Prospectus Supplement

Broadcast International, Inc.

Form 10-Q

Table of Contents

Part I - Financial Information

Page

Item 1. Financial Statements

Item 2. Management’s Discussion and Analysis of Financial Condition

and Results of Operations

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Item 4T Controls and Procedures

Part II -Other Information

Item 1. Legal Proceedings

Item 1A. Risk Factors

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Item 3. Defaults Upon Senior Securities

Item 4. Submission of Matters to a Vote of Security Holders

Item 5. Other Information

Item 6. Exhibits

Signatures

Part I. Financial Information

Item 1. Financial Statements

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS


		December 31,		June 30,
		2007		2008
				(Unaudited)
ASSETS:
Current assets
Cash and cash equivalents	$	16,598,300	$	9,296,764
Trade accounts receivable, net		220,834		643,889
Inventory		57,218		26,682
Prepaid expenses		2,449,236		1,568,821

Total current assets		19,325,588		11,536,156

Property and equipment, net		641,314		1,554,669

Other assets
Debt offering Costs		1,367,583		1,136,025
Patents, net		197,346		195,356
Available-for-sale securities (note 7)		--		2,605,674
Deposits and other assets		8,795		9,058

Total other assets		1,573,724		3,946,113

Total assets	$	21,540,626	$	17,036,938

See accompanying notes to consolidated financial statements.

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Continued)


		December 31,		June 30,
		2007		2008
LIABILITIES:				(Unaudited)

Current liabilities
Accounts payable	$	640,292	$	529,525
Payroll and related expenses		460,236		334,400
Other accrued expenses		55,356		67,750
Unearned revenue		169,359		110,376
Current debt obligations		47,692		--
Derivative valuation		14,267,600		7,942,300

Total current liabilities		15,640,535		8,984,351

Long-term liabilities
Convertible debt (net of $13,068,755 and $10,806,437
discount, respectively)		2,931,245		5,193,563

Total liabilities		18,571,780		14,177,914

Commitments and contingencies (Note 6)

STOCKHOLDERS’ EQUITY:
Preferred stock, no par value, 20,000,000 shares
authorized; none issued		-		-
Common stock, $.05 par value, 180,000,000 shares
authorized; 37,775,034 and 38,631,585 shares issued as
of December 31, 2007 and June 30, 2008, respectively		1,888,752		1,931,579
Additional paid-in capital		69,078,449		72,493,063
Accumulated other comprehensive loss		-		(194,326)
Subscriptions receivable		(25,000)		-
Accumulated deficit		(67,973,355)		(71,371,292)

Total stockholders’ equity		2,968,846		2,859,024

Total liabilities and stockholders’ equity	$	21,540,626	$	17,036,938

See accompanying notes to consolidated financial statements.

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


		For the three months				For the six months
		ended June 30,				ended June 30,
		2007		2008		2007		2008

Net sales	$	763,784	$	810,803	$	2,362,850	$	1,998,195
Cost of sales		800,835		968,859		2,395,610		2,105,305
Gross profit (loss)		(37,051)		(158,056)		(32,760)		(107,110)

Operating expenses:
Administrative and general		1,304,508		1,454,560		2,879,192		2,988,741
Selling and marketing		166,814		356,309		309,435		602,501
Research and development		199,026		1,052,153		384,089		1,828,786
Impairment of license rights		1,142,400		-		1,142,400		-
Total operating expenses		2,812,748		2,863,022		4,715,116		5,420,028

Total operating loss		(2,849,799)		(3,021,078)		(4,747,876)		(5,527,138)

Other income (expense):
Interest income		3,543		101,670		12,578		264,289
Interest expense		(353,008)		(1,492,785)		(1,126,839)		(2,994,577)
Derivative valuation gain (loss)		1,982,480		(1,145,240)		328,090		4,863,823
Other income (expense), net		(3,015)		513		(349)		(4,334)
Total other income (expense)		1,630,000		(2,535,842)		(786,520)		2,129,201

Loss before income taxes		(1,219,799)		(5,556,920)		(5,534,396)		(3,397,937)
Provision for income taxes		--		--		--		--
Net loss	$	(1,219,799)	$	(5,556,920)	$	(5,534,396)	$	(3,397,937)

Net loss per share – basic & diluted	$	(0.04)	$	(0.15)	$	(0.19)	$	(0.09)

Weighted average shares – basic & diluted		30,125,300		38,357,400		28,995,900		38,575,600

See accompanying notes to consolidated financial statements.

BROADCAST INTERNATIONAL, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


		Six Months Ended
		June 30,
		2007		2008
Cash flows from operating activities:
Net loss	$	(5,534,396)	$	(3,397,937)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		116,873		203,101
Common stock issued for services		--		113,400
Common stock issued for in process research and development		--		75,501
Accretion of discount on convertible notes payable		512,502		2,263,075
Stock-based compensation		999,430		350,768
Gain on sale of assets		(5,100)		(363)
Derivative liability valuation		(328,090)		(4,863,823)
Impairment of license rights		1,142,400		--
Extinguishment of debt		318,749		6,056
Allowance for doubtful accounts		50,120		130,802
Changes in assets and liabilities:
Accounts receivable		576,399		(553,857)
Inventories		17,602		30,536
Debt offering costs		200,836		231,558
Prepaid and other assets		1,286,809		1,368,152
Accounts payable and accrued expenses		(317,218)		(302,327)
Deferred revenues		(306,059)		(58,983)

Net cash used in operating activities		(1,269,143)		(4,404,341)

Cash flows from investing activities:
Purchase of equipment		(41,683)		(1,047,867)
Purchase of available-for-sale securities		--		(11,600,000)
Proceeds from sale of available-for-sale securities		--		8,800,000
Proceeds from sale of assets		5,100		11,882

Net cash used in investing activities		(36,583)		(3,835,985)

Cash flows from financing activities:
Proceeds from the exercise of warrants		--		913,040
Principal payments on debt		(583,285)		--
Proceeds from subscription receivable		--		25,000
Proceeds from the exercise of options		--		750
Proceeds for the sale of stock		1,122,999		--
Loan proceeds		299,948		--

Net cash provided by financing activities		839,662		938,790

Net decrease in cash and cash equivalents		(466,064)		(7,301,536)

Cash and cash equivalents, beginning of period		807,741		16,598,300

Cash and cash equivalents, end of period	$	341,677	$	9,296,764

See accompanying notes to consolidated financial statements.

BROADCAST INTERNATIONAL, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

June 30, 2008

NOTE 1 - BASIS OF PRESENTATION

In the opinion of management, the accompanying unaudited condensed consolidated financial statements of Broadcast International, Inc. (“we” or the “Company”) contain the adjustments, all of which are of a normal recurring nature, necessary to present fairly our financial position at December 31, 2007 and June 30, 2008 and the results of operations for the three and six months ended June 30, 2007 and 2008, respectively, with the cash flows for each of the six month periods ended June 30, 2007 and 2008, in conformity with U.S. generally accepted accounting principles.

These condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the year ended December 31, 2007. Operating results for the three and six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

NOTE 2 - RECLASSIFICATIONS

Certain 2007 financial statement amounts have been reclassified to conform to 2008 presentations.

NOTE 3 - WEIGHTED AVERAGE SHARES

The computation of basic earnings (loss) per common share is based on the weighted average number of shares outstanding during each period. The computation of diluted earnings per common share is based on the weighted average number of common shares outstanding during the period, plus the common stock equivalents that would arise from the exercise of stock options and warrants outstanding, using the treasury stock method and the average market price per share during the period, plus the effect of assuming conversion of the convertible debt.

Options and warrants to purchase 15,821,878 and 15,614,557 shares of common stock at prices ranging from $.02 to $45.90 per share were outstanding at June 30, 2008 and 2007, respectively, but were excluded from the calculation of diluted earnings per share because the effect of the stock options and warrants was anti-dilutive. Furthermore, the Company had convertible debt that was convertible into 3,418,961 shares of common stock at June 30, 2008, that was excluded from the calculation of diluted earnings per share because the effect was anti-dilutive.

NOTE 4 - STOCK COMPENSATION

Beginning on January 1, 2006, we began accounting for stock-based compensation under the provisions of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (FAS 123R), which requires the recognition of the fair value of stock-based compensation. We have used the modified prospective application. Under the fair value recognition provisions for FAS 123R, stock-based compensation cost is estimated at the grant date based on the fair value of the awards expected to vest and recognized as expense ratably over the requisite service period of the award. We have used the Black-Scholes valuation model to estimate fair value of our stock-based awards, which requires various judgmental assumptions including estimated stock price volatility, forfeiture rates, and expected life. Our computation of expected volatility is based on a combination of historical and market-based implied volatility.

We calculated the fair market value of each option and warrant awarded on the date of grant using the Black-Scholes option-pricing model. The following assumptions were used for the grants awarded for the three and six months ended June 30, 2008.


Risk-free interest rate	3.17% - 3.99%
Expected lives in years	3 - 10.0
Dividend yield	0
Expected volatility	76.73% - 84.03%

Net loss for the six months ended June 30, 2008 and 2007 includes $350,768 and $999,430, respectively, of non-cash stock-based compensation expense. Options issued to directors vest immediately and all other options and warrants are subject to applicable vesting schedules. Expense is recognized proportionally as each grant vests.

Included in the $350,768 of non-cash stock based compensation expense for the six months ended June 30, 2008 is (i) $85,221 for the vested portion of 316,500 options granted to eleven employees, (ii) $14,800 for the vested portion of 200,000 warrants granted to two consultants, (iii) $268,876 resulting from the vesting of unexpired options and warrants issued prior to January 1, 2008, (iv) ($18,129) credit for recovery of previously recorded expense of unvested options forfeited during the period.

Included in the $999,430 of non-cash stock based compensation expense for the six months ended June 30, 2007 is (i) $499,000 resulting from 600,000 options granted to three directors, (ii) $232,693 resulting from the vesting of unexpired options issued prior to January 1, 2007, (iii) $215,490 resulting from 1,825,000 warrants issued to three consultants, of which, 500,000 warrants were issued to a current member of our board of directors, prior to him becoming a member of the board, (iv) $41,887 resulting from the issuance of 366,500 options issued to non-executive management employees, and (v) $10,360 for repriced options previously granted to executive management. Warrants to acquire 748,670 shares of our common stock were also granted to certain equity investors. See note 8.

The impact on our results of operations for recording stock-based compensation under FAS 123R for the three and six months ended June 30, 2007 and 2008 are as follows:


	For the Three Months		For the Six Months
	Ended June 30,		Ended June 30,
	2007	2008	2007	2008

General and administrative	$ 324,269	$ 70,588	$ 883,457	$ 174,169
Research and development	63,168	91,709	115,973	176,599

Total	$ 387,437	$ 162,297	$ 999,430	$ 350,768

Due to unexercised options and warrants outstanding at June 30, 2008, we will recognize a total of $1,578,834 of compensation expense over the next four years for employees and consultants as a result of the adoption of FAS 123R based upon option and warrant award vesting parameters as shown below:



2008	$ 563,819
2009	581,029
2010	381,467
2011	52,519

Total	$ 1,578,834

The following unaudited tables summarize option and warrant activity during the six months ended June 30, 2008.


	Options and Warrants Outstanding	Options or Warrants Price Per Share

Outstanding at December 31, 2007	16,034,019	$ 0.02	–	$ 45.90
Options granted	316,500	2.60	–	3.45
Warrants issued	200,000	3.35	–	3.35
Expired	--	--	–	--
Forfeited	(131,983)	0.33	–	4.00
Exercised	(596,658)	0.33	–	2.00

Outstanding at June 30, 2008	15,821,878	$ 0.02	–	$ 45.90

The following table summarizes information about stock options and warrants outstanding at June 30, 2008.


		Outstanding				Exercisable
			Weighted Average Remaining		Weighted Average			Weighted Average
	Range of Exercise Prices	Number Outstanding	Contractual Life (years)		Exercise Price	Number Exercisable		Exercise Price
$	0.02-0.04	1,264,495	1.82	$	0.03	1,264,495	$	0.03
	0.33-0.95	1,668,302	6.90		0.72	1,501,635		0.70
	1.06-6.25	12,885,481	3.03		2.55	12,084,981		2.51
	9.50-11.50	2,000	3.02		10.65	2,000		10.65
	36.25-45.90	1,600	2.17		41.08	1,600		41.08
$	0.02-45.90	15,821,878	3.34	$	2.16	14,854,711	$	2.12

NOTE 5- SIGNIFICANT ACCOUNTING POLICIES

Management Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents

We consider all cash on hand and in banks, and highly liquid investments with maturities of three months or less, to be cash equivalents. At June 30, 2008 and 2007, we had bank balances in the excess of amounts insured by the Federal Deposit Insurance Corporation. We have not experienced any losses in such accounts, and believe we are not exposed to any significant credit risk on cash and cash equivalents.

Current financial market conditions have had the effect of restricting liquidity of cash management investments and have increased the risk of even the most liquid investments and the viability of some financial institutions. We do not believe, however, that these conditions will materially affect our business or our ability to meet our obligations or pursue our business plans.

Account Receivables

Included in our $643,889 and $220,834 net accounts receivable for the six months ending June 30, 2008 and year ending December 31, 2007, respectively, were, (i) $28,140 and $35,106 of unbilled trade receivables and (ii) $2,067 and $5,421 for employee travel advances and other receivables, respectively. Trade account receivables are carried at original invoice amount less an estimate made for doubtful receivables based on a review of all outstanding amounts on a monthly basis. Management determines the allowance for doubtful accounts by identifying troubled accounts and by using historical experience applied to an aging of accounts. Trade receivables are written off when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when received.

A trade receivable is considered to be past due if any portion of the receivable balance is outstanding for more than 90 days. After the receivable becomes past due, it is on non-accrual status and accrual of interest is suspended.

Inventories

Inventories consisting of electrical and computer parts are stated at the lower of cost or market determined using the first-in, first-out method.

Property and Equipment

Property and equipment are stated at cost. Depreciation is provided using the straight-line method over the estimated useful lives of the property, generally from three to five years. Repairs and maintenance costs are expensed as incurred except when such repairs significantly add to the useful life or productive capacity of the asset, in which case the repairs are capitalized.

Patents

Patents represent initial legal costs incurred to apply for United States and international patents on the CodecSys technology, and are amortized on a straight-line basis over their useful life of approximately 20 years. We have filed several patents in the United States and foreign countries. As of June 30, 2008, the United States Patent and Trademark Office had approved 2 patents. Additionally, seven foreign countries had approved patent rights. While we are unsure whether we can develop the technology in order to obtain the full benefits, the patents themselves hold value and could be sold to companies with more resources to complete the development. On-going legal expenses incurred for patent follow-up have been expensed from July 2005 forward.

Amortization expense recognized on all patents totaled $1,055 and $1,990 for the three and six months ended June 30, 2008, respectively. Amortization expense recognized on all patents totaled $674 and $1,411 for the three and six months ended June 30, 2007, respectively.

Estimated amortization expense for each of the next five years is as follows:


Year ending December 31:
2008	$10,652
2009	10,652
2010	10,652
2011	10,652
2012	10,652

Long-Lived Assets

We review our long-lived assets, including patents, whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets held and used is measured by a comparison of the carrying amount of an asset to future un-discounted net cash flows expected to be generated by the asset. If such assets are considered to be impaired, then the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the estimated fair value of the assets. Fair value is determined by using cash flow analyses and other market valuations.

Income Taxes

We account for income taxes in accordance with the asset and liability method of accounting for income taxes prescribed by Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to the taxable income in the years in which those temporary differences are expected to be recovered or settled.

Revenue Recognition

We recognize revenue when evidence exists that there is an arrangement between us and our customers, delivery of equipment sold or service has occurred, the selling price to our customers is fixed and determinable with required documentation, and collectability is reasonably assured. We recognize as deferred revenue, payments made in advance by customers for services not yet provided.

When we enter into a multi-year contract with a customer to provide installation, network management, satellite transponder and help desk, or combination of these services, we recognize this revenue as services are performed and as equipment is sold. These agreements typically provide for additional fees, as needed, to be charged if on-site visits are required by the customer in order to ensure that each customer location is able to receive network

communication. As these on-site visits are performed the associated revenue and cost are recognized in the period the work is completed. If we install, for an additional fee, new or replacement equipment to an immaterial number of new customer locations, and the equipment immediately becomes the property of the customer, the associated revenue and cost are recorded in the period in which the work is completed.

Research and Development

Research and development costs are expensed when incurred. We expensed $1,052,153, and $1,828,786 of research and development costs for the three and six months ended June 30, 2008 and $199,026 and $384,089 for the three and six months ended June 30, 2007, respectively.

Concentration of Credit Risk

Financial instruments, which potentially subject us to concentration of credit risk, consist primarily of trade accounts receivable. In the normal course of business, we provide credit terms to our customers. Accordingly, we perform ongoing credit evaluations of our customers and maintain allowances for possible losses which, when realized, have been within the range of management’s expectations.

For the six months ended June 30, 2008, we had 3 customers that individually constituted greater than 10% of our total revenues, which represented 26%, 11% and 11% of our revenues, respectively. For the six months ended June 30, 2007, we had 3 customers that individually constituted greater than 10% of our total revenues, which represented 28%, 19% and 18% of our revenues, respectively. One of the three customers in 2008 was not the same customer as in 2007

Fair Value of Financial Instruments

Our financial instruments consist of cash, receivables, notes receivables, payables, and notes payable. The carrying amount of cash, receivables and payables approximates fair value because of the short-term nature of these items. The aggregate carrying amount of the notes receivable and notes payable approximates fair value as the individual notes bear interest at market interest rates.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

NOTE 6 - LONG TERM OBLIGATIONS

Senior Secured 6.25% Convertible Note

On December 24, 2007, we entered into a securities purchase agreement in which we raised $15,000,000 (less $937,000 of prepaid interest). We intend to use the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. Pursuant to the financing, we issued a senior secured convertible note in the principal amount of $15,000,000, which is due December 21, 2010 and bears interest at 6.25% per annum. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 are due quarterly and commence in April 2009. Interest payments may be made through issuance of common stock in certain circumstances. The note is convertible into 2,752,294 shares of our common stock, at a conversion price of $5.45 per share, convertible any time during the term of the note. We have granted a first priority security interest in all of our property and assets and of our subsidiaries to secure our obligations under the note and related transaction agreements.

In connection with the financing, the senior secured convertible note holder received warrants to acquire 1,875,000 shares of our common stock exercisable at $5.00 per share. The warrants are exercisable any time for a five-year period beginning on the date of grant. We also issued to the convertible note holder 1,000,000 shares of our common stock valued at $3,750,000 and incurred an additional $1,377,000 for commissions, finders fees and other transaction expenses, including the grant of a three-year warrant to purchase 112,500 shares of our common stock to a third party at an exercise price of $3.75 per share, valued at $252,000. A total of $1,377,000 was included in debt offering costs and is being amortized over the term of the note. The warrants and the embedded conversion feature and prepayment provision of the senior secured convertible notes have been accounted for as derivatives pursuant to EITF 00-19 and SFAS No. 133.

The $5.45 conversion price of the senior secured convertible note and the $5.00 exercise price of the warrants are subject to adjustment pursuant to standard anti-dilution rights. These rights include (i) equitable adjustments in the event we effect a stock split, dividend, combination, reclassification or similar transaction; (ii) “weighted average” price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than the then current market price of our common stock; and (iii) “full ratchet” price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than $5.45 per share.

The senior secured convertible note contains a prepayment provision allowing us to prepay, in certain limited circumstances, all or a portion of the note. The portion of the note subject to prepayment must be purchased at a price equal to the greater of (i) 135% of the amount to be purchased and (ii) the company option redemption price, as defined in the note. Even if we elect to prepay the note, the note holder may still convert any portion of the note being prepaid pursuant to the conversion feature thereof.

We also entered into a registration rights agreement with the holder of the senior secured convertible note pursuant to which we agreed to provide certain registration rights with respect to the shares of common stock, the shares of common stock issuable upon conversion of the note, the shares of common stock issuable as interest shares under the note and shares of common stock issuable upon exercise of the warrant under the Securities Act of 1933, as amended. The holder is entitled to demand registration of the above-mentioned shares of common stock after six months from the closing of the securities purchase agreement in certain circumstances.

The securities purchase agreement under which the senior secured convertible note and related securities were issued contains, among other things, covenants that may restrict our ability to obtain additional capital, to declare or pay a dividend or to engage in other business activities. A breach of any of these covenants could result in a default under our senior secured convertible note, in which event the holder of the note could elect to declare all amounts outstanding to be immediately due and payable, which would require us to secure additional debt or equity financing to repay the indebtedness or to seek bankruptcy protection or liquidation. The securities purchase agreement provides that we cannot do any of the following without the prior written consent of the holder:

directly or indirectly, redeem, or declare or pay any cash dividend or distribution on, our common stock;

issue any additional notes or issue any other securities that would cause a breach or default under the senior secured convertible note;

issue or sell any rights, warrants or options to subscribe for or purchase common stock or directly or indirectly convertible into or exchangeable or exercisable for common stock at a price which varies or may vary with the market price of the common stock, including by way of one or more reset(s) to any fixed price unless the conversion, exchange or exercise price of any such security cannot be less than the then applicable conversion price with respect to the common stock into which any note is convertible or the then applicable exercise price with respect to the common stock into which any warrant is exercisable;

enter into or affect any dilutive issuance (as defined in the note) if the effect of such dilutive issuance is to cause us to be required to issue upon conversion of any note or exercise of any warrant any shares of common stock in excess of that number of shares of common stock which we may issue upon conversion of the note and exercise of the warrants without breaching our obligations under the rules or regulations of the principal market or any applicable eligible market;

liquidate, wind up or dissolve (or suffer any liquidation or dissolution);

convey, sell, lease, license, assign, transfer or otherwise dispose of all or any substantial portion of our properties or assets, other than transactions in the ordinary course of business consistent with past practices, and transactions by non-material subsidiaries, if any;

cause, permit or suffer, directly or indirectly, any change in control transaction as defined in the senior secured convertible note.

As of June 30, 2008, we recorded an aggregate derivative liability of $5,607,500, and a derivative valuation gain of $3,012,600 to reflect the change in value of the aggregate derivate liability since December 31, 2007. The aggregate derivative liability of $5,607,500 included $2,945,000 for the conversion feature and $2,662,500 for the warrants. These values were calculated using the Black-Scholes pricing model with the following assumptions: (i) risk-free interest rate between 2.77% and 3.34%, (ii) expected life (in years) of 2.5 for the conversion feature and 4.5 for the warrants; (iii) expected volatility of 90.15% for the conversion feature and 78.72% for the warrants; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $2.80.

The principal value of $15,000,000 of the 6.25% senior secured convertible note is being accreted over the term of the obligation, for which $1,047,825 and $2,095,650 was included in interest expense for the three and six months ended June 30, 2008, respectively. The note bears a 6.25% annual interest rate payable quarterly, and for the three and six months ended June 30, 2008, $234,375 and $468,750, respectively, was included in interest expense. On December 21, 2007, we paid $937,500 as interest for the first year of the note and at June 30, 2008 have recorded $445,312 as prepaid interest.

Unsecured Convertible Note

On September 29, 2006, we entered into a letter of understanding with Triage Capital Management, or Triage, dated September 25, 2006. The letter of understanding provided that Triage loan $1,000,000 to us in exchange for us entering into, on or prior to October 30, 2006, a convertible note securities agreement. It was intended that the funding provided by Triage be replaced by a convertible note and accompanying warrants, as described below. Effective November 2, 2006, we entered into securities purchase agreement, a 5% convertible note, a registration rights agreement, and four classes of warrants to purchase our common stock, all of which were with an individual note holder, the controlling owner of Triage, who caused our agreement with Triage to be assigned to him, which satisfied our agreement with Triage.

Pursuant to the securities purchase agreement, (i) we sold to the convertible note holder a three-year convertible note in the principal amount of $1,000,000 representing the funding received by us on September 29, 2006; (ii) the convertible note bears an annual interest rate of 5%, payable semi-annually in cash or shares of our common stock; (iii) the convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share; and (iv) we issued to the convertible note holder four classes of warrants (A Warrants, B Warrants, C Warrants and D Warrants), which give the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock as described below. The A and B Warrants originally expired one year after the effective date of a registration statement filed under the Securities Act of 1933, as amended (the “Securities Act”), to register the subsequent sale of shares received from exercise of the A and B Warrants. The C Warrants and D Warrants originally expired eighteen months and twenty four months, respectively, after the effective date of a registration statement to be filed under the Securities Act. The A Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.60 per share, the B Warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.75 per share, the C Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $2.10 per share, and the D Warrants grant the convertible note holder the right to purchase up to 2,000,000 shares of common stock at an exercise price of $3.00 per share.

During the fourth quarter of the year ended December 31, 2007, the convertible note holder exercised 454,000 A Warrants at an exercise price of $1.60 per share providing $726,400 in funding to us. Additionally, we entered into an exchange agreement dated October 31, 2007 in which the convertible note holder received 650,000 shares of our common stock in exchange for cancellation of the C and the D Warrants. The expiration date of the A Warrants and the B Warrants was extended from January 11, 2008 to December 3, 2008.

During the three months ended June 30, 2008 convertible note holder exercised 64,400 A Warrants at an exercise price of $1.60 per share providing $103,040 in funding to us. As of June 30, 2008 there were 231,600 A warrants and 750,000 B Warrants available.

As of June 30, 2008 and 2007, we recorded an aggregate derivative liability of $2,276,300 and $2,852,500, and derivative valuation gain of $1,711,260 and derivative valuation loss $418,300, respectively, to reflect the change in value of the aggregate derivate liability since December 31, 2007 and 2006, respectively. The aggregate

derivative liability of $2,276,300 included $1,100,000 for the conversion feature and $1,176,300 for the warrants. These values were calculated using the Black-Scholes pricing model with the following assumptions: (i) risk-free interest rate of 2.36% for the conversion feature and 2.17% for the warrants, (ii) expected life (in years) of 1.30 for the conversion feature and 0.40 for the warrants; (iii) expected volatility of 90.04% for the conversion feature and 81.35% for the warrants; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $2.80.

The principal value of $1,000,000 of the unsecured convertible note is being accreted over the term of the obligation, for which $83,334 and $166,668 was included in interest expense for the three and six months ended June 30, 2008 and 2007, respectively. The note bears a 5% annual interest rate payable semi-annually, and for the three and six months ended June 30, 2008 and 2007, $12,501 and $25,002, respectively, was included in interest expense.

Senior Secured 6% Convertible Notes

On May 16, 2005, we consummated a private placement of $3,000,000 principal amount of 6% senior secured convertible notes and related securities, including common stock warrants and additional investment rights, to four institutional funds. The senior secured convertible notes were originally due May 16, 2008 and were originally convertible into 1,200,000 shares of our common stock at a conversion price of $2.50 per share. On March 16, 2006, we entered into a waiver and amendment agreement (discussed below), which adjusted the conversion rate to $1.50 per share. The warrants and the embedded conversion feature of the senior secured convertible notes have been accounted for as derivatives pursuant to EITF 00-19 and SFAS No. 133.

We issued to the note holders a total of 600,000 A warrants and 600,000 B warrants to purchase common stock with an exercise price of $2.50 and $4.00, respectively. The $2.50 conversion price of the senior secured convertible notes and the $2.50 and $4.00 exercise price of the A Warrants and the B Warrants, respectively, are subject to adjustment pursuant to standard anti-dilution rights. On March 16, 2006, we entered into a waiver and amendment agreement (discussed below), which adjusted the exercise price of both the A and B warrants to $2.00 per share. These anti-dilution rights include (i) equitable adjustments in the event we effect a stock split, dividend, combination, reclassification or similar transaction; (ii) “weighted average” price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than the then current market price of the common stock; and (iii) “full ratchet” price protection adjustments in the event we issue new shares of common stock or common stock equivalents in certain transactions at a price less than $1.50 per share. In no event, however, will the conversion price or exercise price be adjusted below $0.50 per share for the reset provision.

The conversion feature and the prepayment provision of the notes were accounted for as embedded derivatives and valued on the transaction date using a Black-Scholes pricing model. The warrants were accounted for as derivatives and were valued on the transaction date using a Black-Scholes pricing model as well. At the end of each quarterly reporting date, the values of the derivatives are evaluated and adjusted to current fair value. The note conversion feature and the warrants may be exercised at any time and, therefore, have been reported as current liabilities. The prepayment provision was not exercisable by us until May 16, 2007, and then only in certain limited circumstances. For all periods since the issuance of the senior secured convertible notes, the derivative value of the prepayment provision has been nominal and has not had any offsetting effect on the valuation of the conversion feature of the notes.

The senior secured convertible notes required that we secure an effective registration statement with the Securities and Exchange Commission within 120 days from May 16, 2005 (September 13, 2005). Section 4(a) of the senior secured convertible notes enumerated circumstances that are considered an event of default. The remedies for default provide that if an event of default occurs and is continuing, the holders may declare all of the then outstanding principal amount of the notes and any accrued and unpaid interest thereon to be immediately due and payable in cash. In the event of an acceleration, the amount due and owing to the holders is 125% of the outstanding principal amount of the notes and interest on such amount is calculated using the default rate of 18% per annum if the full amount is not paid within one business day after acceleration. We were in default under Section 4(a)(viii), related to the effective date of our registration statement, beginning October 13, 2005 until February 3, 2006, at which time the event of default was cured and is no longer continuing. For the years ended December 31, 2006 and 2005, we recorded $66,000 and $218,000, respectively, as additional interest expense for this default.

On March 16, 2006, we entered into a waiver and amendment agreement with the four institutional funds regarding our default discussed above. Under the terms of the waiver, the institutional funds terminated a forbearance agreement and waived any and all defaults under the senior secured convertible notes and related transaction agreements. In consideration of the waiver, we and the funds agreed to amend the transaction agreements as follows: (i) Section 3.12 of the securities purchase agreement was deleted, which provision gave the funds a preemptive right to acquire any new securities issued by us; (ii) Section 3.15(c) of the securities purchase agreement was deleted, which provision prohibited us from completing a private equity or equity-linked financing; (iii) the conversion price, at which the notes are convertible into shares of our common stock, was amended to be $1.50 instead of $2.50; (iv) the exercise price, at which all warrants (A warrants and B warrants) held by the funds are exercisable, was changed to $2.00 (which exercise price was subsequently reduced to $1.50 due to applicable antidilution provisions); and (v) the notes were amended by adding a new event of default, which is that if we fail to raise and receive at least $3,000,000 in cash net proceeds through one or more private or public placements of its securities by September 30, 2006, we would have been in default under the notes.

On April 21, 2006, two of the institutional funds converted an aggregate of $500,000 of their convertible notes into 333,334 shares of our common stock. Upon completion of this conversion, the principal amount of the senior secured convertible notes was reduced from $3,000,000 to $2,500,000.

On March 18, 2007, two of the institutional funds converted an aggregate of $750,000 of their convertible notes into 500,000 shares of our common stock. Upon completion of this conversion, the principal amount of the senior secured convertible notes was reduced from $2,500,000 to $1,750,000.

On April 4, 2007, one of the institutional funds converted an aggregate of $100,000 of its convertible notes into 66,667 shares of our common stock. Upon completion of this conversion, the principal amount of the senior secured convertible notes was reduced to $1,650,000.

On September 13, 2007, one of the institutional funds assigned $54,505 of its convertible note and certain associated warrants to a third party. On September 25, 2007, two of the institutional funds converted an aggregate of $225,000 of their convertible notes into 150,000 shares of our common stock. Upon completion of this conversion, the principal amount of the senior secured convertible notes was reduced from to $1,425,000.

During October 2007, four of the institutional funds converted an aggregate of $1,091,944 of their convertible notes into 727,963 shares of our common stock. During November 2007, one of the institutional funds converted an aggregate of $278,551 of its convertible notes into 185,701 shares of our common stock. Upon completion of this conversion, the principal amount of the senior secured convertible notes was reduced from to $54,505.

During the three months ended December 31, 2007, four of the institutional funds exercised an aggregate of 667,298 of their A and B warrants at an exercise price of $1.50 providing $1,000,947 in funding to us. As of December 31, 2007, there were 532,702 remaining warrants outstanding.

During the three months ended March 31, 2008, three of the institutional funds exercised an aggregate of 500,000 of their A and B warrants at an exercise price of $1.50 providing $750,000 in funding to us. As of June 30, 2008 there were 32,702 remaining warrants available.

As of June 30, 2008 and 2007, we recorded an aggregate derivative liability of $58,500 and $1,004,000 and a derivative valuation gain of $139,963 and $90,210 to reflect the change in value of the aggregate derivate liability since December 31, 2007 and 2006, respectively. The aggregate derivative liability of $58,500 was for the 32,702 remaining warrants. The value was calculated using the Black-Scholes pricing model with the following assumptions: (i) risk-free interest rate of 2.63%; (ii) expected life (in years) of 1.9; (iii) expected volatility of 90.74%; (iv) expected dividend yield of 0.00%; and (v) stock trading price of $2.80.

The remaining $54,505 principal value of the senior secured convertible notes was converted during the three months ended March 31, 2008. Prior to conversion the outstanding principle value was being accreted over the term of the obligations, for which $757 and $345,834 was included in interest expense for the six months ended June 30, 2008 and 2007, respectively. The accretion included in interest expense for the three months ended June 30, 2007 was $ 137,499. The notes bore a 6% annual interest rate payable semi annually for which (i) $0 and $136 for the three and six months ended June 30, 2008, respectively, and (ii) $24,817 and $60,942 for the three and six months ended June 30, 2007, respectively, were included in interest expense.

IDI Bankruptcy Settlement

On May 18, 2004, the debtor-in-possession’s plan of reorganization for IDI was confirmed by the United States Bankruptcy Court. As a result of this confirmation, we issued to the creditors of IDI approximately 111,842 shares of our common stock, valued at approximately $682,222, and assumed cash liabilities of approximately $312,768 to be paid over a 4-year period in exchange for approximately 50,127,218 shares of the common stock of IDI representing approximately 86% of the equity of IDI.

During the year ended December 31, 2007, we satisfied our obligation to the creditors of IDI. For the three and six months ended June 30, 2007, we paid approximately $17,547 and $35,094, respectively of the $312,768 original obligation. The balance remaining as of June 30, 2007 was approximately $70,187 and had been recorded as a current liability (for that year).

NOTE 7 – FAIR VALUE MEASUREMENTS

The Company adopted SFAS No. 157, “Fair Value Measurements,” (“SFAS 157”) as of January 1, 2008 for financial instruments measured at fair value on a recurring basis. SFAS 157 defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States and expands disclosures about fair value measurements.

SFAS 157 establishes a three-tier fair value hierarchy which prioritizes the inputs used in measuring fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (level 1 measurements) and the lowest priority to unobservable inputs (level 3 measurements). These tiers include:

Level 1, defined as observable inputs such as quoted prices in active markets;

Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

We measure certain financial instruments at fair value on a recurring basis. Assets and liabilities measured at fair value on a recurring basis are as follows at June 30, 2008:


			Quoted Prices in	Significant Other	Significant
			Active Markets for	Observable	Unobservable
			Identical Assets	Inputs	Inputs
		Total	(Level 1)	(Level 2)	(Level 3)
Assets
	Money market funds	$ 1,118,626	$ 1,118,626	$ -	$ -
	Treasury cash reserve securities	8,405,000	8,405,000	-	-
	Auction rate preferred securities	2,605,674	-	-	2,605,674
Total assets measured at fair value		$ 12,129,300	$ 9,523,626	$ -	$ 2,605,674

Liabilities
	Derivative valuation (1)	$ 7,942,300	$ -	$ -	$ 7,942,300
Total liabilities measured at fair value		$ 7,942,300	$ -	$ -	$ 7,942,300

	(1) See Note 6 of the Company's Condensed Consolidated Financial Statements for additional discussion.

The table below presents the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) as defined in SFAS 157 at June 30, 2008. The Company classifies financial instruments in Level 3 of the fair value hierarchy when there is reliance on at least one significant unobservable input to the valuation model.


		Derivative	Auction Rate
		Valuation Liability	Preferred Securities	Total
Balance at December 31, 2007		$ (14,267,600)	$ -	$ (14,267,600)
Total gains or losses (realized and unrealized)
	Included in net loss	4,863,823	-	4,863,823
	Included in other comprehensive loss	-	(194,326)	(194,326)
Purchases, issuances, and settlements, net		1,461,477	2,800,000	4,261,477
Transfers to Level 3		-	-	-
Balance at June 30, 2008		$ (7,942,300)	$ 2,605,674	$ (5,336,626)

Money Market Funds and Treasury Securities

The money market funds and treasury cash reserve securities balances are classified as cash and cash equivalents on the Company’s Condensed Consolidated Balance Sheet.

Auction Rate Preferred Securities

As of June 30, 2008, the Company had investments in auction rate preferred securities (“ARPS”), which are classified as available-for-sale securities on the Company’s Condensed Consolidated Balance Sheet and reflected at fair value. Due to events in credit markets, the auction events for these instruments held by the Company failed during first quarter 2008. Therefore, the fair values of these securities were estimated utilizing a discounted cash flow analysis as of June 30, 2008. This analysis considers, among other items, the collateralization of the underlying security investments, the creditworthiness of the counterparty, the timing of expected future cash flows and the expectation of the next time the security is expected to have a successful auction or the security has been called by the issuer.

As a result of the temporary decline in fair value for the Company’s ARPS, which it attributes to liquidity issues rather than credit issues, the Company has recorded an unrealized loss of $194,326 to Accumulated other comprehensive loss. The ARPS held by the Company at June 30, 2008, totaling $2,800,000 were in AAA rated funds. Due to the Company’s belief that the market for these instruments may take in excess of twelve months to fully recover, the Company has classified these investments as non-current. During second quarter 2008, $8.8 million of the Company’s ARPS, held at March 31, 2008, were redeemed at 100% of their par value. As of June 30, 2008, the Company continues to earn interest on its ARPS under the default interest rate features of the ARPS. Any future fluctuation in fair value related to these instruments that the Company deems to be temporary, including any recoveries of previous write-downs, would be recorded to Accumulated other comprehensive loss. If the Company determines that any future valuation adjustment is other than temporary, it would record a charge to earnings as appropriate.

NOTE 8 – COMPREHENSIVE LOSS

Comprehensive loss equaled net loss of $5,534,396 and $1,219,799 for the three and six months ended June 30, 2007, respectively. Net loss totaled $5,586,755 and $3,397,937 for the three and six months ended June 30, 2008, respectively and included unrealized losses on auction rate preferred securities. The difference between net loss and comprehensive loss for the three and six months ended June 30, 2008 was as follows:


	Three Months Ended	Six Months Ended
	June 30, 2008	June 30, 2008
Net Loss	$ (5,556,920)	$ (3,397,937)
Unrealized gain (loss) on Available-for-sale Securities	365,861	(194,326)
Comprehensive Loss	$ (5,191,059)	$ (3,592,263)

Accumulated other comprehensive loss per the Company’s Condensed Consolidated Balance Sheet consists of the Company’s unrealized loss of $194,326 on its available-for-sale securities.

NOTE 9 - SUPPLEMENTAL CASH FLOW INFORMATION

During the six months ended June 30, 2008, we issued 160,000 shares of our common stock to a corporation, to provide investor relations services for the Company. The value of these shares of $488,000 was recorded as a prepaid expense and will be recognized over the service periods as follows:


2008	$ 427,003
2009	60,997
	$ 488,000

During the six months ended June 30, 2008, we issued 42,000 shares of our common stock pursuant to an existing consulting agreement to a corporation, to provide investor relations services for the Company. The value of these shares of $113,400 was recorded in general and administrative expense.

On March 18, 2007, one of the institutional funds converted an aggregate of $54,505 of their convertible notes into 36,337 shares of our common stock resulting in an extinguishment of debt non-cash expense of $6,056 included as interest expense for the six months ended June 30, 2008. See Note 6.

During the six months ended June 30, 2008, an aggregate of 2,258 options and 30,000 warrants were exercised by one and two individuals providing $750 and $60,000, respectively in funding to the company.

For the six months ended June 30, 2008 and 2007, an aggregate non-cash expense of $2,263,075 and $512,502 was recorded for the accretion of i) the senior 6% convertible notes of $757 and 345,834, respectively, ii) the unsecured convertible note of $166,668 in each of the periods and (iii) $2,095,650 for the senior secured 6.25% Convertible note in 2008, as interest expense. See Note 6.

For the six months ended June 30, 2007, we received $1,122,999 from the sale of 748,683 shares of common stock pursuant to a Private Placement Offering at a price of $1.50 per share. Additionally, the holders of 748,670 of these shares received a warrant to acquire one share of our common stock. The warrants have a three-year exercise period and are exercisable at a $2.00 exercise price.

During the six months ended June 30, 2007, we issued 2,160,000 shares of our common stock to three corporations, which provide investor relations services for us. The value of these shares of $2,124,000 was recorded as a prepaid expense and will be recognized over the service periods as follows:


2007	$ 996,997
2008	968,655
2009	158,348
	$ 2,124,000

On March 18, and April 4, 2007, three of the institutional funds converted an aggregate of $850,000 of their senior secured convertible notes into 566,667 shares of our common stock resulting in an extinguishment of debt non-cash expense in the amount of $345,834 included as interest expense for the six months ended June 30, 2007. See Note 7.

On February 28, March 30, and May 11, 2007, we entered into three unsecured promissory 6% notes with a Utah corporation, in the aggregate of $299,948 included at June 30, 2007 as current debt obligations.

The Company paid no cash for income taxes during the six months ended June 30, 2008 and 2007.

The Company paid $26,108 and $94,508 for interest expense during the six months ended June 30, 2008 and 2007, respectively.

NOTE 10 - RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”), which establishes specific criteria for the fair value measurements of financial and nonfinancial assets and liabilities that are already subject to fair value under current accounting rules. SFAS 157 also requires expanded disclosures related to fair value measurements. In February 2008, the FASB approved FASB Staff Position (FSP) FAS 157-2, “Effective Date of FASB Statement No. 157” (FSP 157-2) which allows companies to elect a one-year delay in applying SFAS 157 to certain fair value measurements of non-financial instruments, except for those recognized or disclosed at fair value on at least an annual basis. We elected the delayed adoption date for the portions of SFAS 157 impacted by FSP 157-2 and, as a result, we partially adopted SFAS 157 on January 1, 2008. The partial adoption of SFAS 157 was prospective and did not have a significant effect on our Condensed Consolidated Financial Statements. See Note 7 for information about fair value measurements. We are currently evaluating the impact of applying the deferred portion of SFAS 157 to the nonrecurring fair value measurements of our nonfinancial assets and nonfinancial liabilities. In accordance with FSP 157-2, the fair value measurements for these items will be adopted effective January 1, 2009.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of SFAS 115” (“SFAS 159”). SFAS 159 permits a company to voluntarily elect to use fair value, instead of historic or original cost, to account for certain financial assets and liabilities. The fair value option is designated on an item-by-item basis, is irrevocable and requires that changes in fair value in subsequent periods be recognized in earnings in the period of change. We adopted SFAS 159 on January 1, 2008. The adoption had no impact on our Condensed Consolidated Financial Statements as we did not make a fair value election for any of our existing financial assets and liabilities. Any election to use the fair value method for future eligible transactions will be made on a case-by-case and instrument-by-instrument basis.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS 141R”). Under SFAS 141R, an entity is required to recognize the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration at their fair value on the acquisition date. It further requires that acquisition-related costs be recognized separately from the acquisition and expensed as incurred, restructuring costs generally be expensed in periods subsequent to the acquisition date, and changes in accounting for deferred tax asset valuation allowances and acquired income tax uncertainties after the measurement period impact income tax expense. In addition, acquired in-process research and development is capitalized as an intangible asset and amortized over its estimated useful life. The adoption of SFAS 141R will change our accounting treatment for business combinations on a prospective basis beginning in the first quarter of fiscal year 2009.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements—an amendment of Accounting Research Bulletin No. 51” (“SFAS 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest, and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. SFAS 160 also establishes disclosure requirements that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS 160 is effective for fiscal years beginning after December 15, 2008. We do not expect that the adoption of SFAS 160 will have a significant impact on our Condensed Consolidated Financial Statements.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities—an amendment of FASB Statement No. 133” (“SFAS 161”), which requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS 161 is effective for fiscal years beginning after November 15, 2008. We are currently evaluating the impact of SFAS 161 on our Condensed Consolidated Financial Statements.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS 162”). SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements in conformity with U.S. generally accepted accounting principles (GAAP) for nongovernmental entities. The statement establishes that the GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP. This statement is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board

Auditing amendments to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not believe implementation of SFAS 162 will have a material impact on its consolidated financial statements.

In May 2008, the FASB issued SFAS No. 163, “Accounting for Financial Guarantee Insurance Contracts - an interpretation of FASB Statement No. 60” (“SFAS 163”). SFAS 163 clarifies how Statement 60 applies to financial guarantee insurance contracts, including the recognition and measurement of premium revenue and claim liabilities. This Statement also requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. The Company does not expect that the adoption of SFAS 163 will have a material impact on its consolidated financial statements.

In June 2008, the FASB issued FASB Staff Position Emerging Issues Task Force (EITF) No. 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities” (“FSP EITF No. 03-6-1”). Under FSP EITF No. 03-6-1, unvested share-based payment awards that contain rights to receive nonforfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing EPS. FSP EITF No. 03-6-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years, and is not expected to have a significant impact on the Company’s consolidated financial statements.

In May 2008, the FASB issued FASB Staff Position APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash Upon Conversion (including Partial Cash Settlement” (“FSP APB 14-1”). FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon conversion are not addressed by APB Opinion No. 14 and specifies that issuers of such instruments should separately for the liability and equity components in a matter that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for fiscal years beginning after December 15, 2008, and interim periods within those years. The Company is currently assessing the impact of the adoption of FSP APB 14-1 on its consolidated financial statements.

In April 2008, the FASB issued FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. 142-3”) to improve the consistency between the useful life of a recognized intangible asset (under SFAS No. 142) and the period of expected cash flows used to measure the fair value of the intangible asset (under SFAS No. 141(R)). FSP No. 142-3 amends the factors to be considered when developing renewal or extension assumptions that are used to estimate an intangible asset’s useful life under SFAS No. 142. The guidance in the new staff position is to be applied prospectively to intangible assets acquired after December 31, 2008. In addition, FSP No. 142-3 increases the disclosure requirements related to renewal or extension assumptions. The Company is currently assessing the impact of the adoption of FSP No. 142-3 on its consolidated financial statements.

The Company has reviewed all other recently issued, but not yet adopted, accounting standards in order to determine their effects, if any, on its condensed consolidated financial statements. Based on that review, the Company believes that none of these pronouncements will have a significant effect on its current or future consolidated financial statements.

NOTE 11- SUBSEQUENT EVENT

On July 14, 2008, warrants to purchase 10,000 shares of our stock were exercised by an individual providing $20,000 in financing for the Company.

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

Cautionary Note Regarding Forward-Looking Statements

This report contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Rule 175 promulgated thereunder, and Section 21E of the Securities Exchange Act of 1934, as amended, and Rule 3b-6 promulgated thereunder, that involve inherent risk and uncertainties. Any statements about our expectations, beliefs, plans, objectives, strategies or future events or performance constitute forward-looking statements. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “estimate,” “plan,” “project,” “continuing,” “ongoing,” “expect,” “believe,” “intend” and similar words or phrases. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed or implied therein. All forward-looking statements are qualified in their entirety by reference to the factors discussed in this report, including, among others, the following risk factors discussed more fully in Item 1A hereof:

dependence on commercialization of our CodecSys technology;

our need and ability to raise sufficient additional capital;

our continued losses;

restrictions contained in our outstanding convertible notes;

general economic and market conditions;

ineffective internal operational and financial control systems;

rapid technological change;

intense competitive factors;

our ability to hire and retain specialized and key personnel;

dependence on the sales efforts of others;

dependence on significant customers;

uncertainty of intellectual property protection;

potential infringement on the intellectual property rights of others;

factors affecting our common stock as a “penny stock;”

extreme price fluctuations in our common stock;

price decreases due to future sales of our common stock;

future shareholder dilution; and

absence of dividends.

Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed or implied in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statement. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of future events or developments. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

Critical Accounting Policies

The preparation of financial statements in conformity with U.S. GAAP requires that we make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our assumptions and estimates, including those related to recognition of revenue, valuation of investments, valuation of inventory, valuation of intangible assets, valuation of derivatives, measurement of stock-based compensation expense and litigation. We base our estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We discuss our critical accounting policies in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2007. Except for the critical accounting policy set forth below entitled “Valuation of Investments,” there have been no other significant changes in our critical accounting policies or estimates since those reported in our Annual Report.

Valuation of Investments

As discussed in Note 6 to the unaudited condensed consolidated financial statements, we adopted the provisions of Statement 157 effective January 1, 2008. In valuing our investments we predominantly use market data or data derived from market sources. When market data is not available, such as when the investment is illiquid, we utilize a discounted cash flow analysis to arrive at the recorded fair value. This process involves incorporating our assumption about the anticipated term and the yield that a market participant would require to purchase the security in the marketplace. We utilized unobservable (Level 3) inputs in determining the fair value of our auction rate preferred securities, which totaled $2,605,674 at June 30, 2008.

Our auction rate preferred securities are classified as available-for-sale securities and reflected at fair value. In prior periods, due to the auction process which took place every 7-30 days for most securities, quoted market prices were readily available, which would qualify as Level 1 under Statement 157. However, due to events in credit markets during first quarter 2008, the auction events for most of these instruments failed, and, therefore, we have determined the estimated fair values of these securities utilizing a discounted cash flow analysis as of June 30, 2008. This analysis considers, among other items, the collateralization of the underlying securities, the expected future cash flows and the expectation of the next time the security is expected to have a successful auction. These securities were also compared, when possible, to other observable market data with similar characteristics to the securities held by us. Due to these events, we reclassified these instruments as Level 3 during first quarter 2008 and recorded a temporary unrealized decline in fair value of $560,187, with an offsetting entry to Accumulated other comprehensive loss at March 31, 2008. During the quarter ended June 30, 2008, we liquidated at par approximately 80% of our auction rate securities held at March 31, 2008 resulting in the temporary unrealized decline in fair value being adjusted to $194,326 at June 30, 2008. We currently believe that this temporary decline in fair value is due entirely to liquidity issues and not credit issues, because they are in AAA closed-end bond mutual funds that are over-collateralized by at least 200% and are backed by the underlying marketable securities. We believe we have sufficient cash and cash equivalents available at June 30, 2008 to allow us sufficient time for the securities to return to full value. We will re-evaluate each of these factors as market conditions change in subsequent periods.

Executive Overview

In March 2007, we commenced a private placement offering of our securities by selling shares of our common stock at a price of $1.50 per share. In the offering, the purchaser of each share received a warrant to acquire one share of common stock. The warrants have a three-year exercise period and are exercisable at an exercise price of $2.00 per share. In the fourth quarter of 2007, we completed the offering pursuant to which we raised $5,975,317 from the sale of 3,983,557 shares of our common stock.

On October 31, 2007, we entered into an exchange agreement with the holder of our unsecured convertible note in the principal amount of $1.0 million and related warrants. Pursuant to the exchange agreement, we cancelled the holder’s warrants to acquire up to 2,000,000 shares of our common stock at $2.10 per share and other warrants to

acquire up to 2,000,000 additional shares of our common stock at $3.00 per share in exchange for the issuance of 650,000 shares of our common stock to the holder.

In the fourth quarter of 2007, the institutional fund holders of our outstanding senior secured convertible notes issued in 2005 completed conversion of substantially all of their convertible notes into shares of our common stock. At December 31, 2007, only an immaterial amount of the senior secured convertible notes remained outstanding, and has since been converted.

On November 15, 2007, we entered into a two-year license agreement with IBM pursuant to which we will license our patented CodecSys technology for use by IBM in video encoders that IBM intends to manufacture and sell. The IBM video encoder is not completed in a commercially deployable form. The IBM agreement is our first significant license of the CodecSys technology for use in a commercial application. We believe this agreement may hold substantial revenue opportunities for our business. Although IBM has commenced marketing and sales activities with respect to products incorporating our CodecSys technology, no sales of products have been made, and we have not derived any material revenue from our CodecSys technology to date.

On December 24, 2007, we completed a $15.0 million private placement of securities with an institutional investor. Pursuant to the financing, we entered into various agreements with the investor, including (i) a securities purchase agreement pursuant to which we, in exchange for $15.0 million, issued and sold to the investor (A) 1,000,000 shares of our common stock, (B) a 6.25% senior secured convertible promissory note in the principal amount of $15.0 million which is convertible into shares of our common stock at a conversion price of $5.45 per share, and (C) a five-year warrant that is exercisable to purchase up to 1,875,000 shares of common stock at an exercise price of $5.00 per share; (ii) a registration rights agreement pursuant to which we agreed to provide certain registration rights with respect to the shares of common stock, the shares of common stock issuable upon conversion of the note, the shares of common stock issuable as interest shares under the note and shares of common stock issuable upon exercise of the warrant; and (iii) a security agreement granting a first priority security interest in all of our property and assets to secure the note.

Our revenues decreased by 18% for the six months ended June 30, 2008 compared to the six months ended June 30, 2007, and the net cash used for operations in the six months ended June 30, 2008 increased compared to the six months ended June 30, 2007 by 247%. Until cash from operations is sufficient to cover all corporate expenses, we will continue to deplete our available cash and increase our need for future equity and debt financing.

The conversion feature and the prepayment provision of the $15.0 million senior secured convertible note and the $1.0 million unsecured convertible note have been accounted for as embedded derivatives and valued on the respective transaction dates using a Black-Scholes pricing model. The warrants related to the convertible notes have been accounted for as derivatives and were valued on the respective transaction dates using a Black-Scholes pricing model as well. At the end of each quarterly reporting date, the values of the embedded derivatives and the warrants are evaluated and adjusted to current market value. The conversion features of the convertible notes and the warrants may be exercised at any time and, therefore, have been reported as current liabilities. Prepayment provisions contained in the convertible notes limit our ability to prepay the notes in certain circumstances. For all periods since the issuance of the senior secured convertible note and the unsecured convertible note, the derivative values of the respective prepayment provisions have been nominal and have not had any offsetting effect on the valuation of the conversion features of the notes. For a description of the accounting treatment of the senior secured convertible note financing, see Note 5 of our notes to consolidated financial statements included elsewhere herein.

Results of Operations for the Six Months ended June 30, 2008 and June 30, 2007

Revenues

We generated $1,998,195 in revenue during the six months ended June 30, 2007. During the same six-month period in 2007, we generated revenue of $2,362,850. The decrease in revenue of $ 364,655 was due primarily to (i) the Company completing installation services for one client in 2007 that was not repeated in 2008, which resulted in a decrease in installation related revenues of $269,534 and (ii) a decrease in satellite fees charged of $172,356 due to the expiration of a customer contract that was not renewed. However, the loss of revenues from installation services performed for the former customer of $668,771 and the loss of revenues from the expiration of the customer contract of $220,800 were offset by increased installation and satellite usage revenues from new and

existing customers. In addition, license fee revenue increased by $58,582, and other revenues increased by $65,282.

Sales revenues from our three largest customers accounted for approximately 50% and 65% of total revenues for the six months ended June 30, 2008 and 2007, respectively. Any material reduction in revenues generated from any one of our largest customers could harm our results of operations, financial condition and liquidity.

Cost of Revenues

Cost of revenues decreased by $ 290,305 to $2,105,305 for the six months ended June 30, 2008 from $2,395,610 for the six months ended June 30, 2007. The decrease was due primarily to decreased activity in installation of equipment for one customer, which resulted in a decrease of $ 239,550 in the costs related to such installations. In addition, the general operations department costs decreased by approximately $81,931, due primarily to the decrease in installation activity, and satellite distribution costs decreased by $58,077, which were offset by an increase in depreciation and amortization of approximately $89,253.

Expenses

General and administrative expenses for the six months ended June 30, 2008 were $2,988,741 compared to $2,879,192 for the six months ended June 30, 2007. The increase of $109,549 resulted from an increase in employee salary and related expenses of $166,717, increased travel expenses of $36,103, and an increase of $83,151 in bad debt expense. In 2007 technical development departmental expenses of $129,615 were classified as general and administrative expenses, but all of the technical development department expenses in 2008 are classified as research and development expenses. Research and development in process increased by $1,444,697 for the six months ended June 30, 2008 to $1,828,786 from $384,089 for the six months ended June 30, 2007 not including a one-time expense for impairment of license rights of $1,142,400 recorded in 2007. The increase resulted primarily from an increase of $838,572 in employee related expenses, an increase of $129,214 in professional services, and increase of $156,551 in software maintenance and patent related expenses, an increase in general operating expenses of $97,483 related to the increased number of employees and an increase of $65,851 in materials and supplies expense. Sales and marketing expenses increased $293,066 to $602,501 for the six months ending June 30, 2008 from $309,435 for the six months ending June 30, 2007. The increases reflect additional sales personnel hired to begin marketing of our CodecSys products and related overhead expenses.

Interest Expense

For the six months ended June 30, 2008, we incurred interest expense of $2,994,577 compared to interest expense for the six months ended June 30, 2007 of $1,126,839. The increase of $1,867,738 resulted primarily from the Company recording more non cash interest expense related to the accretion of note liability on our 6.25% senior secured convertible note and related amortization of debt offering costs, which was not outstanding in 2007 and on our unsecured convertible note. In addition, interest expense paid or accrued on the 6.25% senior secured convertible note is likewise greater due to the increased principal balance outstanding.

Net Loss

We realized a net loss for the six months ended June 30, 2008 of $ 3,397,937 compared with a net loss for the six months ended June 30, 2007 of $5,534,396. The decrease in the net loss of $2,136,459 is primarily due to, an increase in gain of $4,535,733 related to our derivative valuation calculation offset by (i) the increase of $1,867,738 in interest expense, (ii) an increase in operating expenses of $704,912 as explained above, and (iii) a $74,350 decrease in gross margin as a result of decreased sales activity.

Results of Operations for the Three Months ended June 30, 2008 and June 30, 2007

Revenues

The Company generated $810,803 in revenue during the three months ended June 30, 2008. During the same three-month period in 2007, the Company generated revenue of $763,784. The increase in revenue of $ 47,019 was due primarily to the Company performing sufficient installation and service work in the three months ended June 30, 2008, to offset a decrease in satellite fees resulting from the expiration of a long time satellite customer.

The Company realized $ 201,867 more revenue from installation services performed in the quarter ended June 30, 2008, than in the second quarter of 2007, but we realized $166,911 less revenue from satellite fees in the quarter ended June 30, 2008 than we did in the quarter ended June 30, 2007.

The Company's three largest customers’ sales revenues accounted for approximately 62% and 67% of total revenues for the quarters ended June 30, 2008 and 2007, respectively. The three customers with the greatest revenues in 2007 were not the same three customers in 2008. Any material reduction in revenues generated from any one of its largest customers could harm the Company’s results of operations, financial condition and liquidity unless we could replace the lost revenues with new customers.

Cost of Revenues

Costs of Revenues increased by $168,024 to $968,859 for the three months ended June 30, 2008, from $800,835 for the three months ended June 30, 2007. The increase was due primarily to increased activity in installation of equipment, which resulted in an increase in the costs related to such installation services for all the Company’s customers of $160,263. There was not an increase in the cost of equipment relative to the sales price of the equipment, but the general operations department costs increased by approximately $51,388 due to the increase in installation activity. In addition, depreciation increased by $64,563 due to purchases of equipment and upgrades of our internal network primarily for our development activities. The cost increases were partially offset by a decrease of approximately $68,731 in satellite distribution costs.

Expenses

General and Administrative expenses for the three months ended June 30, 2008 were $1,454,560 compared to $1,304,508 for the three months ended June 30, 2007. The increase of $150,052 resulted primarily from increases in expenses incurred for outside consultants of $167,389, in payroll and related expenses of $134,398, legal expenses of $65,061 and outside director fees of $62,750 offset by a decrease in expenses of $243,681 for options and warrants granted. Research and development in process increased by $853,127 for the three months ended June 30, 2008 to $1,052,153 from $199,026 for the three months ended March 31, 2007. This increase resulted primarily from increased development staff and related expenses of increasing the development activity. Sales and marketing expenses increased $189,495 for the three months ended June 30, 2008 to $356,309 from $166,814 for the three months ended June 30, 2007. The increase was due primarily to increased payroll and related expenses resulting from hiring of additional personnel devoted to sales. Total operating expenses were only $80,109 greater for the three months ended June 30, 2008 when compared to total operating expenses for the three months ended June 30, 2007. However, expenses for impairment of license rights was recorded in the period ending June 30, 2007 that was not repeated in the period ending June 30, 2008, which accounted for total expenses in the two quarters being more nearly comparable.

Interest Expense

For the three months ended June 30, 2008, the Company incurred interest expense of $1,492,785 compared to interest expense for the three months ended June 30, 2007 of $353,008. The increase of $1,139,777 resulted primarily from the Company recording non cash interest expense of $1,245,909 related to note accretion of our 6.25% senior secured convertible note, which was not outstanding during the second quarter of 2007, partially offset by note accretion of our 6.0% senior secured convertible notes in 2007, which have since been converted and are no longer outstanding. The $1,492,785 interest expense recorded primarily consisted of $1,131,159 recorded to account for the accretion of note liability on our balance sheet, interest payable on all notes of $246,876 and amortization of debt offering costs of $114,750.

Net Loss

The Company realized net loss for the three months ending June 30, 2008 of $5,556,920 compared with a net loss for the three months ended June 30, 2007 of $1,219,799. The increase in net loss $4,337,121 was primarily the result of an increase in derivative valuation loss of $3,127,720, which resulted primarily from valuation of our 6.25% senior secured convertible note, which was issued in December of 2007, and the increase of $1,139,777 in interest expense.

Liquidity and Capital Resources

At June 30, 2008, we had cash of $ 9,296,764, total current assets of $11,536,156, and total current liabilities of $8,984,351 and total stockholders' equity of $2,859,024. Included in current liabilities is $7,942,300, which relates to the value of the embedded derivatives for the 6.25% senior secured convertible note and related warrants and the unsecured convertible note and warrants. Our current liabilities, without considering the derivative liability are $1,042,051.

As of June 30, 2008, we held approximately $2,800,000 of auction rate preferred securities, valued at $2,605,674 and classified as long term investments. Beginning in February 2008, many of these auction rate preferred securities became illiquid because their scheduled auctions failed to settle. During the second quarter 2008, $8,800,000 of the $11,600,000 auction rate preferred securities held at March 31, 2008 were liquidated at par, with the Company not sustaining any losses. However, we may have limited or no opportunities to liquidate the remaining auction rate investments and fully recover their stated value in the near term. An auction failure occurs when the parties wishing to sell securities at auction cannot. When an auction fails the affected securities begin to pay interest under their default interest rate terms. As a result of this illiquidity caused by the lack of an active market, these investments were classified as non-current. Although approximately 80% of our investments have been redeemed by the issuers, none of the issuers of the auction rate preferred securities still held by us have announced a definitive plan for redemption of the remainder of the securities in the near term. A temporary unrealized loss of $560,187 was recorded in the first quarter of 2008, which was decreased to $ 194,326 at June 30, 2008 to reflect the redemptions which occurred in the second quarter. We utilized a discounted cash flow analysis in determining the fair value of these securities, which used significant unobservable inputs at June 30, 2008.

We believe the impairment of these securities is temporary because they are backed by more than 200% collateral and approximately 80% have already been redeemed. All of our remaining auction rate preferred securities are currently rated AAA, the highest rating by a rating agency. We believe we will ultimately be able to liquidate these investments without significant loss through successful auctions or redemptions of securities by the issuers. However, it could take a long period of time to realize the investments’ full value for a portion of the investments. Based on our expected operating cash flows, and our other sources of cash, we do not anticipate that the current illiquidity of $2,800,000 of these investments will adversely affect our operations.

We experienced negative cash flow used in operations during the six months ending June 30, 2008 of $4,404,341 compared to negative cash flow used in operations for the six months ended June 30, 2007 of $1,269,143. The negative cash flow was met by cash reserves. We expect to continue to experience negative operating cash flow as long as we continue our technology development program or until we begin to receive licensing revenue from licenses of our CodecSys technology or increase our sales by adding new customers.

On December 24, 2007, we entered into a securities purchase agreement described above in which we raised $15,000,000 (less $937,000 of prepaid interest and $1,377,000 of related costs including commissions). We intend to use the proceeds from this financing to support our CodecSys commercialization and development and for general working capital purposes. The senior secured convertible note is due December 21, 2010 and bears interest at 6.25% per annum. Interest for the first year was prepaid at closing. Interest-only payments thereafter in the amount of $234,375 are due quarterly and commence in April 2009. Interest payments may be made through issuance of common stock in certain circumstances. The note is convertible into 2,752,294 shares of our common stock at a conversion price of $5.45 per share, convertible any time during the term of the note. We have granted a first priority security interest in all of our property and assets and of our subsidiaries to secure our obligations under the note and related transaction agreements.

directly or indirectly, redeem, or declare or pay any cash dividend or distribution on, our common stock;

issue any additional notes or issue any other securities that would cause a breach or default under the senior secured convertible note;

liquidate, wind up or dissolve (or suffer any liquidation or dissolution);

cause, permit or suffer, directly or indirectly, any change in control transaction as defined in the senior secured convertible note.

On November 2, 2006, we closed on a convertible note securities agreement dated October 28, 2006 with an individual that provided we issue to the convertible note holder (i) an unsecured convertible note in the principal amount of $1,000,000 representing the funding received by us from an affiliate of the convertible note holder on September 29, 2006, and (ii) four classes of warrants (A warrants, B warrants, C warrants and D warrants) which gave the convertible note holder the right to purchase a total of 5,500,000 shares of our common stock as described below. The unsecured convertible note is due October 16, 2009 and bears an annual interest rate of 5%, payable semi-annually in cash or in shares of our common stock if certain conditions are satisfied. The unsecured convertible note is convertible into shares of our common stock at a conversion price of $1.50 per share, convertible any time during the term of the note, and is subject to standard anti-dilution rights.

The A warrants and B warrants expire December 3, 2008. The original expiration date was to be one year after the effective date of a registration statement filed under the Securities Act registering the subsequent sale of shares received from exercise of the A warrants and B warrants, but was extended in connection with the exchange agreement described below. The A warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.60 per share and the B warrants grant the convertible note holder the right to purchase up to 750,000 shares of common stock at an exercise price of $1.75 per share. The convertible note holder also received C warrants to purchase 2,000,000 shares of common stock and D warrants to purchase 2,000,000 shares of common stock, all of which have been cancelled as discussed below. The A warrants and B warrants are exercisable at any time until their expiration date and are subject to adjustment pursuant to standard anti-dilution rights. As of June 30, 2008, the convertible note holder had exercised 518,400 A warrants and no B warrants.

In October 2007, we entered into an exchange agreement with the convertible note holder. Pursuant to the exchange agreement, we cancelled the C warrant holder’s right to acquire up to 2,000,000 shares of our common stock at $2.10 per share and the D warrant holder’s right to acquire up to 2,000,000 shares of our common stock at $3.00 per share in exchange for the issuance of 650,000 shares of our common stock.

In 2005, we secured a new customer contract, which resulted in revenues of approximately $1,400,000 for 2005 and $8,775,000 for 2006 and was our largest customer in 2007. We realized revenues of only $668,771 from this customer in 2007, but no revenues in 2008. We anticipate that our negative cash flow will diminish as our new customers make projects and equipment available and as we are able to perform under their respective contracts.

Our monthly operating expenses currently exceed our monthly net sales by approximately $500,000 per month. This amount could increase significantly. We expect our operating expenses will continue to outpace our net sales until we are able to generate additional revenue. Our business model contemplates that sources of additional revenue include (i) sales from our private communication network services, (ii) sales resulting from new customer contracts, and (iii) sales, licensing fees and/or royalties related to commercial applications of our CodecSys technology, including from our IBM license agreement.

Our long-term liquidity is dependent upon execution of our business model and the realization of additional revenue and working capital as described above, and upon capital needed for continued commercialization and development of the CodecSys technology. Commercialization and future applications of the CodecSys technology are expected to require additional capital estimated to be approximately $3.0 million annually for the foreseeable future. This estimate will increase or decrease depending on specific opportunities and available funding.

To date, we have met our working capital needs primarily through funds received from sales of our common stock and from convertible debt financings. Until our operations become profitable, we must continue to rely on external funding.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. We do not issue financial instruments for trading purposes or have any derivative financial instruments. As discussed above, however, the embedded conversion feature and prepayment option of our senior secured convertible notes and our related warrants are deemed to be derivatives and are subject to quarterly “mark-to-market” valuations.

We have investments in auction rate preferred securities, which are classified as available-for-sale securities and reflected at fair value. Approximately 80% of our auction rate preferred securities have been redeemed by the issuers at par. The remaining amount of these securities, which are approximately $2,800,000 we have classified as non current assets in the unaudited Condensed Consolidated Balance Sheet as of June 30, 2008 and valued them at 2,605,674. For a complete discussion on auction rate preferred securities, including our methodology for estimating their fair value, see Note 7 to the unaudited condensed consolidated financial statements.

Our cash and cash equivalents are also exposed to market risk. However, because of the short-term maturities of our cash and cash equivalents, we do not believe that an increase in market rates would have any significant impact on the realized value of our cash and cash equivalent investments. We currently do not hedge interest rate exposure and are not exposed to the impact of foreign currency fluctuations.

Item 4T. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended. Our disclosure controls and procedures include controls and procedures designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

As required by Rule 13a-15(b) of the Exchange Act, we conducted an evaluation, under the supervision of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2008. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2008.

Important Considerations

The effectiveness of our disclosure controls and procedures and our internal control over financial reporting is subject to various inherent limitations, including cost limitations, judgments used in decision making, assumptions about the likelihood of future events, the soundness of our systems, the possibility of human error, and the risk of fraud. Moreover, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions and the risk that the degree of compliance with policies or procedures may deteriorate over time. Because of these limitations, there can be no assurance that any system of disclosure controls and procedures or internal control over financial reporting will be successful in preventing all errors or fraud or in making all material information known in a timely manner to the appropriate levels of management.

Changes in Internal Control over Financial Reporting

During the most recent fiscal quarter covered by this report, we further implementedone change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. In order to insure that we timely file reports on Form 8-K regarding issuance of equity securities, we instituted a procedure in which a report is prepared of all issuances of equity securities (stock, warrants, options, and convertibles), and reviewed each time a change is made to determine if a filing is required.

Part II – Other Information

Item 1.

Legal Proceedings

None.

Item 1A. Risk Factors

There have been no material changes in risk factors from those described in our Annual Report of Form 10-K for the year ended December 31, 2007.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

During June and July, 2008, we granted options to four employees pursuant to our Long Term Incentive Plan to acquire up to 330,000 shares of our common stock at various prices, but not less than the fair market value on the date of grant. In the transaction, we relied on the exemption from registration under the Securities Act set forth in Section 4(2) thereof.

In June, 2008, we issued 10,000 shares of our common stock to one warrant holder who exercised his warrants purchased in 2007 as part of a private placement of our stock. The exercise price was $2.00 per share and he paid $20,000 in consideration of the issuance. The warrant holder was fully informed regarding his exercise transaction. We relied on the exemption from registration under the Securities Act set forth in Section 4(2) and Section 4(6).

Item 3. Defaults Upon Senior Securities

None.

Item 4.

Submission of Matters to Vote of Security Holders.

None.

Item 5.

Other Information

(a) None.

(b) None.

Item 6.

Exhibits


Exhibit Number	Description of Document


3.1	Amended and Restated Articles of Incorporation of Broadcast International. (Incorporated by reference to Exhibit No. 3.1 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
3.2	Amended and Restated Bylaws of Broadcast International. (Incorporated by reference to Exhibit No. 3.2 of the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2006 filed with the SEC on November 14, 2006.)
4.1	Specimen Stock Certificate of Common Stock of Broadcast International. (Incorporated by reference to Exhibit No. 4.1 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
4.2	Form of A Warrant issued by Broadcast International to each of Gryphon Master Fund, L.P., GSSF Master Fund, LP, Bushido Capital Master Fund, LP and Gamma Opportunity Capital Partners, LP (the “Institutional Funds”). (Incorporated by reference to Exhibit No. 4.3 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
4.3	Form of B Warrant issued by Broadcast International to each of the Institutional Funds. (Incorporated by reference to Exhibit No. 4.4 of the Company’s Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)

10.1*	Employment Agreement of Rodney M. Tiede dated April 28, 2004. (Incorporated by reference to Exhibit No. 10.1 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)
10.2*	Employment Agreement of Reed L. Benson dated April 28, 2004. (Incorporated by reference to Exhibit No. 10.3 of the Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2004 filed with the SEC on May 12, 2004.)
10.3*	Broadcast International Long-Term Incentive Plan. (Incorporated by reference to Exhibit No. 10.4 of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2003 filed with the SEC on March 30, 2004.)
10.4	Registration Rights Agreement dated May 16, 2005 among Broadcast International and the Institutional Funds. (Incorporated by reference to Exhibit No. 10.7 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)
10.5	Stock Purchase and Option Grant Agreement dated February 6, 2004 among Broadcast International and certain principals and shareholders of Streamware Solutions AB. (Incorporated by reference to Exhibit No. 10.9 of the Company's Registration Statement on Form SB-2, filed under cover of Form S-3, pre-effective Amendment No. 3 filed with the SEC on October 11, 2005.)


10.6	Technology License Agreement – e-publishing technology – dated August 15, 2006 between Broadcast International and Yang Lan Studio Ltd. (Incorporated by reference to Exhibit 10.9 of the Company’s Current Report on Form 8-K filed with the SEC on August 22, 2006.)
10.7	Termination and Release Agreement dated January 17, 2007 among Broadcast International, Yang Lan Studio Ltd., Broadvision Global, Ltd. and Sun Media Investment Holdings, Ltd. (Incorporated by reference to Exhibit No. 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on January 25, 2007.)
10.8	Securities Purchase Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.9	5% Convertible Note dated October 16, 2006 issued by Broadcast International to Leon Frenkel. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.10	Registration Rights Agreement dated October 28, 2006 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.11	Form of A Warrant dated October 28, 2006 issued by Broadcast International to Leon Frenkel. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.12	Form of B Warrant dated October 28, 2006 issued by Broadcast International to Leon Frenkel. (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on November 6, 2006.)
10.13	Exchange Agreement dated October 31, 2007 between Broadcast International and Leon Frenkel. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on November 7, 2007.)
10.14	Securities Purchase Agreement dated as of December 21, 2007, by and among Broadcast International and the investors listed on the Schedule of Buyers attached thereto. (Incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.15	Registration Rights Agreement dated as of December 21, 2007, by and among Broadcast International and the buyers listed therein. (Incorporated by reference to Exhibit 10.2 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.16	6.25% Senior Secured Convertible Promissory Note dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.3 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.17	Warrant to Purchase Common Stock dated December 21, 2007 issued to the holder listed therein. (Incorporated by reference to Exhibit 10.4 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)
10.18	Security Agreement dated as of December 21, 2007, made by each of the parties set forth on the signatures pages thereto, in favor of the collateral agent listed therein. (Incorporated by reference to Exhibit 10.5 of the Company’s Current Report on Form 8-K filed with the SEC on December 26, 2007.)


14.1	Code of Ethics. (Incorporated by reference to Exhibit No. 14 of the Company’s Annual Report on Form 10-KSB filed with the SEC on March 30, 2004.)

21.1	Subsidiaries. (Incorporated by reference to Exhibit No. 21.1 of the Company’s Annual Report on Form 10-KSB filed with the SEC on April 1, 2005.)
31.1	Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	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.
	* Management contract or compensatory plan or arrangement

SIGNATURES

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

Broadcast International, Inc.

Date: August 11, 2008

/s/ Rodney M. Tiede

By: Rodney M. Tiede

Its: President and Chief Executive Officer

(Principal Executive Officer)

Date: August 11, 2008

/s/ Reed L. Benson

By: Reed Benson

Its: Chief Financial Officer (Principal Financial

and Accounting Officer)



Utah		87-0395567
(State or other jurisdiction of		(IRS Employer
incorporation or organization)		Identification No.)


Class	Outstanding as of July 28, 2008
Common Stock, $.05 par value	38,641,585 shares