KickApps Acquisition

On January 28, 2011, we acquired KickApps Corporation, a Delaware corporation (“KickApps”) and provider of solutions that enable the creation and management of next generation video-based Web experiences, in exchange for $4,027 in cash and 2,990,551 shares of our common stock valued at a price of $13.55 (with a discount of $12,503 due to the restriction on the sale of these shares), for a total of $28,019. We are holding 528,507 shares of the merger consideration in escrow for a period not to exceed 15 months following the merger to cover any warranty claims related to undisclosed commercial or tax liabilities or litigation. Of the common stock issued in exchange for KickApps, 60% was released in January 2012 and the balance will be released on the second anniversary of the merger. We have allocated the aggregate cost of the acquisition to KickApps’ net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

 The results of operations of KickApps for the period from January 29, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

Kyte Acquisition

On January 21, 2011, we acquired decentraltv Corporation, a Delaware corporation doing business as Kyte (“Kyte”), a cloud-based publishing platform that enables companies to deliver live and on-demand video experiences to websites, mobile devices and connected TVs, in exchange for $3,607 in cash and 189,348 shares of our common stock at a price of $13.91 (with a discount of $477 due to the restriction on the sale of these shares for 6 months), for a total of $2,158. We are holding 56,803 shares of the consideration in escrow for a period of one year to secure certain indemnification obligations. We have allocated the aggregate cost of the acquisition to Kyte’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

 The results of operations of Kyte for the period from January 21, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

Kewego Acquisition

On January 26, 2011, we acquired Kewego S.A., a société anonyme organized under the laws of France (“Kewego”), professional IP-based, multi-screen video asset management solutions for IP connected devices, including PCs, mobile phones, iPads, connected TVs and gaming consoles, in exchange for $11,965 in cash and 1,411,704 shares of our common stock valued at a price of $14.36 (with a discount of $4,689 due to the restriction on the sale of these shares for 1 year), for a total of $15,341. We have allocated the aggregate cost of the acquisition to Kewego’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

The results of operations of Kewego for the period from January 27, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

WWB Acquisition

On February 21, 2011, we acquired the assets of Worldwide Broadcast Systems Inc. (“WWB”), a United States-based company engaged in providing broadcast video systems integration to customers in South and Central America, in exchange for $1,900 in cash and 23,514 shares of our common stock valued at a price of $13.97 (with a discount of $40 due to the restriction on the sale of these shares for 6 months and a discount of $26 for shares held in escrow), for a total of $263. Additionally, the cost includes a fair value for contingent consideration of $5,112, which will be based on a percentage of revenue over a three-year period after closing, which is included in the Balance Sheet in “Acquisition Liability, net of current.” We have allocated the aggregate cost of the acquisition to WWB’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

 The results of operations of WWB for the period from February 22, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

ioko Acquisition

On May 2, 2011, we acquired ioko365 Ltd. ("ioko") a private company incorporated in England and Wales with principal offices in San Diego, California and London, England and York, England. ioko provides end-to-end managed cloud-based platform solutions for multi-screen video delivery over connected Internet Protocol ("IP") devices to tier-one telecommunications, cable, media and entertainment companies around the world. Total consideration was $74,478 in cash and 1,509,804 of our common stock valued at a price of $10.88 (with a discount of $3,905 due to the restriction on the sale of these shares) for a total value of $12,522. In addition, the cost includes a fair value of contingent consideration of $3,360 based on meeting revenue and earnings targets during the twelve month periods ending March 31, 2012 and March 31, 2013. We are holding $9,000 of the cash and 232,378 shares of the merger consideration in escrow for a period not to exceed 18 months following the merger. Included in this agreement is an employee incentive plan for a total potential payment of our common stock of $7,500 upon meeting specified performance targets during the twelve month periods ending March 31, 2012 and March 31, 2013 and the six month period ended September 30, 2013. We have allocated the aggregate cost of the acquisition to ioko’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

The results of operations of ioko for the period from May 2, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations. 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited) 

 Polymedia Acquisition

On May 17, 2011 we acquired Polymedia S.P.A. (“Polymedia”) a company incorporated in Italy with its principal office in Milan. Polymedia was the IP video platform-provisioning subsidiary of TXT e-solutions, a public company listed on the Italian Stock Exchange. Total consideration was $24,283 in cash and 1,178,381 shares of our common stock valued at a price of $11.89 (with a discount of $969 due to the restriction on the sale of the shares in escrow) for a total of $13,041. In addition, the cost includes a fair value of contingent consideration of $2,750 based on meeting specified revenue and gross margin targets during the 12-month periods ending May 31, 2012 and May 31, 2013. We are holding 354,286 shares of the merger consideration in escrow for a period of up to 12 months following the closing date. We have allocated the aggregate cost of the acquisition to Polymedia’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

The results of operations of Polymedia for the period from May 17, 2011 to March 31, 2012 have been included in the Consolidated Statement of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

Peerset Acquisition

On June 9, 2011, we acquired the assets of Peerset, Inc. (“Peerset”), a Canadian based company engaged in developing technology to provide content recommendation services, in exchange for 10,611 shares of our common stock valued at a price of $11.71 for a total of $124 and cash of $1,375. The Peerset acquisition was primarily a purchase of intellectual property and a dedicated research and development team related to content recommendation technology, and the company was generating virtually no reported revenue at the time of purchase. We have allocated the aggregate cost of the acquisition to Peerset’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

The results of operations of Peerset for the period from June 9, 2011 to March 31, 2012 have been included in the Consolidated Statement of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited) 

Digital Media Production Acquisition

On October 3, 2011, we acquired Digital Media Production a.s. (“DMP”), a Czech company with its principal office in Prague. A former competitor of Brickbox, DMP is engaged in multimedia video production with a focus on enterprise customers. We acquired DMP in exchange for $2,750 cash and 42,500 shares of our common stock valued at a price of $7.53 for a total of $320. The consideration also includes contingent consideration of $4,284 based upon meeting revenue and profit targets for the periods ending December 31, 2011, December 31, 2012 and December 31, 2013. We are holding 7,650 shares of the consideration in escrow pending the end of the first contingency period and will hold 15% of each contingency payment in escrow for 1 year following the end of that contingency period. We have allocated the aggregate cost of the acquisition to DMP’s net tangible and identifiable intangible assets based on their estimated fair values. The excess of the aggregate cost of the acquisition over the net estimated fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

The results of operations of DMP for the period from October 3, 2011 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited) 

Sezmi Acquisition

On December 30, 2011, we acquired substantially all the assets and assumed certain liabilities of Sezmi Corporation (“Sezmi”) a Delaware corporation, pursuant to an Asset Purchase Agreement dated as of December 30, 2011. Headquartered in Belmont, CA, Sezmi is a leading global provider of broadband-broadcast hybrid TV solutions. Sezmi employs a cloud-based software-as-a-service model and its target customers are service operators, such as telecommunication companies and Internet service providers, as well as content providers who desire to provide licensed or owned video content to subscribers across mobile and Internet protocol (IP)-connected home entertainment devices. Total consideration was $7,850 in cash, the assumption of $16,526 in liabilities, $2,625 owed to the shareholders of Sezmi which will be issued in shares and held in escrow for a period of up to 12 months following the closing date and contingent consideration based upon revenue and other targets totaling $25,003. The excess of the aggregate cost of the acquisition over the net estimated fair value of the tangible and identifiable intangible assets and liabilities assumed was recorded as goodwill.

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

There were no results of operations of Sezmi for the period from December 30, 2011 to December 31, 2011 and therefore have not been included in the Consolidated Statements of Operations. The results of operations of Sezmi for the period from January 1, 2012 to March 31, 2012 have been included in the Consolidated Statements of Operations. Revenue and net income after acquisition are not provided as it is impracticable to distinguish due to the integration of sales, delivery and overhead into our overall regional and global operations.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited) 

Selected unaudited pro forma combined results of operations for the three months ended March 31, 2011, assuming the Kyte, Kewego, Kickapps, WWB, ioko, Polymedia, Peerset, DMP and Sezmi acquisitions occurred on January 1, 2011 using actual unaudited figures from each entity prior to acquisition, are presented as follows:

(11) Loan Receivable

In December 2010, we lent $10,847 in gross proceeds in relation to the sale of subsidiary. It matures on January 28, 2015. Commencing on February 28, 2011, payments are due in forty-eight equal consecutive monthly payments of $226. The loan is secured by accounts receivable, cash and other assets.

(12) Secured Notes Payable

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

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

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

As of March 31, 2012, we were in default of a debt covenant on all of our secured notes payable which states that we must maintain at least 75% of the dollar value of worldwide cash with one or more banks located in the United States. We have received a waiver from the lender for the period through March 31, 2012. No adjustment was made for the default due to the waiver from the lender. As of May 11, 2012, we again complied with the covenant and the lender has not asserted any rights it might have with respect to our non-compliance during that period. We anticipate refinancing this facility but cannot provide assurance as to our success in doing so or the timing thereof.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(13) Acquisition Liabilities

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

Acquisition Liabilities consisted of the following: 

The fair value of the acquisition-related contingent consideration for Benchmark included above was $8,378 on the acquisition date of May 14, 2010. As of March 31, 2011, the fair value of the acquisition-related contingent consideration for the first anniversary on May 15, 2011 for Benchmark increased by $2,873 based on changes in management’s estimates and other factors that occurred during the three months ended March 31, 2011. As of June 30, 2011, the fair value of the acquisition-related contingent consideration for the first anniversary on May 15, 2011 for Benchmark increased by an additional $2,148 based on the actual earn-out provisions which has been agreed and finalized. As of June 30, 2011, the fair value of the acquisition-related contingent consideration for the second anniversary on May 15, 2012 for Benchmark increased by $3,208 based on changes in management’s estimates and other factors that occurred during the three months ended June 30, 2011. The increase in the liabilities were recorded as a charge to earnings and is included in the “Merger and acquisition and investor relations expenses” line item in the Consolidated Statements of Operations. Also in the three months ended June 30, 2011, the working capital liability was agreed and paid for $357 with the difference of $762 recorded as an offset to the “Merger and acquisition and investor relations expenses” line item in the Consolidated Statements of Operations.

Pursuant to the Benchmark Stock Purchase Agreement on May 14, 2010, following the 12-month anniversary of the closing, we agreed to pay the seller in the form of shares of our common stock $0.60 for every $1.00 of recognized revenue generated by Benchmark during the 12-month period following the closing, less the purchase price paid at closing.  The price per share of our common stock issuable following the first anniversary of the closing was calculated based on the weighted average price of our common stock for the 30 trading days immediately preceding the first anniversary. Pursuant to an amendment to the Stock Purchase Agreement dated August 2, 2011, the parties agreed to accelerate half of the payment which would otherwise be payable to the seller with respect to the 12 months ending May 15, 2012 (based on financial results ending May 15, 2011), and extended a portion of the balance of the 2012 payment until May 15, 2013.  In accordance with the Benchmark Stock Purchase Agreement and the amendment, we issued 816,592 shares of our common stock to the seller for the first anniversary payment. On August 4, 2011, we issued 816,592 shares of our common stock valued at $7,905 in satisfaction of $9,378 of the earn-out provision. The difference of $1,473 was recorded as other income in the Consolidated Statements of Operations due to the change in value of the shares upon issuance. In satisfaction of $1,597 of the earn-out provision, we issued 72,648 shares of our common stock on October 11, 2011 valued at $615, another 27,686 shares of our common stock on November 11, 2011 valued at $342 and paid $640 in cash in the fourth quarter of 2011.

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

On May 22, 2011, we signed an amendment to the securities purchase agreement to issue 265,262 shares valued at $3,053 for the full settlement of the Brickbox contingent acquisition liabilities estimate of $3,023, with the difference booked to expense in the three months ended June 30, 2011. These shares were issued on May 23, 2011.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(14) Derivative Liabilities

In June 2008, the Financial Accounting Standards Board issued a new accounting standard. Under this standard, instruments which contain full ratchet anti-dilution provisions will no longer be considered indexed to a company’s own stock for purposes of determining whether it meets the first part of the scope exception. The adoption required us to (1) evaluate our instrument’s contingent exercise provisions and (2) evaluate the instrument’s settlement provisions. Based upon applying this approach to instruments within the scope of the consensus, we have determined that certain of our warrants which were classified in stockholders’ equity on December 31, 2008, no longer meet the definition of Indexed to a Company’s Own Stock provided in the Consensus. Accordingly, effective on January 1, 2009, we were required to reclassify those warrants, at their fair value, into liabilities. The accounting standard requires that the fair value of these liabilities be re-measured at the end of every reporting period with the change in value over the period reported in the statement of operations. The difference between the amount the warrants were originally recorded in the financial statements and the fair value of the instruments on January 1, 2009 was considered a cumulative effect of a change in accounting principle and required an adjustment to the opening balance of retained earnings and a reduction in additional paid-in capital in the amount of $8,498 and $24,235, respectively. The derivative liability as of January 1, 2009 was $15,737. The common shares indexed to the derivative financial instruments used in the calculation of the fair value and recorded as liabilities at January 1, 2009, December 31, 2011 and March 31, 2012 were 5,806,230, 251,021 and 251,021, respectively. The number of shares for the determination of liability have been computed based on the effective exercise price used in the valuation. The actual number of common shares indexed to the warrants at January 1, 2009, December 31, 2011 and March 31, 2012 were 2,886,038, 251,021 and 251,021, respectively.

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

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

The following table summarizes the components of derivative liabilities as of March 31, 2012, December 31, 2011 and the re-measurement date, January 1, 2009:

Fair value hierarchy:

The effects on our income (expense) associated with changes in the fair values of our derivative financial instruments for the three months ended March 31, 2012 and 2011 were $187 and $2,610, respectively.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(15) Other Current Liabilities

Other current liabilities consisted of the following:

(16) Fair Value Measurement

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

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

The amount of total gains or losses for the three months included in losses attributable to the change in unrealized gains or losses relating to liabilities still held at March 31, 2012

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

The amount of total gains or losses for the three months included in losses attributable to the change in unrealized gains or losses relating to liabilities still held at March 31, 2012

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(17) Stock-Based Compensation

In December 2010, our board of directors voted unanimously to increase the number of shares which may be issued under the 2008 Incentive Plan by 1,500,000 to an aggregate of 5,000,000 shares of common stock, subject to ratification by our stockholders. Subsequently, as a result of acquisition activity, our board of directors authorized at its meetings on March 5, 2011 and August 5, 2011 to amend and increase the number of shares which may be issued under the 2008 Incentive Plan to a new total of 9,500,000 shares of common stock. The holders of a majority of our outstanding shares of common stock approved the amendment to the 2008 Incentive Plan at the stockholders meeting held on October 21, 2011. The 2008 Incentive Plan had 546,275 shares of common stock available for future grants as of March 31, 2012. The 2004 Stock Option Plan has reserved 342,858 shares of common stock for issuance of which 262,858 shares of common stock were available for future grants as of March 31, 2012..

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

For the three months ended March 31, 2012 and 2011, the Company recognized $7,303 and $2,027, respectively, of non-cash stock-based compensation expense in the consolidated statements of operations. Included in the 2012 amount of $7,303, is $1,451 for restricted stock units, $980 for restricted stock, $685 for stock issued as compensation, $1,318 for compensation accrued for which stock is to be issued in 2012 and $341 for director’s compensation accrued and to be paid in stock options. Included in the 2011 amount of $2,027, is $238 for restricted stock units and $170 for restricted stock. Also included in non-cash stock-based compensation are warrants to purchase 34,286 shares of common stock with an exercise price of $4.655 issued on March 30, 2008, that vest over three years from the issue date with $12 recognized in the three months ended March 31, 2011. As of March 31, 2011, all of these warrants were vested. The intrinsic value as of March 31, 2012 and December 31, 2011 of these outstanding and exercisable warrants was $87 and $130, respectively.

As of March 31, 2012, there was approximately $24,833 of total unrecognized compensation cost related to unvested share-based compensation grants, which is expected to be amortized over a weighted-average period of 2.7 years. As of December 31, 2011, there was approximately $26,513 of total unrecognized compensation cost related to unvested share-based compensation grants, which is expected to be amortized over a weighted-average period of 2.8 years.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

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

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

A summary of the status of stock option awards and changes during the three months ended March 31, 2012 is presented below:

The weighted-average grant-date fair value of option awards granted during the three months ended March 31, 2012 was $7.54.

(18) Stock Issuances

During the quarter ended March 31, 2012, we issued 1,100,189 shares of common stock. Of this amount, we issued 767,539 shares related to the acquisition of Sezmi, 4,500 shares for services, 264,867 shares for restricted stock and 63,283 shares for the exercise of options with proceeds of $483. 

As of March 31, 2012, the outstanding warrants (excluding the warrants included in the derivative liability of 251,021 and stock-based compensation of 34,286) were 1,122,960 with a weighted average exercise price of $21.24. As of December 31, 2011, the outstanding warrants (excluding the warrants included in the derivative liability of 251,021 and stock-based compensation of 34,286) were 1,361,935 with a weighted average exercise price of $24.21.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(19) Restructuring Charges

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

The following table summarizes the restructuring charges for the year ended December 31, 2011 and the three months ended March 31, 2012, for the plan approved in the first quarter 2010:

The accrued restructuring of $164 is included in accrued expenses in the consolidated balance sheets as of March 31, 2012.

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

The following table summarizes the restructuring charges:

(20) Integration Expenses

The Company has recorded integration charges related to the cost overlap due to the reorganization and integration of acquisitions of $8,688 for the three ended March 31, 2011. Integration expenses include one-time expenses for integrating acquired businesses together and eliminating duplication and inefficiencies. This includes rationalizing hosting and delivery infrastructure (data center consolidation, related hardware purchases, trunk T1 and T3 purchases and combinations, etc.) to merging software platforms and physical plant/office combination. These expenses include directly allocable staff time, travel and associated charges related to executing these integration initiatives. These expenses are almost without exception cash-based.

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(21) Segment Reporting

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

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

In the assets listed above, Corporate includes all intangible assets and goodwill.

(22) Related Party Transactions

The managerial services of Kaleil Isaza Tuzman, our former Chairman and Chief Executive Officer, and other non-executive personnel, were provided through KIT Capital, which is beneficially controlled by Mr. Isaza Tuzman. The total amount included in our results of operations in the three months ended March 31, 2012 and 2011 were $79 and $97, respectively.

(23) Income Taxes

Income taxes for the interim periods presented have been included in the accompanying financial statements on the basis of an estimated annual effective tax rate of 1.2% for the three months ended March 31, 2012 and 2.3% for the year ended December 31, 2011. The effective tax rate may vary from period to period depending on, among other factors, the geographic and business mix of taxable earnings, losses and tax planning.

We are not currently under examination by any taxing authorities. 

KIT DIGITAL, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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

(Unaudited)

(24) Subsequent Events

On April 12, 2012, our Board of Directors accepted the April 11, 2012 resignation of Kaleil Isaza Tuzman, as Chairman and a member of our Board of Directors.

On April 21, 2012, we signed a definitive agreement to acquire Hyro Limited ("Hyro") for consideration of approximately 2,100,000 shares of our common stock or cash, at our option. The closing of the transaction is subject to Hyro’s shareholder approval at the Hyro Annual General Meeting in the first week of June 2012. Hyro, a public company listed on the Australian Stock Exchange with headquarters in Melbourne, Australia, is a digital solutions company that provides enterprise grade technology, systems integration, software and managed services solutions.

On May 4, 2012, Barak Bar-Cohen, our Chief Executive Officer, was elected to our Board of Directors.

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

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

Overview

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

Subsequent to the quarter ended March 31, 2012, we experienced a decline in our stock price and market capitalization. If our stock price does not recover in the near term, this may result in an interim test of impairment of our goodwill.

Set forth below is a discussion of the financial condition and results of operations of KIT digital, Inc. and its consolidated subsidiaries (collectively, “we,” “us” or “our”), for the three months ended March 31, 2012 and 2011. The following discussion should be read in conjunction with the information set forth in the consolidated financial statements and the related notes thereto appearing elsewhere in this report.

Results of Operations - Three Months Ended March 31, 2012 Compared to Three Months Ended March 31, 2011

Revenue. Consolidated revenue increased by $24,580 from $34,450 for the three months ended March 31, 2011 to $59,030 for the three months ended March 31, 2012, an increase of 71%. This increase was primarily due to increased spending by existing customers, an increase in customers and revenue from the acquired companies not included in prior period results. In 2012, our average monthly revenue per client increased, reflecting the company’s focus on higher-end opportunities in the market and large, multi-year contracts in emerging geographies. The company’s client base has increased from 1,000 customers in the beginning of 2010 to over 2,300 customers at present. The acquisitions which were the primary contributors to inorganic growth in 2012 over 2011 were Ioko, Megahertz and Polymedia.

Variable and Direct Third Party Costs

Cost of Goods and Services (Exclusive of Depreciation shown separately below). These costs increased by $9,025 from $10,747 for the three months ended March 31, 2011 to $19,772 for the three months ended March 31, 2012, a increase of 84%. These costs represent the costs of equipment and services for the supply of digital media and IPTV solutions, services and components. The increase is primarily due to the timing of the sale of services for the supply of digital media solutions, services and components in the three months ended March 31, 2012. These costs will increase in 2012 due to the increase in the sale of services for the supply of digital media solutions, services and components, but overall our total gross margin is expected to increase or remain stable due to our overall revenue mix.

Hosting, Delivery, Reporting and Content Costs. These costs increased by $2,072 from $1,362 for the three months ended March 31, 2011 to $3,434 for the three months ended March 31, 2012, an increase of 152%. These costs increased primarily due to the increase in revenue over 2011 and costs relating to the acquisition of ioko in May 2011 for hosting, delivery and reporting offset by the decrease of $147 for the reduction of the use of content in integrated sales activity and therefore the subsequent reduction in usage and the level of minimum guarantees paid for content. We expect these costs to decrease as an overall percentage of revenue through the continued consolidation of our data centers and price negotiations with our content delivery providers due to our increased size and bargaining power.

Direct Third Party Creative Production Costs. Direct third party creative production costs decreased by $252 from $365 for the three months ended March 31, 2011 to $617 for the three months ended March 31, 2012, a increase of 69% attributable to a decrease in revenue requiring creative production costs.

General and Administrative Expenses

Compensation, Travel and Associated Costs (Including Non-Cash Stock-Based Compensation). These costs increased by $29,960 from $12,307 for the three months ended March 31, 2011 to $42,267 for the three months ended March 31, 2012, an increase of 243%.  The increase was primarily due to the acquisitions in 2011, which was offset in part by continuing cost cutting measures as we integrated the acquired businesses and some of these costs were included in integration expenses. The non-cash stock-based compensation expense increased by $5,276, from $2,027 for the three months ended March 31, 2011 to $7,303 for the three months ended March 31, 2012 primarily due to the increase in stock options granted in 2011 and 2012, $1,318 accrued in 2012 for compensation to be issued in stock and $2,431 for restricted stock units and restricted stock vested in 2012.

Legal, Accounting, Audit and Other Professional Services Fees. These expenses increased by $550 from $637 for the three months ended March 31, 2011 to $7,031 for the three months ended March 31, 2012, an increase of 86%. These costs increased primarily due to increases in accounting and audit fees combined with an overall increase in these expenses from the acquisitions. We expect these absolute costs to remain materially the same or decrease slightly and continue to decrease as a percentage of revenue due to an overall strategy to maintain these overall costs by negotiation of consulting agreements.

Office, Marketing and Other Corporate Costs. These expenses increased by $3,040 from $3,991 for the three months ended March 31, 2011 to $7,031 for the three months ended March 31, 2012, an increase of 76%.  The increase was primarily due to the acquisitions which increased our number of offices and overall office costs. We expect these costs as a percentage of revenue to decrease in 2021 as we consolidate office space and manage our office costs through cost-cutting policies and negotiations with vendors.

Merger and Acquisition Related Expenses. Merger and acquisition related expenses decreased by $760 from $5,250 for the three months ended March 31, 2011 to $4,490 for the three months ended March 31, 2012, a decrease of 14%. The decrease was primarily due to the significant acquisitions in the three months ended March 31, 2011 as compared to none in the three months ended March 31, 2012. We expect these costs to continue to decrease substantially going forward due to the completion of these acquisitions.

Depreciation and Amortization. Depreciation and amortization expense increased by $1,787 from $2,434 for the three months ended March 31, 2011 to $4,221 for the three months ended March 31, 2012, an increase of 73%. The increase was primarily due to the acquisitions in 2011. We expect these costs to remain relatively stable for the rest of 2012.

Restructuring Charges. Restructuring charges was $3,318 for the three months ended March 31, 2011. These charges reflect the 2011 plan that was initiated in the first quarter of 2011. There were no restructuring charges in the three months ended March 31, 2012.

Integration Expenses. Integration expenses was $8,688 for the three months ended March 31, 2011. There were no integration charges for the three months ended March 31, 2012. Integration expenses in 2011 consisted of cost overlap due to the integration of acquisitions. These costs have been completed now as a result of the acquired businesses being integrated.

Interest Income.  Interest income decreased by $19 from $72 for the three months ended March 31, 2011 to $53 for the three months ended March 31, 2012. This increase was primarily due to the fluctuation in the level of our cash and cash equivalents.

Interest Expense. Interest expense increased by $420 from $270 for the three months ended March 31, 2011 to $690 for the three months ended March 31, 2012, an increase of 156%. This increase was mainly due to the issuance of secured notes in May 2011.

Amortization of Deferred Financing Costs and Debt Discount. Amortization of deferred financing costs and debt discount was $104 for the three months ended March 31, 2012 and $19 for the three months ended March 31, 2011. These costs resulted from the issuance of secured notes payable of $5,000 in April 2010, $1,000 in June 2010 and $15,000 in May 2011.

Derivative Income (Expense). Derivative income was $2,610 for the three months ended March 31, 2011 as compared to derivative income of $187 for the three months ended March 31, 2012. Derivative income or expense is the change in the period based on the fair value of warrants containing reset provisions.

 Other Income/(Expense). Other income/(expense) changed by $172 from $106 in other expense for the three months ended March 31, 2011 to other expense of $278 for the three months ended March 31, 2012.

Net Loss Available to Common Shareholders. As a result of the factors described above, we reported net loss available to common shareholders of $24,882 for the three months ended March 31, 2012 compared to a net loss available to common shareholders of $12,501 for the three months ended March 31, 2011, an increase in net loss of $12,381.

 Liquidity and Capital Resources

As of March 31, 2012, we had cash and cash equivalents of $26,099 and working capital of approximately $38,463. Management anticipates that it has enough cash reserves and cash flows from its operating activities, with the addition of the capital expected from the closing of our May 15, 2012 agreement below, to be sufficient to fund its operations, anticipated capital expenditures and debt repayment obligations for at least the next 12 months.

On May 15, 2012, we entered into a definitive securities purchase agreement with certain institutional investors to sell 7,000,000 shares of our common stock and warrants to purchase 5,250,000 shares of common stock in a private placement. Gross proceeds of the financing are $29,190, before deducting placement agent fees and estimated offering expenses, and assuming no exercise of the warrants. The warrants will be exercisable at an exercise price of $5.00 per share commencing on the six-month anniversary of the closing date and expiring five years after the date on which they become exercisable. The warrant exercise price is subject to adjustment under certain circumstances and the warrant contains "full-ratchet" anti-dilution provisions. In addition, we will be required to issue additional shares of common stock to the investors in the event that the price per share of the common stock is less than the price paid in the private placement during a specified period following the date on which the investors' securities have been registered for resale with the SEC. In connection with the private placement, we agreed to file a registration statement with the SEC for the resale of the shares of common stock and warrants issued pursuant to the securities purchase agreement. 

As of March 31, 2012, we were in default of a debt covenant on all of our secured notes payable which states that we must maintain at least 75% of the dollar value of worldwide cash with one or more banks located in the United States. We have received a waiver from the lender for the period through March 31, 2012. No adjustment was made for the default due to the waiver from the lender. As of May 11, 2012, we again complied with the covenant and the lender has not asserted any rights it might have with respect to our non-compliance during that period. We anticipate refinancing this facility but cannot provide assurance as to our success in doing so or the timing thereof.

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

Net cash used by operating activities was $11,785 for the three months ended March 31, 2012, compared to $9,065 for the three months ended March 31, 2011, an increase of $2,720. This was primarily due to the increases in general and administrative expenses related to the acquisitions in 2011.

Net cash used by investing activities was $5,749 for the three months ended March 31, 2012, compared to $23,378 for the three months ended March 31, 2011, an decrease in net cash used in investing activities of $17,629. The decrease in net cash used in investing activities was primarily attributable to the decrease in cash paid in acquisitions in 2012 of $16,912 as compared to 2011 offset by an increase in merger and acquisition expenses of $1,506..

Net cash used by financing activities was $2,434 for the three months ended March 31, 2012, compared to net cash provided by financing activities of $59 for the three months ended March 31, 2011. In 2012, this primarily consisted of the payments of secured notes of $958, the payments of notes payable of $1,650 related to the Sezmi acquisition, payments of capital leases and other obligations of $45 and proceeds from the exercise of options of $483. In 2011, this primarily consisted of the payments of secured notes of $264, payments of capital leases and other obligations of $184 and proceeds from the exercise of options of $389.

Off-Balance Sheet Arrangements

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

SPECIAL NOTE REGARDING FORWARD-LOOKING INFORMATION

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

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

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

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

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

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

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

ITEM 4. CONTROLS AND PROCEDURES.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our chief executive officer and chief financial officer of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) of the Exchange Act). Based upon this evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures are still not effective with respect to the material weakness disclosed in our 10-K to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is: (1) accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure; and (2) recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms.

Changes in Internal Control Over Financial Reporting

There was no change to our internal controls or in other factors that could affect these controls during our last fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Status of Remediation Efforts

Prior to the filing date of our 10-Q we have undertaken or completed the following activities related to remediation of the Material Weakness disclosed in our 10-K filing. Items completed include:

Items undertaken and in progress include:

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

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

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

In December 2007, two former consultants of ROO Media Corporation (ROO Media) (currently KIT Media Corporation) sued that entity together with ROO Group, Inc. (now KIT digital, Inc.) and its founder and former Vice Chairman and ROO Media’s former President and Chief Operating Officer in New York Supreme Court, New York County, New York, alleging breach of an oral employment agreement, fraudulent inducement and other claims relating to the plaintiffs’ employment at ROO Media. In March 2009, the court dismissed all of plaintiffs’ claims except their breach of contract claim on the grounds that it is based on an alleged oral agreement, which, according to the court, plaintiffs may be able to prove. In July 2011, following the completion of discovery, defendants made a motion for summary judgment dismissing the remaining claim in the case. Briefing and oral argument on that motion were recently completed and a decision is expected in the spring of 2012. If defendants win this motion, the case is completed, except for the possibility of an appeal by plaintiffs. If defendants do not prevail, the case will go to trial. We believe that there is no merit to this suit and we intend to continue to defend vigorously.

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

In May 2009, a former employee of Wurld filed suit against ten shareholders of Wurld, Wurld, ROO HD (now KIT HD), and ROO Group, Inc. (now KIT digital, Inc.), in New York Supreme Court, Albany County, New York. Plaintiff seeks to hold the ten largest shareholders of Wurld liable under Business Corporation Law §630, for $100 in wages that Wurld allegedly failed to pay plaintiff. She further asserts a variety of claims based on the allegation that KIT HD’s acquisition of certain assets of Wurld was a fraudulent conveyance, and that KIT HD is the successor to Wurld and liable for Wurld’s debts. Based on these allegations, plaintiff seeks payment of her wages, the (unspecified) fair market value of her shares of stock in Wurld, rescission of the asset purchase agreement between Wurld and KIT HD, plus attorney’s fees. In October 2009, the court dismissed plaintiff's claims against three shareholder/defendants on the grounds that BCL §630 does not apply to Wurld because it is not a New York corporation, a decision that plaintiff appealed to the intermediate appellate court and lost. Plaintiff pursued her appeal to the Court of Appeals (New York State’s highest court) and, in early March 2012, she lost that appeal. Consequently, all of plaintiff’s claims against the Wurld shareholder defendants are, or will be, finally dismissed; and this case should move into the discovery phase, as the plaintiff is now likely to move ahead with her claims against us and KIT HD. We and KIT HD have been served and answered. We believe that this lawsuit is without merit and we intend to defend ourself vigorously.

Our company and Mr. Isaza Tuzman have been required to produce documents to the SEC under two simultaneous February 24, 2012 subpoenas issued by the SEC. The investigation includes and we believe may focus on June 2010 transactions in company common stock and a related Form 4 filing by Mr. Isaza Tuzman that reported a purchase of 54,645 shares of company common stock, but we cannot be certain of its scope or outcome. We are cooperating fully with the SEC.

ITEM 1A. RISK FACTORS.

There are no material changes in the risk factors previously disclosed in our annual report on Form 10-K for the year ended December 31, 2011.

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

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4. MINE SAFETY DISCLOSURES

None

ITEM 5. OTHER INFORMATION.

None

ITEM 6. EXHIBITS.

SIGNATURES

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