
                  
                  $
                  (7,384
                  )





Selected
unaudited pro forma combined results of operations for the nine months ended
September 30, 2010, assuming the Multicast, Benchmark, Accela, Megahertz and
Brickbox acquisitions occurred on January 1, 2010 using actual unaudited figures
from each entity prior to acquisition, are presented as follows:





Total
      revenue
                  
                  $
                  98,256Net
      income
                  
                  $
                  (29,113
                  )





The
acquisitions of Nunet AG and The FeedRoom, Inc. from October 2009 are not
presented above in the proforma combined results of operations for the nine
months ended September 30, 2009 as portions of these businesses ceased and
management believes that the organization and nature of these businesses have
changed significantly after acquisition.





(10)
Derivative Liabilities





Upon the
adoption of a new standard effective January 1, 2009, 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. The common shares indexed to the derivative financial instruments
used in the calculation of the fair value and recorded as liabilities at January
1, 2009, December 31, 2009 and September 30, 2010 were 5,806,230, 4,794,400 and
696,647, respectively. The number of shares for the determination of the
liability have been computed based on the effective exercise price used in the
valuation. The actual number of common shares indexed to the warrants at January
1, 2009, December 31, 2009 and September 30, 2010 were 2,886,038, 4,794,400 and
696,647, respectively.





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




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


13





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(10)
Derivative Liabilities (continued)





The
following table summarizes the components of derivative liabilities as of
September 30, 2010, December 31, 2009 and the re-measurement date, January 1,
2009:





September
                  30, 2010
                
                
                December
                  31, 2009
                
                
                Re-measurement
                  date
                  January 1, 2009Fair
      value of warrants with anti-dilution provisions
                
                $
                (3,869
                )
                
                $
                (21,314
                )
                
                $
                (15,736
                )Significant
      assumptions (or ranges):Trading
      market values  (1)
                
                $
                11.99
                
                
                $
                11.00
                
                
                
                5.25Term
      (years)   (3)
                
                
                2.61
                
                
                3.35
      to 4.00
                
                
                $
                4.35
      to 5.00Volatility   (1)
                
                
                59.87
                %
                
                
                61.98
                %
                
                
                101.98
                %Risk-free
      rate   (2)
                
                
                0.64
                %
                
                
                1.70
                %
                
                
                1.55
                %Effective
      Exercise price  (3)
                
                $
                7.00
                
                
                $
                7.00
                
                
                $
                5.92





Fair
value hierarchy:





(1)
            Level
      1 inputs are quoted prices in active markets for identical assets and
      liabilities, or derived there from. Our trading market values and the
      volatilities that are calculated thereupon are level 1
    inputs.(2)
            Level
      2 inputs are inputs other than quoted prices that are observable. We use
      the current published yields for zero-coupon US Treasury Securities, with
      terms nearest the remaining term of the warrants for our risk free
      rate.(3)
            Level
      3 inputs are unobservable inputs. Inputs for which any parts are level 3
      inputs are classified as level 3 in their entirety. The remaining term
      used equals the remaining contractual term as our best estimate of the
      expected term and the effective exercise price which is based on the
      stated exercise price adjusted for anti-dilution
    provisions.





The
effects on our income (expense) associated with changes in the fair values of
our derivative financial instruments for the three months ended September 30,
2010 and 2009 was $(1,451) and $(8,449), respectively. Included in the $1,451
expense for the three months ended September 30, 2010 is a gain on
settlement of $55 related to the repurchase of warrants. The effects on our
income (expense) associated with changes in the fair values of our derivative
financial instruments for the nine months ended September 30, 2010 and 2009 was
$(10,526) and $2,233, respectively. Included in the $(10,526) expense for the
nine months ended September 30, 2010 is a loss on settlement of $(2,961) related
to the repurchase of warrants.





On March
7, 2010, our board of directors approved the repurchase of certain outstanding
warrants with exercise prices below the then-current market price from certain
warrant holders (who had acquired the warrants in prior private placement
financings), including KIT Media, an entity controlled by Kaleil Isaza Tuzman,
our Chairman and Chief Executive Officer and Wellington Management Company
(“Wellington”), an entity with greater than a 10% holding in KIT digital’s
outstanding common stock at the time of the transaction. KIT Media and
Wellington are considered related parties of the Company. The terms of the
warrant repurchase were identical for KIT Media and Wellington, and the
negotiation of such terms was led by Wellington. The Company offered to purchase
and cancel these warrants at 133% of the intrinsic value of the warrants
(intrinsic value being based on a 20-day trailing volume weighted average price
of the underlying common stock).  These warrants with anti-ratchet
dilution provisions totaling 3,030,747 were cancelled effective on March 31,
2010. These warrants were included in the warrant buyback liability as at March
31, 2010 and were paid after such date. We also repurchased and cancelled
another 347,835, 4,860 and 44,706 warrants with anti-ratchet dilution provisions
during the quarters ended March 31, 2010, June 30, 2010 and September 30, 2010,
respectively, at varying prices, from parties other than KIT Media and
Wellington for $1,141, $14 and $130, respectively.


14





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)




(11)
Stock-Based Compensation





On March
17, 2008, the board of directors adopted an incentive compensation plan (the
“2008 Incentive Stock Plan”). The 2008 Incentive Stock Plan currently has
reserved 857,143 shares of common stock for issuance. The 2004 Stock Option Plan
has reserved 342,858 shares of common stock for issuance. In November 2009, our
board of directors voted unanimously to increase the number of shares which may
be issued under the 2008 Incentive Plan by 2,642,857 to an aggregate of
3,500,000 shares of common stock subject to ratification by our stockholders at
our next Annual Meeting of Stockholders. At our annual meeting of stockholders
held on September 30, 2010, our stockholders approved an amendment to our 2008
Incentive Stock Plan increasing the number of shares of common stock reserved
for issuance thereunder by 2,642,857 shares to 3,500,000 shares from 857,143
shares.





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





On May 8,
2010, our board of directors authorized the issuance of 2,141,013 stock options
pursuant to the 2008 Incentive Stock Plan, at an exercise price of $12.36 per
share (reflecting the previous trading day’s closing price), subject to approval
by a majority of the Company’s shareholders at the next Annual Meeting of
Stockholders. These stock options carry a four-year quarterly vesting term and a
five-year exercise term. In aggregate, as of May 17, 2010, shares underlying the
Company’s total issued employee stock options represent less than 14% of the
Company’s outstanding common shares. The board of directors had not authorized a
substantial issuance of stock options since June 2008. The board of directors
authorized the issuance of the 2,141,013 stock options to (a) account for the
addition of over 200 staff members since the last authorized options issuance,
(b) incentivize all staff for future performance, and (c) adjust existing
employees’ options levels to account for dilution in the Company’s total shares
outstanding that has occurred over time. Kaleil Isaza Tuzman, Gavin Campion and
Robin Smyth did not receive any new options as part of this issuance. As of
August 13, 2010, these options were re-priced to an exercise price of $8.05 per
share (reflecting the trading day’s closing price) for additional non-cash
stock-based compensation expense of $320 in the quarter ended September 30,
2010.





On August
30, 2010, our board of directors authorized the issuance of 787,700 stock
options pursuant to the 2008 Incentive Stock Plan and 441,250 restricted stock
units to Company’s the senior executives. The stock options have an exercise
price of $8.62 per share (reflecting the trading day’s closing price) and are
valued at $2,741 under the Black-Scholes method. These stock options carry a
four-year quarterly vesting term and a five-year exercise term. The restricted
stock units are valued at $3,804 based on a stock price of $8.62 on the date of
issuance and vest monthly over four years with 183,738 of these with performance
based criteria.





For the
three months ended September 30, 2010 and 2009, we recognized $1,273 and $536,
respectively, of non-cash stock-based compensation expense in the consolidated
statements of operations. Also included in non-cash stock-based compensation are
warrants to purchase 34,286 shares of common stock with an exercise price of
$4.655 issued on March 30, 2008, that vest over three years from the issue date.
During the three months ended September 30, 2010, a total of 2,857 of these
warrants vested with 28,571 vested and 5,715 unvested as of September 30, 2010.
The intrinsic value as of September 30, 2010 of these outstanding warrants and
exercisable warrants are $251 and $210, respectively.





As of
September 30, 2010, there was approximately $10,838 of total unrecognized
compensation cost related to unvested share-based compensation grants, which is
expected to be amortized over a weighted-average period of 3.1
years.


15





KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





(11)
Stock-Based Compensation (continued)





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





Nine Months Ended
                  September
                  30, 2010
                
                
                Nine
                  Months Ended
                  September
                  30, 2009Expected
      life (in years)
                
                
                3.85
                
                
                
                5.00Risk-free
      interest rate
                
                
                1.08
                %
                
                
                2.83
                %Volatility
                
                
                50.69
                %
                
                
                77.55
                %Dividend
      yield
                
                
                0
                
                
                
                0





A summary
of the status of stock option awards and changes during the nine months ended
September 30, 2010 are presented below:





Shares
                  
                  
                  Weighted
                    Average
                    Exercise
                    Price
                  
                  
                  Weighted
                    Average
                    Remaining
                    Contractual
                    Life (Years)
                  
                  
                  Intrinsic
                    ValueOutstanding
      at December 31, 2009
                  
                  
                  877,973
                  
                  
                  
                  7.14Granted
                  
                  
                  3,019,509
                  
                  
                  
                  8.27Exercised
                  
                  
                  (14,673
                  )
                  
                  
                  5.08Cancelled,
      expired, or forfeited
                  
                  
                  (349,360
                  )
                  
                  
                  7.89Outstanding
      at September 30, 2010
                  
                  
                  3,533,449
                  
                  
                  
                  8.04
                  
                  
                  
                  4.38
                  
                  
                  $
                  13,947Exercisable
      at September 30, 2010
                  
                  
                  661,723
                  
                  
                  
                  7.61
                  
                  
                  
                  3.82
                  
                  
                  $
                  2,900





The
weighted-average grant-date fair value of option awards granted during the nine
months ended September 30, 2010 was $6.73.





(12) Stock
Issuances





On
September 30, 2010, we filed a certificate of amendment of our certificate of
incorporation to increase the number of authorized shares of our common stock to
80,000,000 shares from 30,000,000 shares.  Our board viewed this
increase of authorized shares as a means to maximize strategic
flexibility.  The amendment was adopted by stockholders holding a
majority of our outstanding shares of common stock at our annual meeting of
stockholders held on September 30, 2010.





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


16


KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





(12) Stock
Issuances (continued)





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





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





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





During
the quarter ended June 30, 2010, we issued 5,614,333 shares of common stock. Of
this amount, we issued 4,230,770 shares in the April 2010 public offering,
634,615 shares in the May 2010 over-allotment, 353,774 shares in the acquisition
of Benchmark, 122,911 shares in the final payout of the acquisition of Visual,
260,151 shares for the exercise of warrants with proceeds of $1,582, 6,112
shares for the exercise of options with proceeds of $26 and 6,000 shares for
services valued at $82.





On April
27, 2010, we completed an underwritten public offering of 4,230,770 shares of
our common stock, pursuant to our shelf registration statement on Form S-3 (No.
333-164655), which was originally filed and declared effective in February 2010,
and related prospectus supplement dated April 22, 2010. We sold such shares in
the offering at a price of $13.00 per share and received $55,000 in gross
proceeds and approximately $50,574 in net proceeds, after deducting underwriting
discounts, commissions, legal fees and other estimated offering expenses. We
subsequently sold 634,615 additional shares of common stock pursuant to an
underwriters’ over-allotment option on May 6, 2010, and received $8,250 in gross
proceeds and approximately $7,628 in net proceeds. KIT Capital purchased $1,300
of common stock (100,000 shares) in the April 27, 2010 offering at the same
price and on the same terms as the other investors in this
offering.





During
the quarter ended September 30, 2010, we issued 683,773 shares of common stock.
Of this amount, we issued 332,764 shares in the acquisition of Accela, 339,476
shares in the acquisition of Brickbox, 939 shares for the exercise of options
with proceeds of $7 and 10,594 shares for services valued at $94.




As of
September 30, 2010, the outstanding warrants (excluding the warrants included in
the derivative liability of 696,647 and stock-based compensation of 34,286) were
749,454 with a weighted average exercise price of $22.76. As of December 31,
2009, the outstanding warrants (excluding the warrants included in the
derivative liability of 4,794,400 and stock-based compensation of 34,286) were
510,639 with a weighted average exercise price of $51.36.





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


17


KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited )





(13)
Restructuring Charges





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





The
following table summarizes the restructuring charges for the three and nine
months ended September 30, 2010, respectively:





Three months ended
                  
                  
                  Nine months endedSeptember 30, 2010
                  
                  
                  September 30, 2010Employee
      termination costs
                  
                  $
                  (66)
                  
                  
                  $
                  2,566Contract
      settlements
                  
                  
                  -
                  
                  
                  
                  67Facility
      closing costs
                  
                  
                  (27
                  )
                  
                  
                  848Total
      restructuring charges
                  
                  $
                  (93
                  )
                  
                  $
                  3,481





The
following table summarizes the restructuring activity for the three and nine
months ended September 30, 2010:





Employee
                    Termination
                    Costs
                  
                  
                  Contract
                    Settlements
                  
                  
                  Facility
                    Closing Costs
                  
                  
                  TotalBalance
      as of December 31, 2009
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  829
                  
                  
                  $
                  829Additions
                  
                  
                  2,632
                  
                  
                  
                  67
                  
                  
                  
                  1,020
                  
                  
                  
                  3,719Reversal
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (145
                  )
                  
                  
                  (145
                  )Cash
      payments
                  
                  
                  (368
                  )
                  
                  
                  (50
                  )
                  
                  
                  (994
                  )
                  
                  
                  (1,412
                  )Balance
      as of June 30 , 2010
                  
                  $
                  2,264
                  
                  
                  $
                  17
                  
                  
                  $
                  710
                  
                  
                  $
                  2,991Additions
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Reversal
                  
                  
                  (66
                  )
                  
                  
                  -
                  
                  
                  
                  (27
                  )
                  
                  
                  (93
                  )Cash
      payments
                  
                  
                  (162
                  )
                  
                  
                  (2
                  )
                  
                  
                  (69
                  )
                  
                  
                  (233
                  )Balance
      as of September 30, 2010
                  
                  $
                  2,036
                  
                  
                  $
                  15
                  
                  
                  $
                  614
                  
                  
                  $
                  2,665





The
accrued restructuring of $2,665 and $829 are included in accrued expenses in the
consolidated balance sheets as of September 30, 2010 and December 31, 2009,
respectively.





The
Company recorded restructuring charges of $340 and $654 for the three and nine
months ended September 30, 2009, respectively. These amounts are comprised of
employee termination costs related to the reorganization of the Company of $128
and $271, and contract settlements and facility closing costs related to the
closing of one of the Melbourne, Australia offices and a Dubai office of $212
and $383 for the three and nine months ended September 30, 2009,
respectively.





(14)
Integration Expenses





The
Company has recorded integration charges related to the redundancy in staff and
consultants during reorganization, corporate rebranding related to the
reorganization, and the integration of acquired companies and assets of $4,535
and $10,834 for the three and nine months ended September 30, 2010,
respectively.





The
Company has recorded integration charges related to the redundancy in staff and
consultants for the transition of technology infrastructure during
reorganization due to the centralizing of resources in Prague of $641 and $1,632
for the three and nine months ended September 30, 2009,
respectively.


18


KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited )





(15)
Segment Reporting





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





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




Three months ended
                  
                  
                  Nine months endedSeptember 30,
                  
                  
                  September 30,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009Revenue:EMEA
                  
                  $
                  12,375
                  
                  
                  $
                  7,802
                  
                  
                  $
                  33,912
                  
                  
                  $
                  21,411AsiaPac
                  
                  
                  9,898
                  
                  
                  
                  2,626
                  
                  
                  
                  18,094
                  
                  
                  $
                  8,052Americas
                  
                  
                  5,473
                  
                  
                  
                  608
                  
                  
                  
                  16,159
                  
                  
                  $
                  1,691Total
      revenue
                  
                  $
                  27,746
                  
                  
                  $
                  11,036
                  
                  
                  $
                  68,165
                  
                  
                  $
                  31,154





September 30,
                  
                  
                  December 31,2010
                  
                  
                  2009Assets:EMEA
                  
                  $
                  43,455
                  
                  
                  $
                  21,887AsiaPac
                  
                  
                  9,690
                  
                  
                  
                  3,743Americas
                  
                  
                  8,246
                  
                  
                  
                  4,447Corporate
                  
                  
                  150,317
                  
                  
                  
                  50,337Total
      assets
                  
                  $
                  211,708
                  
                  
                  $
                  80,414


19


KIT
DIGITAL, INC. AND SUBSIDIARIES


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


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


(Unaudited)





(16)
Related Party Transactions





In
December 2007, we entered into an agreement with KIT Capital, Ltd. (“KIT
Capital”), a company beneficially controlled and led by Kaleil Isaza
Tuzman, our Chairman and Chief Executive Officer, under which KIT Capital has
provided us managerial services. The total amount paid to KIT Capital and
included in our results of operations in the nine months ended September 30,
2010 and 2009 were $330 and $390, respectively. KIT Capital employs two other
staff members which provide full-time services to the Company in addition to Mr.
Isaza Tuzman, and payments for managerial services made to KIT Capital are
inclusive of fees to all three total KIT Capital staff members.





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





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




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





See Note
12, “Stock Issuances”, for a description of warrant repurchase from Robin Smyth,
Chief Financial Offcier.





(17)
Subsequent Events





On
October 22, 2010, the U.S. Securities and Exchange Commission declared effective
the registration statement on Form S-3 of KIT digital, Inc. filed on October 13,
2010. The registration statement permits the Company to issue, in one or more
offerings, shares of common stock at an aggregate offering price not to exceed
$250,000.





On
November 19, 2010, the Company entered into an underwriting agreement (the
“Underwriting Agreement”) with Roth Capital Partners, LLC acting as the
representative of the several underwriters. Pursuant to the terms and conditions
of the Underwriting Agreement, the Company agreed to sell 8,000,000 shares of
its common stock, par value $0.0001 per share at a price to the public of $12.00
per share. Pursuant to the Underwriting Agreement, the Company granted the
underwriters an option to purchase up to an additional 1,200,000 shares of its
common stock within 30 days after the date of the Underwriting Agreement to
cover over-allotments, if any. The Company expects to receive approximately up
to $89,000 in net proceeds from the offering after underwriting fees and
offering expenses, or approximately $102,000 if the underwriters’ over-allotment
option is exercised in full. The offering is scheduled to close on or about
November 24, 2010, subject to customary closing conditions. Merriman Capital,
ThinkEquity Partners, Janney Montgomery Scott and Northland Capital Markets
acted as co-managers in the transaction, and Jefferies & Co. acted as a
financial advisor to the Company in connection with the
transaction.





On
November 19, 2010, after a decision in early November we signed an agreement to
sell a portion of our business in the Czech Republicfocusing on professional
services and non-SaaS activities which will allow management to focus even more
on our core software-as-a-service offerings. Activities spun out include some
encoding services and broadcast systems equipment set-up. The closing date for
the transaction is November 30 and is based on the balance sheet as at that
date. The amount of this transaction will be approximately $12,000, including
the repayment of the outstanding loans to KIT digital.


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 Internet protocol television
(“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 principal offices in
Atlanta, Beijing, Boston, Buenos Aires, Cairo, Chennai, Cologne, Delhi, Dubai,
Ely (United Kingdom), London, Los Angeles, Kolkata, Melbourne (Australia),
Mumbai, New York, Prague, Stockholm, Singapore, Sofia and Toronto. 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, 2010 and 2009. The
following discussion should be read in conjunction with the information set
forth in the consolidated financial statements and the related notes thereto
appearing elsewhere in this report.





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





Results
of Operations - Three Months Ended September 30, 2010 Compared to Three Months
Ended September 30, 2009





Revenue. Consolidated revenue
increased by $16,710 from $11,036 for the three months ended September 30, 2009
to $27,746 for the three months ended September 30, 2010, an increase of
151%. This increase is primarily due to an increase in customers, increased
spending by existing customers, and revenue from the acquired companies not
included in prior period results.





Variable
and Direct Third Party Costs





Cost of Goods and Services.
Cost of goods and services increased by $6,922 from $4,550 for the three months
ended September 30, 2009 to $11,472 for the three months ended September 30,
2010, an increase of 152%. These costs represent the costs of equipment and
services for the supply of digital media and IPTV solutions, services and
components. The increase was due to an increase in revenue for the supply of
digital media and IPTV solutions, services and components and the acquisition of
Benchmark in May 2010.





Hosting, Delivery and
Reporting. These costs increased by $340 from $331 for the three months
ended September 30, 2009 to $671 for the three months ended September 30, 2010,
an increase of 103%.  These costs increased primarily due to the
recent acquisitions in October 2009 and March 2010.





Content Costs. Content costs
decreased by $25 from $287 for the three months ended September 30, 2009 to $262
for the three months ended September 30, 2010, a decrease of 9%. The decrease
was primarily due to the elimination of monthly minimum guarantees with
many content providers and the reduction in content providers.




Direct Third Party Creative
Production Costs. Direct third party creative production costs increased
by $491 from $583 for the three months ended September 30, 2009 to $1,074 for
the three months ended September 30, 2010, a increase of 84% attributable to an
increase in revenue requiring creative production costs.


21


General
and Administrative Expenses





Compensation, Travel and Associated
Costs (Including Non-Cash Stock-Based Compensation). These costs
increased by $3,513 from $3,846 for the three months ended September 30, 2009 to
$7,359 for the three months ended September 30, 2010, an increase of
91%.  The increase was primarily due to the recent acquisitions in
October 2009, March 2010, May 2010 and September 2010 and the increase in
non-cash stock-based compensation of $737.





Legal, Accounting, Audit and Other
Professional Services Fees. These expenses increased by $271 from $154
for the three months ended September 30, 2009 to $425 for the three months ended
September 30, 2010, an increase of 176%,  primarily due to the
increase in audit, Sarbanes-Oxley consulting fees and other legal
fees.





Office, Marketing and Other Corporate
Costs. These expenses increased by $2,447 from $894 for the three months
ended September 30, 2009 to $3,341 for the three months ended September 30,
2010, an increase of 274%.  The increase was primarily due to the
increases related to recent acquisitions in October 2009, March 2010, May 2010
and September 2010.





Merger and Acquisition and Investor
Relation Expenses. Merger and acquisition and certain investor relation
expenses increased by $784 from $522 for the three months ended September 30,
2009 to $1,306 for the three months ended September 30, 2010 an increase of
150%. The increase in costs for the three months are primarily due to the
acquisitions of Accela, Megahertz and Brickbox in September 2010 and other
merger and acquisition activities and investor relation expenses.





Depreciation and Amortization.
Depreciation and amortization expense increased by $1,430 from $977 for the
three months ended September 30, 2009 to $2,407 for the three months ended
September 30, 2010, an increase of 146%. The increase is primarily attributed to
the amortization of intangible assets and depreciation of long lived assets
acquired as part of the acquisitions of Nunet and Feedroom in October 2009,
Multicast in March 2010 and Benchmark in May 2010.




Restructuring Charges.
Restructuring charges decreased by $433, from an expense of $340 for the three
months ended September 30, 2009 to a gain of $93 for the three months ended
September 30, 2010, a decrease of 127%. This was due to a benefit derived from
the lower than expected payout of facility costs.





Integration expenses.
Integration expenses increased by $3,894 from $641 for the three months ended
September 30, 2009 to $4,535 for the three months ended September 30, 2010.
Integration expenses are related to the redundancy in staff and consultants
during reorganization, corporate rebranding related to the reorganization, and
the integration of acquired companies.





Interest Expense. Interest
expense increased by $99 from $124 for the three months ended September 30, 2009
to $223 for the three months ended September 30, 2010, due to an increase in
debt.




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 which was repaid in August 2009. Amortization of deferred financing costs
and debt discount were $19 for the three months ended September 30, 2010. These
costs resulted from the issuance of $6,000 of secured notes payable in April
2010 and June 2010.





Derivative expense. Derivative
expense was $1,451 for the three months ended September 30, 2010 as compared to
$8,449 for the three months ended September 30, 2009. Derivative income or
expense is the change in the period based on the fair value of warrants
containing reset provisions.





Other Income/(Expense). Other
expense increased by $1,328 from $65 in other income for the three months ended
September 30, 2009 to other expense of $1,263 for the three months
ended September 30, 2010, primarily due to an increase in 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 $7,974 for the three months ended
September 30, 2010 compared to a net loss available to common shareholders of
$11,134 for the three months ended September 30, 2009, a decrease in net loss of
$3,160.


22


Results of Operations - Nine
Months Ended September 30, 2010 Compared to Nine Months Ended September 30,
2009





Revenue. Consolidated revenue
increased by $37,011 from $31,154 for the nine months ended September 30, 2009
to $68,165 for the nine months ended September 30, 2010, an increase of 119%.
This increase in primarily due an increase in customers, increased spending by
existing customers, and revenue from the acquired companies not included in
prior period results.




Variable
and Direct Third Party Costs





Cost of Goods and Services.
Cost of goods and services increased by $10,528 from $11,662 for the nine months
ended September 30, 2009 to $22,190 for the nine months ended September 30,
2010, an increase of 90%. These costs represent the costs of equipment and
services for the supply of digital media and IPTV solutions, services and
components. The increase is due to an increase in revenue for the supply of
digital media and IPTV solutions, services and components and the acquisition of
Benchmark in May 2010.





Hosting, Delivery and
Reporting. These costs increased by $2,008 from $1,027 for the nine
months ended September 30, 2009 to $3,035 for the nine months ended September
30, 2010, an increase of 196%.  These costs increased primarily due to
the recent acquisitions in October 2009 and March 2010.





Content Costs. Content costs
decreased by $359 from $1,105 for the nine months ended September 30, 2009 to
$746 for the nine months ended September 30, 2010, a decrease of 32%. The
decrease is primarily due to the elimination of monthly minimum guarantees
with many content providers and the reduction in content providers.




Direct Third Party Creative
Production Costs. Direct third party creative production costs increased
by $79 from $2,541 for the nine months ended September 30, 2009 to $2,620 for
the nine months ended September 30, 2010, a increase of 3% attributable to an
increase in revenue requiring creative production costs.





General
and Administrative Expenses





Compensation, Travel and Associated
Costs (Including Non-Cash Stock-Based Compensation). These costs
increased by $10,525 from $11,020 for the nine months ended September 30, 2009
to $21,545 for the nine months ended September 30, 2010, an increase of
96%.  The increase was primarily due to the recent acquisitions in
October 2009, March 2010, May 2010 and September 2010 and the increase in
non-cash stock-based compensation of $1,822.





Legal, Accounting, Audit and Other
Professional Services Fees. These expenses increased by $1,061 from $584
for the nine months ended September 30, 2009 to $1,645 for the nine months ended
September 30, 2010, an increase of 182%,  primarily due to the
increase in audit, Sarbanes-Oxley consulting fees and other legal
fees.





Office, Marketing and Other Corporate
Costs. These expenses increased by $5,211 from $2,507 for the nine months
ended September 30, 2009 to $7,718 for the nine months ended September 30, 2010,
an increase of 208%.  The increase was primarily due to the increases
related to recent acquisitions in October 2009, March 2010, May 2010 and
September 2010.




Merger and Acquisition and Investor
Relation Expenses. Merger and acquisition and certain investor relation
expenses increased by $2,160 from $1,251 for the nine months ended September 30,
2009 to $3,411 for the nine months ended September 30, 2010 an increase of 173%.
The increase in costs are primarily due to the acquisitions of Multicast in
March 2010, Benchmark in May 2010, Accela, Megahertz and Brickbox in September
2010 and other merger and acquisition activities and investor relation
expenses.





Depreciation and Amortization.
Depreciation and amortization expense increased by $3,540 from $2,570 for the
nine months ended September 30, 2009 to $6,110 for the nine months ended
September 30, 2010, an increase of 138%. The increase is primarily attributed to
the amortization of intangible assets and depreciation of long lived assets
acquired as part of the acquisitions of Nunet and Feedroom in October 2009,
Multicast in March 2010 and Benchmark in May 2010.




Restructuring Charges.
Restructuring charges increased by $2,827, from $654 for the nine months ended
September 30, 2009 to $3,481 for the nine months ended September 30,
2010.  Restructuring charges consist of employee termination costs,
contract settlements and facility closing costs. These charges increased due to
the approved restructuring plan put into place in the first quarter of
2010.




23





Integration expenses.
Integration expenses increased by $9,202 from $1,632 for the nine months ended
September 30, 2009 to $10,834 for the nine months ended September 30, 2010.
Integration expenses are related to the redundancy in staff and consultants
during reorganization, corporate rebranding related to the reorganization, and
the integration of acquired companies.





Interest Expense. Interest
expense increased by $122 from $441 for the nine months ended September 30, 2009
to $563 for the nine months ended September 30, 2010, due to an increase in
debt.




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 resulted from the issuance of $1,500 of a senior secured note in November
2008 which was repaid in August 2009. Amortization of deferred financing costs
and debt discount were $33 for the nine months ended September 30, 2010. These
costs resulted from the issuance of $6,000 of secured notes payable in April
2010 and June 2010.





Derivative income/expense.
Derivative expense was $10,526 for the nine months ended September 30, 2010 as
compared to derivative income of $2,233 for the nine months ended September 30,
2009. Derivative income or expense is the change in the period based on the fair
value of warrants containing reset provisions.





Other Income/(Expense). Other
income decreased by $880 from $405 for the nine months ended September 30, 2009
to other expense of $475 for the nine months ended September 30, 2010, primarily
due to an increase in 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 $26,758 for the nine months ended
September 30, 2010 compared to net loss available to common shareholders of
$4,350 for the nine months ended September 30, 2009, an increase in net loss of
$22,408.





Liquidity
and Capital Resources





As of
September 30, 2010, we had cash and cash equivalents of $50,052 and working
capital of approximately $54,679. During the nine months ended September 30,
2010, we received net proceeds of $106,615 in public offerings, repurchased
warrants for $24,054 and paid net cash of $19,757 related to acquisitions. We
plan to primarily use net proceeds of the most recent equity offering to finance
the costs of acquiring or investing in competitive and complementary businesses,
products and technologies as a part of our growth strategy. Management
anticipates that going-forward, we will generate sufficient cash flows from
operating activities to meet our capital requirements. We believe that we have
sufficient liquidity to finance our operational and acquisition plan for the
next twelve months.





Net cash
used by operating activities was $17,468 for the nine months ended September 30,
2010, compared to $8,506 for the nine months ended September 30, 2009, an
increase of $8,962. The increase in net cash used in operating activities is
primarily related to the increase in receivables attributable to an increase in
revenues and a couple slower paying major clients, an increase in merger and
acquisition and investor relations expenses and restructuring and integration
expenses offset by the accrual for these items in the nine months ended
September 30, 2010.





Net cash
used by investing activities was $25,151 for the nine months ended September 30,
2010, compared to $6,840 for the nine months ended September 30, 2009, an
increase in net cash used in investing activities of $18,311. In 2010, this
consisted primarily of  net cash paid in acquisitions of $19,757, cash
paid into restricted cash related to the Benchmark acquisition of $2,035, cash
paid into investment of $700 and purchase of equipment of $1,272. 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.





Net cash
provided by financing activities was $85,322 for the nine months ended September
30, 2010, compared to net cash provided by financing activities of $23,392 for
the nine months ended September 30, 2009. In 2010, this primarily consisted of
the proceeds from public offerings of $106,615, net proceeds from the issuance
of secured notes of $5,762, proceeds from the exercise of warrants and options
of $3,104 offset by payments related to the buyback of warrants of $24,054,
payments of notes related to the Multicast acquisition of $4,500 and payments of
other notes, capital leases and other obligations of $1,814. In 2009, this
primarily consisted of net proceeds from public offerings of $26,090, proceeds
from the issuance of secured notes of $849 offset by payments of capital leases,
secured notes and other obligations of $2,835.


24


Off-Balance
Sheet Arrangements





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





SPECIAL
NOTE REGARDING FORWARD-LOOKING INFORMATION




This
Form 10-Q includes forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933, as amended (the “Securities Act”), and Section
21E of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”).  We intend such forward-looking statements to be covered by the
safe harbor provisions for forward-looking statements contained in the United
States Private Securities Litigation Reform Act of 1995.  All
statements, other than statements of historical facts, included in this Form
10-Q regarding our strategy, future operations, financial position, future
revenues, projected costs, prospects, plans and objectives of management are
forward-looking statements.  The words “anticipates,” “believes,”
“estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would”
and similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain these identifying words. We
cannot guarantee that we actually will achieve the plans, intentions or
expectations disclosed in our forward-looking statements and you should not
place undue reliance on our forward-looking statements.  There are a
number of important factors that could cause our actual results to differ
materially from those indicated by these forward-looking
statements.  These important factors include risks related to our
history of net losses and accumulated deficits, integration of acquired
businesses, future capital requirements, competition and technological advances,
dependence on the market for digital advertising, and other factors that we
identify in this Form 10-Q and in other filings we make with the
SEC.  For additional factors that can affect these forward-looking
statements, see the “Risk Factors” section in our Annual Report on Form 10-K for
the year ended December 31, 2009.  You should read these factors and
other cautionary statements made in this Form 10-Q as being applicable to all
related forward-looking statements wherever they appear in the Form
10-Q.  Except to the extent required by federal securities laws, we do
not assume any obligation to update any forward-looking statements made by
us.





Recent
Accounting Pronouncements





See Note
2 to our consolidated financial statements included herein.


25


ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.





See
Item 7A of Part II of our annual report on Form 10-K for the year ended
December 31, 2009. There have been no material changes since disclosure in
the most recently filed Form 10-K.





ITEM
4. CONTROLS AND PROCEDURES.





Conclusion
Regarding the Effectiveness of Disclosure Controls and Procedures





As of the
end of the period covered by this report, we conducted an evaluation, under the
supervision and with the participation of our chief executive officer and chief
financial officer of our disclosure controls and procedures (as defined in Rule
13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation,
our chief executive officer and chief financial officer concluded that our
disclosure controls and procedures are 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.





Changes
in Internal Control Over Financial Reporting





As a
result of increased market capitalization, acquisitions in the first and second
quarter of 2010 as well as an increase in business related to complex
multi-element contracts, KIT engaged an outside firm to review and update its
internal controls.  The evaluation was performed during the 2nd
quarter and implementation of updated and new controls occurred during the 3rd
quarter.  The summary of enhancements and updates are as
follows:





•
            Enhanced
      global Human Resource entity level controls over employee communication
      and responsibility for internal controls as well as providing management
      with timely feedback on a confidential basis to take appropriate
      action.


•
            Added
      a dedicated Global SOX Compliance Lead resource for coordinating
      implementation and execution of all procedures and
    controls.


•
            Centralized
      global Human Resource function to control the on-boarding and termination
      process throughout all KIT offices around the
  world.


•
            Organizing
      the controls into a regional structure for routine daily and transactional
      controls as well as reporting results to corporate finance for the
      preparation of consolidated financial
  statements.


•
            Augmenting
      and updating revenue recognition controls for multi-element
      contracts.


•
            Standardizing
      controls as well as financial statement close checklists and timeline
      across all regions and locations across the
  company.


•
            Updated
      procedures and controls ensuring consistency across the regions for
      spreadsheet review and approval.


•
            Implementing
      a secure global electronic filing system for ensuring consistency of valid
      reporting from the regions to
corporate.


•
            Updating
      tax controls to reflect the expanded global nature of the
      business.


•
            Updated
      all controls to reflect recent FASB Codification of standards and
      pronouncements


•
            IT
      General Controls across the global infrastructure of KIT as it relates to
      financial reporting


•
            Change
      management controls over development and implementation of systems that
      are relevant to financial
reporting.


•
            Controls
      and procedures to ensure that information and communication between
      corporate and the regions related to reporting in accordance with US GAAP
      is properly facilitated.


•
            Created
      standardized global controls for treasury, banking and cash management for
      corporate and all regions.


•
            Updated
      delegation of authority as well as acquisition related controls for
      corporate and all regions.


•
            Updated
      controls over goodwill as well as other intangibles related to
      acquisitions.


•
            Updated
      management test plans to obtain testing coverage for each region based for
      control objectives to be achieved.





Management
believes the internal control changes summarized above were necessary and
significant to meet the needs of the continued growth of KIT through
acquisitions and organically.  The primary objective achieved by
updating the internal controls is to standardize and streamline compliance
across all KIT offices around the world as well as for producing monthly and
quarterly financial statements in accordance with US GAAP.  The
combined effect of the implementation of the enhanced and revised internal
controls is not expected to materially affect our internal control over
financial reporting.




26





PART
II - OTHER INFORMATION





ITEM
1. LEGAL PROCEEDINGS.





None





ITEM
1A. RISK FACTORS.





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





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




None





ITEM
3. DEFAULTS UPON SENIOR SECURITIES.





None





ITEM
4. RESERVED




None





ITEM
5. OTHER INFORMATION.




None




ITEM
6. EXHIBITS.





Exhibit No.
              
              Description31.1
              
              Certification
      of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.31.2
              
              Certification
      of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley
      Act of 2002.32.1
              
              Certification
      of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.32.2
              
              Certification
      of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
      pursuant to Section 906 of the Sarbanes-Oxley Act of
  2002.




27


SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




KIT
      DIGITAL, INC.Dated:  November
      22, 2010
                    By:
                    /s/ Kaleil Isaza TuzmanKaleil
      Isaza TuzmanChairman
      and Chief Executive Officer
                      (principal
      executive officer)Dated:  November
      22, 2010
                    By:
                    /s/
      Robin SmythRobin
      SmythChief
      Financial Officer
                      (principal
      financial and accounting
officer)


28