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EX-31.2 - Onstream Media CORPv185159_ex31-2.htm
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EX-32.1 - Onstream Media CORPv185159_ex32-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2010
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _________ to _________

Commission file number 000-22849

Onstream Media Corporation
(Exact name of registrant as specified in its charter)

65-0420146
(IRS Employer Identification No.)

Florida
(State or other jurisdiction of incorporation or organization)

1291 SW 29 Avenue, Pompano Beach, Florida 33069
(Address of principal executive offices)

954-917-6655
(Registrant's telephone number)

(Former name, former address and former fiscal year, if changed since last report)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ¨   No ¨

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

Large accelerated filer ¨
Accelerated filer ¨
Non-accelerated filer   ¨ (Do not check if a smaller reporting company)
Smaller reporting company x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act)    Yes ¨   No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  As of May 7, 2010 the registrant had issued and outstanding 7,739,626 shares of common stock (after giving effect to a 1-for-6 reverse stock split that was effective on April 5, 2010).

 
 

 

TABLE OF CONTENTS

 
PAGE
   
PART I – FINANCIAL INFORMATION
 
   
Item 1 - Financial Statements
4
   
Unaudited Consolidated Balance Sheet at March 31, 2010 and Consolidated Balance Sheet at September 30, 2009
4
   
Unaudited Consolidated Statements of Operations for the Six and Three Months Ended March 31, 2010 and 2009
5
   
Unaudited Consolidated Statement of Stockholders’ Equity for the Six Months Ended March 31, 2010
6
   
Unaudited Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2010 and 2009
7 –8
   
Notes to Unaudited Consolidated Financial Statements
9 – 54
   
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
55 – 78
   
Item 4 - Controls and Procedures
79
   
PART II – OTHER INFORMATION
 
   
Item 1 – Legal Proceedings
80
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
80
   
Item 3 – Defaults upon Senior Securities
82
   
Item 4 – Submission of Matters to a Vote of Security Holders
82
   
Item 5 – Other Information
82
   
Item 6 - Exhibits
82
   
Signatures
82
 
 
2

 

A 1-for-6 reverse stock split of the outstanding shares of our common stock was effective on April 5, 2010. Except as otherwise indicated, all related amounts reported in our consolidated financial statements and in this 10-Q, including common share quantities, convertible debenture conversion prices and exercise prices of options and warrants, have been retroactively adjusted for the effect of this reverse stock split.

FORWARD-LOOKING STATEMENTS AND ASSOCIATED RISKS

 Certain statements in this quarterly report on Form 10-Q contain or may contain forward-looking statements that are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, our ability to implement our strategic initiatives (including our ability to successfully complete, produce, market and/or sell the DMSP and/or our ability to eliminate cash flow deficits by increasing our sales), economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk, U.S. and global competition, and other factors affecting the Company's operations and the fluctuation of our common stock price, and other factors discussed elsewhere in this report and in other documents filed by us with the Securities and Exchange Commission from time to time.  Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of March 31, 2010. You should carefully review this Form 10-Q in its entirety, including but not limited to our financial statements and the notes thereto, as well as our most recently filed 10-K. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. Actual results could differ materially from the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will, in fact, occur. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

 
3

 

PART I – FINANCIAL INFORMATION
Item 1 - Financial Statements
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 
   
March 31,
2010
   
September 30,
2009
 
   
(unaudited)
       
ASSETS
           
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 710,485     $ 541,206  
Accounts receivable, net of allowance for doubtful accounts of $291,035 and $241,298, respectively
    2,856,848       2,189,252  
Prepaid expenses
    612,805       356,963  
Inventories and other current assets
    118,200       198,960  
Total current assets
    4,298,338       3,286,381  
                 
PROPERTY AND EQUIPMENT, net
    2,911,381       3,083,096  
INTANGIBLE ASSETS, net
    1,545,935       2,499,150  
GOODWILL, net
    13,996,948       16,496,948  
OTHER NON-CURRENT ASSETS
    122,276       118,398  
                 
Total assets
  $ 22,874,878     $ 25,483,973  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
                 
CURRENT LIABILITIES:
               
Accounts payable
  $ 2,776,935     $ 2,384,344  
Accrued liabilities
    1,176,480       1,199,843  
Amounts due to directors and officers
    257,015       229,908  
Deferred revenue
    159,014       163,198  
Notes and leases payable –  current portion, net of discount
    1,940,719       1,615,891  
Convertible debentures, net of discount
    541,651       -  
Series A-12 Convertible Preferred stock – redeemable portion, net of discount
    -       98,000  
Total current liabilities
    6,851,814       5,691,184  
                 
Notes and leases payable, net of current portion
    618,662       505,061  
Convertible debentures, net of discount
    1,317,585       1,109,583  
Total liabilities
    8,788,061       7,305,828  
                 
COMMITMENTS AND CONTINGENCIES
               
STOCKHOLDERS' EQUITY:
               
Series A-12 Convertible Preferred stock, par value $.0001 per share, authorized 100,000 shares,  
-0- and 70,000 issued and outstanding, respectively
    -       7  
Series A-13 Convertible Preferred stock, par value $.0001 per share, authorized 170,000 shares,
35,000 and -0- issued and outstanding, respectively
    3       -  
Common stock, par value $.0001 per share, authorized 75,000,000 shares, 7,739,626 and 7,388,783 
issued and outstanding, respectively
    774       739  
Additional paid-in capital
    133,825,182       132,299,589  
Unamortized discount
    (6,747 )     (12,000 )
Accumulated deficit
    (119,732,395 )     (114,110,190 )
Total stockholders’ equity
    14,086,817       18,178,145  
                 
Total liabilities and stockholders’ equity
  $ 22,874,878     $ 25,483,973  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
4

 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited)

   
Six Months Ended
March 31,
   
Three Months Ended
March 31,
 
   
2010
   
2009
   
2010
   
2009
 
REVENUE:
                       
DMSP and hosting
  $ 1,067,373     $ 868,489     $ 515,148     $ 471,114  
Webcasting
    2,873,542       2,913,536       1,463,535       1,349,348  
Audio and web conferencing
    3,242,522       3,653,021       1,652,561       1,896,052  
Network usage
    894,637       1,031,935       438,424       490,195  
Other
    124,733       294,877       64,026       175,952  
Total revenue
    8,202,807       8,761,858       4,133,694       4,382,661  
                                 
COSTS OF REVENUE:
                               
DMSP and hosting
    487,778       307,298       234,770       152,047  
Webcasting
    791,914       905,646       465,003       444,352  
Audio and web conferencing
    994,816       863,486       459,119       433,447  
Network usage
    382,314       454,976       194,672       220,686  
Other
    206,081       262,106       102,863       130,103  
Total costs of revenue
    2,862,903       2,793,512       1,456,427       1,380,635  
                                 
GROSS MARGIN
    5,339,904       5,968, 346       2,677,267       3,002,026  
                                 
OPERATING EXPENSES:
                               
General and administrative:
                               
Compensation
    4,252,712       4,909,122       2,176,335       2,505,283  
Professional fees
    918,113       661,754       440,054       263,156  
Other
    1,111,205       1,209,704       565,912       601,902  
Write off deferred acquisition costs
    -       540,007       -       540,007  
Impairment loss on goodwill and other intangible assets
    3,100,000       5,500,000       -       -  
Depreciation and amortization
    1,116,161       2,011,451       548,800       918,075  
Total operating expenses
    10,498,191       14,832,038       3,731,101       4,828,423  
                                 
Loss from operations
    (5,158,287 )     (8,863,692 )     (1,053,834 )     (1,826,397 )
                                 
OTHER EXPENSE, NET:
                               
Interest expense
    (537,929 )     (262,472 )     (302,529 )     (123,292 )
Other income, net
    95,011       33,599       96,199       2,521  
                                 
Total other expense, net
    (442,918 )     (228,873 )     (206,330 )     (120,771 )
                                 
Net loss
  $ (5,601,205 )   $ (9,092,565 )   $ (1,260,164 )   $ (1,947,168 )
                                 
Loss per share – basic and diluted:
                               
Net loss per share
  $ (0.75 )   $ (1.27 )   $ (0.17 )   $ (0.27 )
Weighted average shares of common stock outstanding – basic and diluted
    7,512,738       7,176,367       7,596,482       7,227,788  

The accompanying notes are an integral part of these consolidated financial statements.

 
5

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
SIX MONTHS ENDED MARCH 31, 2010
(unaudited)

   
Series A- 12
Preferred Stock
   
Series A- 13
Preferred Stock
   
Common Stock*
   
Additional Paid-in
Capital
   
Accumulated
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Shares
   
Amount
   
Gross
   
Discount
   
Deficit
   
Total
 
                                                             
Balance, September 30, 2009
    70,000     $ 7       -     $ -       7,388,783     $ 739     $ 132,299,589     $ (12,000 )   $ (114,110,190 )   $ 18,178,145  
Issuance of shares, warrants and options for consultant services
    -       -       -       -       159,267       16       443,650       -       -       443,666  
Issuance of options for employee services
    -       -       -       -       -       -       444,458       -       -       444,458  
Surrender of Series A-12 preferred for Series A-13 preferred
    (35,000 )     (4 )     35,000       3       -       -       108,500       (6,747 )     -       101,752  
Reclassification of redeemable portion of Series A-12 preferred as equity
    -       -       -       -       -       -       100,000       (2,000 )     -       98,000  
Issuance of common shares, or right to obtain common shares, for financing fees
    -       -       -       -       12,500       1       116,249       -       -       116,250  
Common shares and warrants issued for interest and fees on convertible debentures
    -       -       -       -       120,743       12       312,739       -       -       312,751  
Conversion of Series A-12 preferred to common shares
    (35,000 )     (3 )     -       -       58,333       6       (3 )     -       -       -  
Dividends accrued or paid on Series A-12 preferred
    -       -       -       -       -       -       -       14,000       (14,000 )     -  
Dividends accrued or paid on Series A-13 preferred
    -       -       -       -       -       -       -       -       (7,000 )     (7,000 )
Net loss
    -       -       -       -       -       -       -       -       (5,601,205 )     (5,601,205 )
                                                                                 
Balance, March 31, 2010
    -     $ -       35,000     $ 3       7,739,626     $ 774     $ 133,825,182     $ (6,747 )   $ (119,732,395 )   $ 14,086,817  

The accompanying notes are an integral part of these consolidated financial statements.
 
* A 1-for-6 reverse stock split of the outstanding shares of our common stock was effective on April 5, 2010. Except as otherwise indicated, all related amounts reported in these consolidated financial statements, including common share quantities, convertible debenture conversion prices and exercise prices of options and warrants, have been retroactively adjusted for the effect of this reverse stock split.

 
6

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

   
Six Months Ended
March 31,
 
   
2010
   
2009
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
Net loss
  $ (5,601,205 )   $ (9,092,565 )
Adjustments to reconcile net loss to net cash
(used in) provided by operating activities:
               
Impairment loss on goodwill and other intangible assets
    3,100,000       5,500,000  
Depreciation and amortization
    1,116,161       2,011,451  
Write off deferred acquisition costs
    -       540,007  
Amortization of deferred professional fee expenses paid with equity
    246,351       114,822  
Compensation expenses paid with equity
    444,458       430,136  
Amortization of discount on convertible debentures
    106,146       36,731  
Amortization of discount on notes payable
    114,101       12,110  
Interest expense paid in common shares and options
    67,040       31,103  
Bad debt expense
    49,737       81,902  
Gain from settlements of obligations and sales of equipment
    (86,352 )     (32,246 )
Net cash (used in) operating activities, before changes in current assets and liabilities
    (443,563 )     (366,549 )
Changes in current assets and liabilities:
               
(Increase) in accounts receivable
    (746,577 )     (130,089 )
(Increase) Decrease in prepaid expenses
    (44,430 )     17,140  
Decrease (Increase) in inventories and other current assets
    62,783       (18,203 )
Increase in accounts payable, accrued liabilities and amounts due to directors and officers
    820,050       852,430  
(Decrease) in deferred revenue
    (4,184 )        (5,670 )
Net cash (used in) provided by operating activities
    (355,921 )        349,059  
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Acquisition of property and equipment
    (593,350 )     (555,899 )
Narrowstep acquisition costs (written off to expense in March 2009)
    (115,000 )       (147,649 )
Net cash (used in) investing activities
    (708,350 )     (703,548 )

(Continued)

 
7

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)

(continued)

   
Six Months Ended
March 31,
 
   
2010
   
2009
 
CASH FLOWS FROM FINANCING ACTIVITIES:
           
Proceeds from notes payable, net of expenses
  $ 955,380     $ 443,378  
Proceeds from convertible debentures
    835,000       -  
Proceeds from sale of A-12 preferred shares, net of expenses
    -       200,000  
Proceeds from sale of A-13 preferred shares, net of expenses
    (6,747 )     -  
Repayment of notes and leases payable
    (537,083 )     (457,542 )
Repayment of convertible debentures
     (13,000 )       -  
Net cash provided by financing activities
    1,233,550         185,836  
                 
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    169,279       (168,653 )
                 
CASH AND CASH EQUIVALENTS, beginning of period
    541,206       674,492  
                 
CASH AND CASH EQUIVALENTS, end of period
  $ 710,485     $ 505,839  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
Cash payments for interest
  $ 312,885     $   144,637  
                 
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
               
                 
Issuance of shares, warrants and options for consultant services
  $ 443,666     $ 71,867  
Issuance of shares and options for employee services
  $ 444,458     $ 430,136  
Issuance of A-10 preferred shares for A-10 dividends
  $ -     $ 29,938  
Issuance of common shares for A-12 dividends
  $ -     $ 64,000  
Issuance of common shares and warrants for interest
  $ 312,751     $ 69,520  
Issuance of common shares for A-10 preferred shares and dividends
  $ -     $ 186,318  
Issuance of common shares, or right to obtain common shares, for financing fees
  $ 116,250     $ -  
Issuance of A-12 preferred shares for A-10 preferred shares
  $ -     $ 600,000  
Issuance of A-13 preferred shares for A-12 preferred shares
  $ 350,000     $ -  
Issuance of common shares for A-12 preferred shares
  $ 350,000     $ -  
Conversion of short-term advance to convertible debenture
  $ 200,000     $ -  
Declaration of dividends payable on A-13 preferred shares
  $ 7,000     $ -  

The accompanying notes are an integral part of these consolidated financial statements.

 
8

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010

NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Onstream Media Corporation (“we” or "Onstream" or "ONSM"), organized in 1993, is a leading online service provider of live and on-demand Internet video, corporate web communications and content management applications, including digital media services and webcasting services. Digital media services are provided primarily to entertainment, advertising and financial industry customers. Webcasting services are provided primarily to corporate, education, government and travel industry customers.

The Digital Media Services Group consists primarily of our Webcasting division, our DMSP (“Digital Media Services Platform”) division, our UGC (“User Generated Content”) division and our Smart Encoding division.

The Webcasting division, which operates primarily from facilities in Pompano Beach, Florida, provides an array of web-based media services to the corporate market including live audio and video webcasting, packaged corporate announcements, and rich media information storage and distribution for any business entity. The Webcasting division generates revenue through production and distribution fees.

The DMSP division, which operates primarily from facilities in Colorado Springs, Colorado, provides an online, subscription based service that includes access to enabling technologies and features for our clients to acquire, store, index, secure, manage, distribute and transform these digital assets into saleable commodities. The UGC division, which operates primarily from facilities in Colorado Springs, Colorado and also operates as Auction Video (see note 2), provides a video ingestion and flash encoder that can be used by our clients on a stand-alone basis or in conjunction with the DMSP.

The Smart Encoding division, which operates primarily from facilities in San Francisco, California, provides both automated and manual encoding and editorial services for processing digital media, using a set of coordinated technologies and processes that allow the quick and efficient online search, retrieval, and streaming of this media, which can include photos, videos, audio, engineering specs, architectural plans, web pages, and many other pieces of business collateral. This division also provides hosting, storage and streaming services for digital media, which are provided via the DMSP.

The Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division and our EDNet division. Our Infinite division, which operates primarily from facilities in the New York City metropolitan area, generates revenues from usage charges and fees for other services provided in connection with “reservationless” and operator-assisted audio and web conferencing services – see note 2.

Our EDNet division, which operates primarily from facilities in San Francisco, California, provides connectivity (in the form of high quality audio, compressed video and multimedia data communications) within the entertainment and advertising industries through its managed network, which encompasses production and post-production companies, advertisers, producers, directors, and talent. EDNet also provides systems integration and engineering services, application-specific technical advice, audio equipment, proprietary and off-the-shelf codecs, teleconferencing equipment, and other innovative products to facilitate its broadcast and production applications. EDNet generates revenues from network usage, sale, rental and installation of equipment, and other related fees.

 
9

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010


NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Liquidity

The consolidated financial statements have been presented on the basis that we are an ongoing concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have incurred losses since our inception, and have an accumulated deficit of approximately $119.7 million as of March 31, 2010. Our operations have been financed primarily through the issuance of equity and debt. For the year ended September 30, 2009, we had a net loss of approximately $11.8 million, although cash provided by operations for that period was approximately $322,000. For the six months ended March 31, 2010, we had a net loss of approximately $5.6 million and cash used in operations for that period was approximately $356,000. Although we had cash of approximately $710,000 at March 31, 2010, our working capital was a deficit of approximately $2.6 million at that date.

We are constantly evaluating our cash needs, in order to make appropriate adjustments to operating expenses. Depending on our actual future cash needs, we may need to raise additional debt or equity capital to provide funding for ongoing future operations, or to refinance existing indebtedness. No assurances can be given that we will be successful in obtaining additional capital, or that such capital will be available on terms acceptable to us. Our continued existence is dependent upon our ability to raise capital and to market and sell our services successfully. The financial statements do not include any adjustments to reflect future effects on the recoverability and classification of assets or amounts and classification of liabilities that may result if we are unsuccessful.
 
During February 2009, we took actions to reduce our operating costs, primarily personnel related, by approximately $65,000 per month. During October 2009, we took additional actions to reduce our operating costs, primarily personnel related, by another approximately $62,000 per month. We recently began to identify and implement certain infrastructure related cost savings, which actions have reduced our costs of revenue by approximately $34,000 per month as of March 31, 2010 and we expect will reduce our costs of revenue by another approximately $21,000 per month, once fully implemented by the end of fiscal 2010.

We have estimated that, including the above reductions in our expenditure levels, we would require an approximately 13-17% increase in our consolidated revenues for the remainder of fiscal 2010, as compared to the corresponding period of fiscal 2009, in order to adequately fund our minimum anticipated expenditures (including debt service and a basic level of capital expenditures) through September 30, 2010.  We have estimated that, in addition to this ongoing revenue increase, we will also require additional near-term debt or equity financing of approximately $250,000 (in addition to the $250,000 loan proceeds we received in May 2010 – see note 9) to adequately address past due liabilities we believe are necessary to pay to continue our operations. If we were to obtain financing in excess of this $250,000, the required revenue increase could be less than as stated above.
 
We have implemented specific actions, including hiring additional sales personnel, developing new products and initiating new marketing programs, geared towards achieving the above revenue increases. The costs associated with these actions were contemplated in the above calculations.  However, in the event we are unable to achieve these revenue increases, we believe that a combination of identified decreases in our current level of expenditures that we would implement and the raising of additional capital in the form of debt and/or equity that we believe we could obtain from identified sources would be sufficient to allow us to operate through September 30, 2010. We will closely monitor our revenue and other business activity through the remainder of fiscal 2010 to determine if further cost reductions, the raising of additional capital or other activity is considered necessary.

 
10

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Liquidity (continued)

During December 2009, we received funding commitment letters (“Letters”) executed by three entities agreeing to provide us, within twenty days after our notice given on or before December 31, 2010, aggregate cash funding of $750,000. Funding under the Letters would be in exchange for our equity under mutually agreeable terms to be negotiated at the time of funding, or in the event such terms could not be reached, in the form of repayable debt. Terms of the repayable debt would also be subject to negotiation at the time of funding, provided that the debt (i) would be unsecured and subordinated to our other debts, (ii) would be subject to approval by our other creditors having the right of such pre-approval, (iii) would provide for no principal or interest payments in cash prior to December 31, 2010, although, at our option, consideration may be given in the form of equity issued before that date and (iv) would provide that any cash repayment of principal after that date would be in equal monthly installments over at least one year but no greater than four years. The rate of return on such debt, including cash and equity consideration given, would be negotiable based on market values at the time of funding but in any event would be not be greater than (i) a cash coupon rate of fifteen percent (15%) per annum and a (ii) total effective interest rate of thirty percent (30%) per annum (such rate including the cash coupon rate plus the fair value of our shares given and/or the Black-Scholes valuation of debt conversion features and/or issuance of options and/or warrants).  As consideration for these Letters, the issuing entities received an aggregate of 12,500 unregistered shares. One of the Letters, for $250,000, was executed by Mr. Charles Johnston, one of our directors. Furthermore, certain principals of Triumph Small Cap Fund, which provided one of the Letters, for $250,000, are also principals in Greenberg Capital and required us to release Triumph Small Cap Fund from their commitment under that Letter, as part of a February 2010 modification to the Greenberg Note – see note 4.

A prospectus allowing us to offer and sell up to $6.6 million of our registered common shares (“Shelf Registration”) was declared effective by the SEC on April 30, 2010. Although there is no assurance that we will make sales under that Shelf Registration, or if we do make such sales what the timing or proceeds will be, we anticipate that the first approximately $900,000 of such proceeds will be used to repay the outstanding balances due under the Greenberg Note, the Wilmington Notes and the Lehmann Note – see notes 4 and 9. In addition, we may incur fees in connection with such sales. Furthermore, sales under the Shelf Registration that exceed in aggregate twenty percent (20%) of our outstanding shares would be subject to prior shareholder approval.

Basis of Consolidation

The accompanying consolidated financial statements include the accounts of Onstream Media Corporation and its subsidiaries - Infinite Conferencing, Inc., Entertainment Digital Network, Inc., OSM Acquisition, Inc., AV Acquisition, Inc., Auction Video Japan, Inc., HotelView Corporation and Media On Demand, Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

Reverse stock split

A 1-for-6 reverse stock split of the outstanding shares of our common stock was effective on April 5, 2010. Except as otherwise indicated, all related amounts reported in these consolidated financial statements, including common share quantities, convertible debenture conversion prices and exercise prices of options and warrants, have been retroactively adjusted for the effect of this reverse stock split.

 
11

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Cash and cash equivalents

Cash and cash equivalents consists of all highly liquid investments with original maturities of three months or less.

Concentration of Credit Risk

We at times have cash in banks in excess of FDIC insurance limits and place our temporary cash investments with high credit quality financial institutions. We perform ongoing credit evaluations of our customers' financial condition and do not require collateral from them. Reserves for credit losses are maintained at levels considered adequate by our management.

Bad Debt Reserves

Where we are aware of circumstances that may impair a specific customer's ability to meet its financial obligations, we record a specific allowance against amounts due from it, and thereby reduces the receivable to an amount we reasonably believe will be collected. For all other customers, we recognize allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and historical experience.

Inventories

Inventories are stated at the lower of cost (first-in, first-out method) or market by analyzing market conditions, current sales prices, inventory costs, and inventory balances.  We evaluate inventory balances for excess quantities and obsolescence on a regular basis by analyzing backlog, estimated demand, inventory on hand, sales levels and other information. Based on that analysis, our management estimates the amount of provisions made for obsolete or slow moving inventory.

Fair Value Measurements
 
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities and amounts due to directors and officers approximate fair value due to the short maturity of the instruments. The carrying amounts of the current portion of notes, debentures and leases payable approximate fair value due to the short maturity of the instruments, as well as the market value interest rates they carry.
 
Effective October 1, 2008, we adopted the provisions of the Fair Values Measurements and Disclosures topic of the Accounting Standards Codification (“ASC”), with respect to our financial assets and liabilities, identified based on the definition of a financial instrument contained in the Financial Instruments topic of the ASC. This definition includes a contract that imposes a contractual obligation on us to exchange other financial instruments with the other party to the contract on potentially unfavorable terms. We have determined that the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note and the Equipment Notes discussed in note 4 and the redeemable portion of the Series A-12 (preferred stock) discussed in note 6 are financial liabilities subject to the accounting and disclosure requirements of the Fair Values Measurements and Disclosures topic of the ASC. This is further discussed in “Effects of Recent Accounting Pronouncements” below.

 
12

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Fair Value Measurements (continued)

Under the above accounting standards, fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. The accounting standards describe a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

Level 1 - Quoted prices in active markets for identical assets or liabilities.

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted   prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

We have determined that there are no Level 1 inputs for determining the fair value of the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note, the Equipment Notes or the redeemable portion of the Series A-12. However, we have determined that the fair value of the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note, the Equipment Notes and the redeemable portion of the Series A-12 may be determined using Level 2 inputs, as follows: the fair market value interest rate paid by us under our line of credit arrangement (the “Line”) as discussed in note 4 and the value of conversion rights contained in those arrangements, based on the relevant aspects of the same Black Scholes valuation model used by us to value our options and warrants. We have also determined that the fair value of the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note, the Equipment Notes and the redeemable portion of the Series A-12 may be determined using Level 3 inputs, as follows: third party studies arriving at recommended discount factors for valuing payments made in unregistered restricted stock instead of cash.
 
Based on the use of the inputs described above, we have determined that there was no material difference between the carrying value and the fair value of the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note, the Equipment Notes and the redeemable portion of the Series A-12 as of October 1, 2008, March 31, 2009, September 30, 2009, or March 31, 2010 (to the extent each of those liabilities were outstanding on each of those dates) and therefore no adjustment with respect to fair value was made to our financial statements as of those dates or for the six and three months ended March 31, 2010 and 2009, respectively.
 
 
13

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Property and Equipment

Property and equipment are recorded at cost, less accumulated depreciation.  Property and equipment under capital leases are stated at the lower of the present value of the minimum lease payments at the beginning of the lease term or the fair value at the inception of the lease. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization expense on assets acquired under capital leases is included in depreciation expense. The costs of leasehold improvements are amortized over the lesser of the lease term or the life of the improvement.

Software

Included in property and equipment is computer software developed for internal use, including the Digital Media Services Platform (“DMSP”), the iEncode webcasting software and the MarketPlace365 (“MP365”) platform – see notes 2 and 3.  Such amounts have been accounted for in accordance with the Intangibles – Goodwill and Other topic of the ASC and are amortized on a straight-line basis over three to five years, commencing when the related asset (or major upgrade release thereof) has been substantially placed in service.

Goodwill and other intangible assets

In accordance with the Intangibles – Goodwill and Other topic of the ASC, goodwill is reviewed annually (or more frequently if impairment indicators arise) for impairment. Other intangible assets, such as customer lists, are amortized to expense over their estimated useful lives, although they are still subject to review and adjustment for impairment.

We review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We assess the recoverability of such assets by comparing the estimated undiscounted cash flows associated with the related asset or group of assets against their respective carrying amounts. The impairment amount, if any, is calculated based on the excess of the carrying amount over the fair value of those assets.

We follow a two step process for impairment testing of goodwill. The first step of this test, used to identify potential impairment and described above, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment, including a comparison and reconciliation of the carrying value of all of our reporting units to our market capitalization, after appropriate adjustments for control premium and other considerations. See note 2 – Goodwill and other Acquisition-Related Intangible Assets.
 
 
14

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition

Revenues from sales of goods and services are recognized when (i) persuasive evidence of an arrangement between us and the customer exists, (ii) the good or service has been provided to the customer, (iii) the price to the customer is fixed or determinable and (iv) collectibility of the sales price is reasonably assured.

The Webcasting division of the Digital Media Services Group recognizes revenue from live and on-demand webcasts at the time an event is accessible for streaming over the Internet.  Webcasting services are provided to customers using our proprietary streaming media software, tools and processes. Customer billings are typically based on (i) the volume of data streamed at rates agreed upon in the customer contract or (ii) a set monthly fee. Since the primary deliverable for the webcasting group is a webcast, returns are inapplicable.  If we have difficulty in producing the webcast, we may reduce the fee charged to the customer.  Historically these reductions have been immaterial, and are recorded in the month the event occurs.

Services for live webcast events are usually sold for a single price that includes on-demand webcasting services in which we host an archive of the webcast event for future access on an on-demand basis for periods ranging from one month to one year. However, on-demand webcasting services are sometimes sold separately without the live event component and we have referred to these separately billed transactions as verifiable and objective evidence of the amount of our revenues related to on-demand services.  In addition, we have determined that the material portion of all views of archived webcasts take place within the first ten days after the live webcast.

Based on our review of the above data, we have determined that the material portion of our revenues for on-demand webcasting services are recognized during the period in which those services are provided, which complies with the provisions of the Revenue Recognition topic of the ASC. Furthermore, we have determined that the maximum potentially deferrable revenue from on-demand webcasting services charged for but not provided as of March 31, 2010 and September 30, 2009 was immaterial in relation to our recorded liabilities at those dates.

We include the DMSP and UGC divisions’ revenues, along with the Smart Encoding division’s revenues from hosting, storage and streaming, in the DMSP and hosting revenue caption. We include the EDNet division’s revenues from equipment sales and rentals and the Smart Encoding division’s revenues from encoding and editorial services in the Other Revenue caption.

The DMSP, UGC and Smart Encoding divisions of the Digital Media Services Group recognize revenues from the acquisition, editing, transcoding, indexing, storage and distribution of their customers’ digital media. Charges to customers by these divisions generally include a monthly subscription or hosting fee. Additional charges based on the activity or volumes of media processed, streamed or stored by us, expressed in megabytes or similar terms, are recognized at the time the service is performed. Fees charged for customized applications or set-up are recognized as revenue at the time the application or set-up is completed.
 
 
15

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition (continued)

The Infinite division of the Audio and Web Conferencing Services Group generates revenues from audio conferencing and web conferencing services, plus recording and other ancillary services.  Infinite owns telephone switches used for audio conference calls by its customers, which are generally charged for those calls based on a per-minute usage rate. Infinite provides online webconferencing services to its customers, charging either a per-minute rate or a monthly subscription fee allowing a certain level of usage. Audio conferencing and web conferencing revenue is recognized based on the timing of the customer’s use of those services.

The EDNet division of the Audio and Web Conferencing Services Group generates revenues from customer usage of digital telephone connections controlled by EDNet, as well as bridging services and the sale and rental of equipment.  EDNet purchases digital phone lines from telephone companies (and resellers) and sells access to the lines, as well as separate per-minute usage charges. Network usage and bridging revenue is recognized based on the timing of the customer’s use of those services.

EDNet sells various audio codecs and video transport systems, equipment which enables its customers to collaborate with other companies or with other locations.  As such, revenue is recognized for the sale of equipment when the equipment is installed or upon signing of a contract after the equipment is installed and successfully operating.  All sales are final and there are no refund rights or rights of return. EDNet leases some equipment to customers under terms that are accounted for as operating leases.  Rental revenue from leases is recognized ratably over the life of the lease and the related equipment is depreciated over its estimated useful life.  All leases of the related equipment contain fixed terms.

Deferred revenue represents amounts billed to customers for webcasting, EDNet, smart encoding or DMSP services to be provided in future accounting periods.  As projects or events are completed and/or the services provided, the revenue is recognized.

Comprehensive Income or Loss

We have recognized no transactions generating comprehensive income or loss that are not included in our net loss, and accordingly, net loss equals comprehensive loss for all periods presented.

Advertising and marketing

Advertising and marketing costs, which are charged to operations as incurred and included in Professional Fees and Other General and Administrative Operating Expenses, were approximately $148,000 and $169,000 for the six months ended March 31, 2010 and 2009, and approximately $84,000 and $65,000 for the three months ended March 31, 2010 and 2009, respectively.
 
 
16

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes

Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against those deferred tax assets. We had a deferred tax asset of approximately $34.6 million as of March 31, 2010, primarily resulting from net operating loss carryforwards. A full valuation allowance has been recorded related to the deferred tax asset due to the uncertainty of realizing the benefits of certain net operating loss carryforwards before they expire. Our management will continue to assess the likelihood that the deferred tax asset will be realizable and the valuation allowance will be adjusted accordingly.

Accordingly, no income tax benefit was recorded in our consolidated statement of operations as a result of the net tax losses for the six and three months ended March 31, 2010 and 2009.  The primary differences between the net loss for book and the net loss for tax purposes are the following items expensed for book purposes but not deductible for tax purposes – amortization of certain loan discounts, amortization and/or impairment adjustments of certain acquired intangible assets, and expenses for stock options and shares issued in payment for consultant and employee services but not exercised by the recipients, or in the case of shares, not registered for or eligible for resale.

The Income Taxes topic of the ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. However, as of March 31, 2010 or September 30, 2009, we have not taken, nor recognized the financial statement impact of, any material tax positions, as defined above. Our policy is to recognize, as non-operating expense, interest or penalties related to income tax matters at the time such payments become probable, although we had not recognized any such material items in our statement of operations for the six and three months ended March 31, 2010 and 2009. The tax years ending September 30, 2006 and thereafter remain subject to examination by Federal and various state tax jurisdictions.

Compensation and related expenses
 
Compensation costs for employees considered to be direct labor are included as part of webcasting and smart encoding costs of revenue. Certain compensation costs for employees involved in development of software for internal use, as discussed under Software above, are capitalized. Accrued liabilities and amounts due to directors and officers includes, in aggregate, approximately $687,000 and $661,000 as of March 31, 2010 and September 30, 2009, respectively, related to salaries, commissions, taxes, vacation and other benefits earned but not paid as of those dates.
 
 
17

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Equity Compensation to Employees and Consultants

We have a stock based compensation plan (the “2007 Plan”) for our employees. The Compensation – Stock Compensation topic of the ASC requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value, which we adopted as of October 1, 2006 (the required date) and first applied during the year ended September 30, 2007, using the modified-prospective-transition method. Under this method, compensation cost recognized for the six and three months ended March 31, 2010 and 2009 includes compensation cost for all share-based payments granted subsequent to September 30, 2006, calculated using the Black-Scholes model, based on the estimated grant-date fair value and allocated over the applicable vesting and/or service period. As of October 1, 2006, there were no outstanding share-based payments granted prior to that date, but not yet vested. There were no 2007 Plan options granted during the three months ended March 31, 2010. For 2007 Plan options that were granted and thus valued under the Black-Scholes model during the three months ended December 31, 2009, the expected volatility rate was 88%, the risk-free interest rate was 2.5%, expected dividends were $0 and the expected term was 5 years, the full term of the related options. There were no 2007 Plan options granted during the six months ended March 31, 2009.

We have granted Non-Plan Options to consultants and other third parties. These options have been accounted for under the Equity topic (Equity-Based Payments to Non-Employees subtopic) of the ASC, under which the fair value of the options at the time of their issuance, calculated using the Black-Scholes model, is reflected as a prepaid expense in our consolidated balance sheet at that time and expensed as professional fees during the time the services contemplated by the options are provided to us. There were no Non-Plan options granted during the three months ended March 31, 2010. For Non-Plan options that were granted and thus valued under the Black-Scholes model during the three months ended December 31, 2009, the expected volatility rate was 91 to 99%, the risk-free interest rate was 1.9 to 2.6%, expected dividends were $0 and the expected term was 4 to 5 years, the full term of the related options. There were no Non-Plan options granted during the six months ended March 31, 2009.

See Note 8 for additional information related to all stock option issuances.

Net Loss Per Share

For the six and three months ended March 31, 2010 and 2009, net loss per share is based on the net loss divided by the weighted average number of shares of common stock outstanding – see discussion of reverse stock split above.  Since the effect of common stock equivalents was anti-dilutive, all such equivalents were excluded from the calculation of weighted average shares outstanding. The total outstanding options and warrants, which have been excluded from the calculation of weighted average shares outstanding, were 2,043,398 and 2,534,753 at March 31, 2010 and 2009, respectively.

 
18

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Net Loss Per Share (continued)

In addition, the potential dilutive effects of the following convertible securities outstanding at March 31, 2010 have been excluded from the calculation of weighted average shares outstanding: (i) 35,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”) which could potentially convert into 116,667 shares of ONSM common stock, (ii) $1,000,000 of convertible notes which in aggregate could potentially convert into up to 208,333 shares of our common stock (excluding interest), (iii) 366,667 restricted shares of our common stock for the origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us, (iv) the $500,000 convertible portion of the Rockridge Note which could potentially convert into up to 208,333 shares of our common stock, (v) the $200,000 CCJ Note, which could potentially convert into up to 66,667 shares of our common stock, (vi) the $237,000 remaining outstanding balance of the Greenberg Note, which could potentially convert into up to 98,750 shares of our common stock, and (vii) the $500,000 outstanding balance of the Wilmington Notes, which could potentially convert into up to 179,272 shares of our common stock.

Furthermore, if we sell all or substantially all of our assets prior to the repayment of the Rockridge Note, the remaining outstanding principal amount of the Rockridge Note may be converted into restricted shares of our common stock, which would have been 502,563 shares as of March 31, 2010 (in addition to the 208,333 shares noted above).

The potential dilutive effects of the following convertible securities previously outstanding at March 31, 2009 were excluded from the calculation of weighted average shares outstanding: (i) 80,000 shares of Series A-12 Redeemable Convertible Preferred Stock (“Series A-12”) which could have potentially converted into 133,333 shares of our common stock and (ii) $1,000,000 of convertible notes which in aggregate could have potentially converted into up to 208,333 shares of our common stock (excluding interest).

Accounting Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires our management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates are used when accounting for allowances for doubtful accounts, revenue reserves, inventory reserves, depreciation and amortization lives and methods, income taxes and related reserves, contingencies and goodwill and other impairment allowances. Such estimates are reviewed on an on-going basis and actual results could be materially affected by those estimates.

Reclassifications
 
Certain prior year amounts have been reclassified to conform to the current year presentation, including inventories and other current asset balance sheet groupings, property and equipment footnote category classifications and classifications between accounts payable, accrued liabilities and amounts due to directors and officers. Also see discussion of reverse stock split above.
 
 
19

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Interim Financial Data

In the opinion of our management, the accompanying unaudited interim financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission. These interim financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements and should be read in conjunction with our annual financial statements as of September 30, 2009. These interim financial statements have not been audited. However, our management believes the accompanying unaudited interim financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary to present fairly our consolidated financial position as of March 31, 2010, the results of our operations for the six and three months ended March 31, 2010 and 2009 and our cash flows for the six months ended March 31, 2010 and 2009. The results of operations and cash flows for the interim period are not necessarily indicative of the results of operations or cash flows that can be expected for the year ending September 30, 2010.

Effects of Recent Accounting Pronouncements

The Fair Value Measurements and Disclosures topic of the ASC includes certain concepts first set forth in September 2006, which define the use of fair value measures in financial statements, establish a framework for measuring fair value and expand disclosure related to the use of fair value measures. In February 2008, the FASB provided a one-year deferral of the effective date of those concepts for non-financial assets and non-financial liabilities, except those that are recognized or disclosed in the financial statements at fair value at least annually. The application of these concepts was effective for our fiscal year beginning October 1, 2008, excluding the effect of the one-year deferral noted above. See “Fair Value Measurements” above. We adopted these concepts with respect to our non-financial assets and non-financial liabilities that are not measured at fair value at least annually, effective October 1, 2009. The adoption of these concepts did not have a material impact on our financial position, results of operations or cash flows.

The Financial Instruments topic of the ASC includes certain concepts first set forth in February 2007, under which we may elect to report most financial instruments and certain other items at fair value on an instrument-by-instrument basis with changes in fair value reported in earnings. After the initial adoption, the election is made at the acquisition of an eligible financial asset, financial liability, or firm commitment or when certain specified reconsideration events occur. The fair value election may not be revoked once an election is made. The application of these concepts was effective for our fiscal year beginning October 1, 2008 – however, we have elected not to measure eligible financial assets and liabilities at fair value. Accordingly, the adoption of these concepts did not have a material impact on our financial position, results of operations or cash flows.

The Business Combinations topic of the ASC establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in an acquiree, including the recognition and measurement of goodwill acquired in a business combination.  Certain provisions of this guidance were first effective for our fiscal year beginning October 1, 2009. Had these provisions been in effect prior to that date, the $540,007 currently reflected as a write off of those costs for the six and three months ended March 31, 2009 would have been replaced by an expense of $121,948 and $77,917, respectively, the amount of such costs incurred during each of those periods.

 
20

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Effects of Recent Accounting Pronouncements (continued)

The Intangibles – Goodwill and Other topic of the ASC states the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset, which requirements were effective for our fiscal year beginning October 1, 2009. The objective of these requirements is to improve the consistency between the useful life of a recognized intangible asset under the Intangibles – Goodwill and Other topic of the ASC and the period of expected cash flows used to measure the fair value of the asset under the Business Combinations topic of the ASC. These requirements apply to all intangible assets, whether acquired in a business combination or otherwise, and will be applied prospectively to intangible assets acquired after the effective date.

The Debt topic of the ASC specifies that issuers of convertible debt instruments that may be settled in cash upon conversion (including partial cash settlement) should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. These requirements were effective for our fiscal year beginning October 1, 2009, although they did not have a material impact on our financial position, results of operations or cash flows.

In October 2009, the Financial Accounting Standards Board (“FASB”) issued ASC update number 2009-14 -Software (Topic 985): Certain Revenue Arrangements That Include Software Elements (“Update 2009-14”) and ASC update number 2009-13 - Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements (“Update 2009-13”). As summarized in Update 2009-14, ASC Topic 985 has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. As summarized in Update 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. These requirements will be effective for our fiscal year ended September 30, 2011 with early adoption permitted. Adoption may either be on a prospective basis or by retrospective application. We are currently assessing the impact of these requirements and at this time we are unable to quantify their impact on our financial statements or to determine the timing and/or method of their adoption.
 
In January 2010, the FASB issued ASC update number 2010-06 - Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements (“Update 2010-06”). Update 2010-06 requires new and revised disclosures for recurring or non-recurring fair value measurements, specifically related to significant transfers into and out of Levels 1 and 2, and for purchases, sales, issuances, and settlements in the rollforward of activity for Level 3 fair value measurements. Update 2010-06 also clarifies existing disclosures related to the level of disaggregation and the inputs and valuation techniques used for fair value measurements. The new disclosures and clarifications of existing disclosures about fair value measurements were effective January 1, 2010. However, the disclosures about purchases, sales, issuances, and settlements in the rollforward of activity for Level 3 fair value measurements are not effective until our fiscal year ended September 30, 2012. Our adoption of Update 2010-06 did not, and is not expected to, have a material impact on our financial position, results of operations or cash flows.
 
 
21

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Effects of Recent Accounting Pronouncements (continued)

In February 2010, the FASB issued ASC update number 2010-09, which amended ASC Topic 855 (Subsequent Events), effective upon issuance, to remove the requirement that an SEC filer disclose the date through which subsequent events have been evaluated. Our adoption of this guidance was limited to the form and content of disclosures and did not have a material impact on our consolidated financial statements.

NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

Information regarding the Company’s goodwill and other acquisition-related intangible assets is as follows:
   
March 31, 2010
   
September 30, 2009
 
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Book
Value
   
Gross
Carrying
Amount
   
Accumulated
Amortization
   
Net Book
Value
 
Goodwill:
                                   
Infinite Conferencing
  $ 8,600,887     $ -     $ 8,600,887     $ 11,100,887     $ -     $ 11,100,887  
Acquired Onstream
    4,121,401       -       4,121,401       4,121,401       -       4,121,401  
EDNet
    1,271,444       -       1,271,444       1,271,444       -       1,271,444  
Auction Video
    3,216       -       3,216       3,216       -       3,216  
Total goodwill
    13,996,948       -       13,996,948       16,496,948       -       16,496,948  
                                                 
Acquisition-related intangible assets:
                                               
Infinite  Conferencing  -  customer lists,  trademarks,   URLs, supplier terms and  Consulting/non- competes
    3,783,604       ( 2,390,082 )     1,393,522       4,383,604       ( 2,061,105 )     2,322,499  
Auction Video - customer  lists, patent pending  and  consulting/non- competes
    1,117,643       ( 965,230 )     152,413       1,110,671       ( 934,020 )     176,651  
Total intangible assets
    4,901,247       ( 3,355,312 )     1,545,935       5,494,275       ( 2,995,125 )     2,499,150  
                                                 
Total goodwill and other acquisition-related intangible assets
  $ 18,898,195     $ (3,355,312 )   $ 15,542,883     $ 21,991,223     $ (2,995,125 )   $ 18,996,098  

Infinite Conferencing – April 27, 2007

On April 27, 2007 we completed the acquisition of Infinite Conferencing LLC (“Infinite”), a Georgia limited liability company. The transaction, by which we acquired 100% of the membership interests of Infinite, was structured as a merger by and between Infinite and our wholly-owned subsidiary, Infinite Conferencing, Inc. (the “Infinite Merger”). The primary assets acquired, in addition to Infinite’s ongoing audio and web conferencing operations, were accounts receivable, equipment, internally developed software, customer lists, trademarks, URLs (internet domain names), favorable supplier terms and employment and non-compete agreements. The consideration for the Infinite Merger was a combination of $14 million in cash and restricted shares of our common stock valued at approximately $4.0 million, for an aggregate purchase price of approximately $18.2 million, including transaction costs.

 
22

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010

NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)

Infinite Conferencing – April 27, 2007 (continued)

The fair value of certain intangible assets (internally developed software, customer lists, trademarks, URLs (internet domain names), favorable contractual terms and employment and non-compete agreements) acquired as part of the Infinite Merger was determined by our management at the time of the merger. This fair value was primarily based on the discounted projected cash flows related to these assets for the next three to six years immediately following the merger on a stand-alone basis without regard to the Infinite Merger, as projected by our management and Infinite’s management. The discount rate utilized considered equity risk factors (including small stock risk) as well as risks associated with profitability and working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining. We are amortizing these assets over useful lives ranging from 3 to 6 years.

The approximately $18.2 million purchase price exceeded the fair values we assigned to Infinite’s tangible and intangible assets (net of liabilities at fair value) by approximately $12.0 million, which we recorded as goodwill as of the purchase date. As discussed in “Testing for Impairment” below, this initially recorded goodwill was determined to be impaired as of December 31, 2008 and a $900,000 adjustment was made to reduce its carrying value to approximately $11.1 million as of that date.  A similar adjustment of $200,000 was made as of that date to reduce the carrying value of certain intangible assets acquired as part of the Infinite Merger. These adjustments, totaling $1.1 million, were included in the aggregate $5.5 million charge for impairment of goodwill and other intangible assets as reflected in our results of operations for the six months ended March 31, 2009. Furthermore, the Infinite goodwill was determined to be further impaired as of December 31, 2009 and a $2.5 million adjustment was made to reduce the carrying value of that goodwill to approximately $8.6 million as of that date. A similar adjustment of $600,000 was made as of that date to reduce the carrying value of certain intangible assets acquired as part of the Infinite Merger. These adjustments, totaling $3.1 million, were reflected in our results of operations for the six months ended March 31, 2010, as a charge for impairment of goodwill and other intangible assets.

Auction Video – March 27, 2007

On March 27, 2007 we completed the acquisition of the assets, technology and patents pending of privately owned Auction Video, Inc., a Utah corporation, and Auction Video Japan, Inc., a Tokyo-Japan corporation (collectively, “Auction Video”). The Auction Video, Inc. transaction was structured as a purchase of assets and the assumption of certain identified liabilities by our wholly-owned U.S. subsidiary, AV Acquisition, Inc. The Auction Video Japan, Inc. transaction was structured as a purchase of 100% of the issued and outstanding capital stock of Auction Video Japan, Inc. The acquisitions were made with a combination of restricted shares of our common stock valued at approximately $1.5 million issued to the stockholders of Auction Video Japan, Inc. and $500,000 cash paid to certain stockholders and creditors of Auction Video, Inc., for an aggregate purchase price of approximately $2.0 million, including transaction costs.
 
 
23

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)

Auction Video – March 27, 2007 (continued)

We allocated the Auction Video purchase price to the identifiable tangible and intangible assets acquired, based on a determination of their reasonable fair value as of the date of the acquisition. The technology and patent pending related to the video ingestion and flash transcoder, the Auction Video customer lists and the consulting and non-compete agreements entered into with the former executives and owners of Auction Video were valued in aggregate at $1,150,000 and are being amortized over various lives between two to five years commencing April 2007. $600,000 was assigned as the value of the video ingestion and flash transcoder, which was already integrated into our DMSP as of the date of the acquisition and was added to that asset’s carrying cost for financial statement purposes, with depreciation over a three-year life commencing April 2007 – see note 3. Future cost savings for Auction Video services to be provided to our customers existing prior to the acquisition were valued at $250,000 and were amortized to cost of sales over a two-year period commencing April 2007.

Subsequent to the Auction Video acquisition, we began pursuing the final approval of the patent pending application and in March 2008 retained the law firm of Hunton & Williams to assist in expediting the patent approval process and to help protect rights related to our UGV (User Generated Video) technology. In April 2008, we revised the original patent application primarily for the purpose of splitting it into two separate applications, which, while related, were being evaluated separately by the U.S. Patent Office (“USPO”). With respect to the claims pending in the first of the two applications, the USPO issued non-final rejections in August 2008, February 2009 and May 2009, as well as a final rejection in January 2010. On April 21, 2010 we filed a written response to this final rejection with the USPO, along with a "Request for Continued Examination”. Regardless of the ultimate outcome of this matter, our management has determined that an adverse decision with respect to this patent application would not have a material adverse effect on our financial position or results of operations. The USPO has taken no formal action with regard to the second of the two applications. Certain of the former owners of Auction Video, Inc. have an interest in proceeds that we may receive under certain circumstances in connection with these patents.

On December 5, 2008 we entered into an agreement whereby one of the former owners of Auction Video Japan, Inc. agreed to shut down the Japan office of Auction Video as well as assume all of our outstanding assets and liabilities connected with that operation, in exchange for non-exclusive rights to sell our products in Japan and be compensated on a commission-only basis. As a result, we recognized other income of approximately $45,000 for the six months ended March 31, 2009, which is the difference between the assumed liabilities of approximately $84,000 and the assumed assets of approximately $39,000. It is the opinion of our management that any further developments with respect to this shut down or the above agreement will not have a material adverse effect on our financial position or results of operations.

As discussed in “Testing for Impairment” below, the carrying value of the initially recorded identifiable intangible assets acquired as part of the Auction Video Acquisition were determined to be impaired as of December 31, 2008 and an adjustment was made to reduce the net carrying value of those intangible assets by $100,000.  This $100,000 adjustment was included in the aggregate $5.5 million charge for impairment of goodwill and other intangible assets as reflected in our results of operations for the six months ended March 31, 2009.
 
 
24

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)

Acquired Onstream – December 23, 2004

On December 23, 2004, privately held Onstream Media Corporation (“Acquired Onstream”) was merged with and into our wholly owned subsidiary OSM Acquisition, Inc. (the “Onstream Merger”). At that time, all outstanding shares of Acquired Onstream capital stock and options not already owned by us (representing 74% ownership interest) were converted into restricted shares of our common stock plus options and warrants to purchase our common stock. We also issued common stock options to directors and management as additional compensation at the time of and for the Onstream Merger, accounted for at the time in accordance with Accounting Principles Board Opinion 25 (which accounting pronouncement has since been superseded by the ASC).

Acquired Onstream was a development stage company founded in 2001 that began working on a feature rich digital asset management service offered on an application service provider (“ASP”) basis, to allow corporations to better manage their digital rich media without the major capital expense for the hardware, software and additional staff necessary to build their own digital asset management solution. This service was intended to be offered via the Digital Media Services Platform (“DMSP”), which was initially designed and managed by Science Applications International Corporation (“SAIC”), one of the country's foremost IT security firms, providing services to all branches of the federal government as well as leading corporations.

The primary asset acquired in the Onstream Merger was the partially completed DMSP, recorded at fair value as of the December 23, 2004 closing, in accordance with the Business Combinations topic of the ASC. The fair value was primarily based on the discounted projected cash flows related to this asset for the five years immediately following the acquisition on a stand-alone basis without regard to the Onstream Merger, as projected at the time of the acquisition by our management and Acquired Onstream’s management. The discount rate utilized considered equity risk factors (including small stock risk and bridge/IPO stage risk) plus risks associated with profitability/working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining.

The approximately $10.0 million purchase price we paid for 100% of Acquired Onstream exceeded the fair values we assigned to Acquired Onstream’s tangible and intangible assets (net of liabilities at fair value) by approximately $8.4 million, which we recorded as goodwill as of the purchase date. As discussed in “Testing for Impairment” below, this initially recorded goodwill was determined to be impaired as of December 31, 2008 and a $4.3 million adjustment was made to reduce the carrying value of that goodwill to approximately $4.1 million as of that date.  This adjustment was included in the aggregate $5.5 million charge for impairment of goodwill and other intangible assets as reflected in our results of operations for the six months ended March 31, 2009.

 
25

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)

Testing for Impairment

The Intangibles – Goodwill and Other topic of the ASC, which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, requires that goodwill be tested for impairment on a periodic basis. Although other intangible assets are being amortized to expense over their estimated useful lives, the unamortized balances are still subject to review and adjustment for impairment.

There is a two step process for impairment testing of goodwill. The first step of this test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment. We performed impairment tests on Infinite, EDNet and Acquired Onstream as of December 31, 2008. We assessed the fair value of the net assets of these reporting units by considering the projected cash flows and by analysis of comparable companies, including such factors as the relationship of the comparable companies’ revenues to their respective market values.  Based on these factors, we concluded that there was no impairment of the assets of EDNet as of that date. Although the first step of the two step testing process of the assets of Acquired Onstream and Infinite preliminarily indicated that the fair value of those intangible assets exceeded their recorded carrying value as of December 31, 2008, it was noted that as a result of the then recent substantial volatility in the capital markets, the price of our common stock and our market value had decreased significantly and as of December 31, 2008, our market capitalization, after appropriate adjustments for control premium and other considerations, was determined to be less than our net book value (i.e., stockholders’ equity as reflected in our financial statements). Based on this condition, and in accordance with the provisions of the Intangibles – Goodwill and Other topic of the ASC, we recorded a non-cash expense, for the impairment of our goodwill and other intangible assets, of $5.5 million for the six months ended March 31, 2009. As discussed above, this $5.5 million adjustment was determined to relate to $1.1 million of goodwill and intangible assets of Infinite, $100,000 of intangible assets of Auction Video and $4.3 million of goodwill of Acquired Onstream.

We also performed impairment tests on Infinite, EDNet and Acquired Onstream as of December 31, 2009, using the same methodologies discussed above.  Based on these factors, we concluded that there was no impairment of the assets of Acquired Onstream or EDNet as of that date. However, we determined that Infinite’s goodwill and certain of its intangible assets were impaired as of that date and based on that condition, and as discussed above, in accordance with the provisions of the Intangibles – Goodwill and Other topic of the ASC, we recorded a non-cash expense, for the impairment of our goodwill and other intangible assets, of $3.1 million for the six months ended March 31, 2010.

Although we determined that our market value (after certain adjustments as discussed above) exceeded our net book value as of December 31, 2009, if the price of our common stock and our market value were to decline, such condition could result in future non-cash impairment charges to our results of operations related to our goodwill and other intangible assets arising from our next scheduled recurring annual impairment review, which will be as of December 31, 2010.
 
 
26

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued)

Testing for Impairment (continued)

The valuations of Infinite, EDNet and Acquired Onstream incorporate our management’s estimates of future sales and operating income, which estimates in the cases of Infinite and Acquired Onstream are dependent on products (audio and web conferencing and the DMSP, respectively) from which significant sales increases may be required to support that valuation. Furthermore, even if our market value continues to exceed our net book value, annual reviews for impairment in future periods may result in future periodic write-downs.  Tests for impairment between annual tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of the net carrying amount.
 
NOTE 3:  PROPERTY AND EQUIPMENT

Property and equipment, including equipment acquired under capital leases, consists of:

   
March 31, 2010
   
September 30, 2009
       
   
 
Historical
Cost
   
Accumulated Depreciation
and
Amortization
   
 
Net Book
Value
   
 
Historical
Cost
   
Accumulated Depreciation
and
Amortization
   
 
Net Book
Value
   
Useful
Lives
(Yrs)
 
Equipment and software
  $ 10,553,293     $ (9,493,389 )   $ 1,059,904     $ 10,442,539     $ (9,079,681 )   $ 1,362,858       1-5  
DMSP
    5,854,460       (5,008,258 )     846,202       5,719,979       (4,791,517 )     928,462       3-5  
Travel video library
     1,368,112       (1,368,112 )     -        1,368,112       (1,368,112 )     -       N/A  
Other capitalized internal use software
       1,474,138       (517,739 )       956,399          1,215,401       (448,218 )       767,183         3-5  
Furniture, fixtures and leasehold improvements
    510,334       (461,458 )          48,876            475,857       (451,264 )          24,593           2-7  
Totals
  $ 19,760,337     $ (16,848,956 )   $ 2,911,381     $ 19,221,888     $ (16,138,792 )   $ 3,083,096          
 
Depreciation and amortization expense for property and equipment was approximately (i) $756,000 and $1,446,000 for the six months ended March 31, 2010 and 2009, respectively, and (ii) $391,000 and $704,000 for the three months ended March 31, 2010 and 2009, respectively.

As part of the Onstream Merger (see note 2), we became obligated under a contract with SAIC, under which SAIC would build a platform that eventually, albeit after further extensive design and re-engineering by us, led to the DMSP. This platform was the primary asset included in our purchase of Acquired Onstream. The SAIC contract terminated by mutual agreement of the parties on June 30, 2008. Although cancellation of the contract releases SAIC to offer what is identified as the “Onstream Media Solution” directly or indirectly to third parties, we do not expect this right to result in a material adverse impact on future DMSP sales.

 
27

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 3:  PROPERTY AND EQUIPMENT (Continued)
 
The DMSP is comprised of four separate “products”- transcoding, storage, search/retrieval and distribution. A limited version of the DMSP, with three of the four products, was first placed in service in November 2005.  “Store and Stream” was the first version of the DMSP sold to the general public, starting in October 2006. In connection with the development of “Streaming Publisher”, a second version of the DMSP with additional functionality, we have capitalized as part of the DMSP approximately $740,000 of employee compensation, payments to contract programmers and related costs as of March 31, 2010, including $132,000 capitalized during the six months ended March 31, 2010, $422,000 during the year ended September 30, 2009 and $186,000 during the year ended September 30, 2008. As of March 31, 2010, approximately $449,000 of these costs had been placed in service and are being depreciated primarily over five years. The remainder of the costs not in service relate primarily to new versions and/or releases of the DMSP under development. Although Streaming Publisher is a stand-alone product, it is based on a different architecture than “Store and Stream” and is a primary building block of the MP365 platform, discussed below.
 
On March 27, 2007 we completed the acquisition of Auction Video – see note 2. The assets acquired included a video ingestion and flash transcoder, which was already integrated into the DMSP as of the date of the acquisition. Based on our determination of the fair value of that transcoder at the date of the acquisition, $600,000 was added to the DMSP’s carrying cost, which additional cost is being depreciated over a three-year life commencing April 2007.

On March 31, 2008 we agreed to pay $300,000 for a perpetual license for certain digital asset management software, which we currently utilize to provide our automatic meta-tagging services, in addition to and in accordance with a limited term license that we purchased in 2007 for $281,250 - see note 5 for additional terms of this perpetual license and possible limits on its future use. At the time of this purchase, in addition to continuing to use this software to provide our automatic meta-tagging services, we expanded our use of this software in providing our core DMSP services. Therefore,  we recorded a portion of this purchase, plus a portion of the remaining unamortized 2007 purchase amount, as an aggregate $243,750 increase in the DMSP’s carrying cost, such additional cost being depreciated over five years commencing April 2008.

Other capitalized internal use software as of March 31, 2010 includes approximately $615,000 of employee compensation and other costs related to the development of iEncode software, which runs on a self-administered, webcasting appliance that can be used anywhere to produce a live video webcast. $114,000 was capitalized during the six months ended March 31, 2010, $288,000 during the year ended September 30, 2009 and $213,000 during the year ended September 30, 2008. As of March 31, 2010, $564,000 of these costs had been placed in service and are being depreciated over a five-year life, with depreciation commencing on $509,000 of these costs during the six and three months ended December 31, 2009.

Other capitalized internal use software as of March 31, 2010 includes approximately $300,000 of employee compensation and payments to contract programmers related to the development of the MP365 platform, which will enable the creation of on-line virtual marketplaces and trade shows utilizing many of our other technologies such as DMSP, webcasting, UGC and conferencing. $144,000 was capitalized during the six months ended March 31, 2010 and $156,000 during the year ended September 30, 2009. This excludes related costs for the development of Streaming Publisher, as discussed above.

 
28

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT

Debt includes convertible debentures, notes payable and capitalized lease obligations.

Convertible Debentures

Convertible debentures consist of the following as of March 31, 2010 and September 30, 2009, respectively:

   
March 31,
 2010
   
September 30,
2009
 
Equipment Notes
  $ 1,000,000     $ 1,000,000  
CCJ Note
    200,000       -  
Greenberg Note
    237,000       -  
Wilmington Notes
    500,000       -  
Rockridge Note (excluding portion classified under notes payable)
    500,000       375,000  
Total convertible debentures
    2,437,000       1,375,000  
Less: discount on convertible debentures
    (577,764 )     (265,417 )
Convertible debentures, net of discount
    1,859,236       1,109,583  
Less: current portion, net of discount
    ( 541,651 )     -  
Convertible debentures, net of current portion
  $ 1,317,585     $ 1,109,583  
 
Equipment Notes
 
During the period from June 3, 2008 through July 8, 2008 we received an aggregate of $1.0 million from seven accredited individuals and other entities (the “Investors”), under a software and equipment financing arrangement. This included $50,000 received from CCJ Trust (“CCJ”). CCJ is a trust for the adult children of Mr. Charles Johnston, one of our directors, and he disclaims any beneficial ownership interest in CCJ.

We issued notes to those Investors (the “Equipment Notes”), which are collateralized by specifically designated software and equipment owned by us with a cost basis of approximately $1.5 million, as well as a subordinated lien on certain other of our assets to the extent that the designated software and equipment, or other software and equipment added to the collateral at a later date, is not considered sufficient security for the loan. Under this arrangement, the Investors received 1,667 restricted ONSM common shares for each $100,000 lent to us, and also receive interest at 12% per annum. Interest is payable every 6 months in cash or, at our option, in restricted ONSM common shares, based on a conversion price equal to seventy-five percent (75%) of the average ONSM closing price for the thirty (30) trading days prior to the date the applicable payment is due. On November 11, 2008, we elected to issue 26,333 unregistered common shares to the Investors in lieu of $48,740 cash interest on these Equipment Notes for June 2008 through October 2008, which was recorded as interest expense of $69,520 on our books, based on the fair value of those shares on the issuance date. On May 21, 2009, we elected to issue 49,098 unregistered common shares to the Investors in lieu of $60,000 cash interest on these Equipment Notes for November 2008 through April 2009, which was recorded as interest expense of $67,756 on our books, based on the fair value of those shares on the issuance date. On November 11, 2009, we elected to issue 34,917 unregistered common shares to the Investors in lieu of $60,493 cash interest on these Equipment Notes for May 2009 through October 2009, which was recorded as interest expense of $77,515 on our books, based on the fair value of those shares on the issuance date. On April 30, 2010, we elected to issue 44,369 unregistered common shares to the Investors in lieu of $59,507 cash interest on these Equipment Notes for November 2009 through April 2010, which was recorded as interest expense of $92,288 on our books, based on the fair value of those shares on the issuance date. The next interest due date is October 31, 2010.
 
 
29

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes (continued)

We may prepay the Equipment Notes, which mature June 3, 2011, at any time upon ten (10) days' prior written notice to the Investors during which time any or all of the Investors may choose to convert the Equipment Notes held by them.  In the event of such repayment, all interest accrued and due for the remaining unexpired loan period is due and payable and may be paid in cash or restricted ONSM common shares in accordance with the above formula.

The outstanding principal is due on demand in the event a payment default is uncured ten (10) business days after written notice. Investors holding in excess of 50% of the outstanding principal amount of the Equipment Notes may declare a default and may take steps to amend or otherwise modify the terms of the Equipment Notes and related security agreement.

The Equipment Notes may be converted to restricted ONSM common shares at any time prior to their maturity date, at the Investors’ option, based on a conversion price equal to seventy-five percent (75%) of the average ONSM closing price for the thirty (30) trading days prior to the date of conversion, but in no event may the conversion price be less than $4.80 per share. In the event the Equipment Notes are converted prior to maturity, interest on the Equipment Notes for the remaining unexpired loan period will be due and payable in additional restricted ONSM common shares in accordance with the same formula for interest payments as described above.

Fees were paid to placement agents and finders for their services in connection with the Equipment Notes in aggregate of 16,875 restricted ONSM common shares and $31,500 paid in cash. These 16,875 shares, plus the 16,667 shares issued to the investors (as discussed above) had a fair market value of approximately $186,513. The value of these 33,542 shares, plus the $31,500 cash fees and $9,160 paid for legal fees and other issuance costs related to the Equipment Notes, were reflected as a $227,173 discount against the Equipment Notes and are being amortized as interest expense over the three year term of the Equipment Notes. The effective interest rate of the Equipment Notes is approximately 19.5% per annum, excluding the potential effect of a premium to market prices if payment of interest is made in common shares instead of cash. The unamortized portion of this discount was $93,875 and $130,607 at March 31, 2010 and September 30, 2009, respectively.

Although the minimum conversion price was established in the Equipment Notes at $4.80 per ONSM share, the quoted market price was approximately $5.58 per ONSM share at the time the material portion of the proceeds ($950,000 out of $1 million total) were received by us (including releases of funds previously placed in escrow) and the related Equipment Notes were issued (June 3-5, 2008). However, the quoted market price per ONSM share was $4.86 on April 30, 2008, $5.04 on May 20, 2008 and back to $4.80 by June 27, 2008, less than one month after the issuance of the related Equipment Notes. Therefore, we have determined that the $4.80 per share conversion price in the Equipment Notes was materially equivalent to fair value at the date of issuance, which was the intent of all parties when the deal was originally discussed between them in late April and early May 2008. Accordingly, we determined that there was not a beneficial conversion feature included in the Equipment Notes and did not record additional discount in that respect.
 
 
30

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

CCJ Note
 
During August 2009, CCJ Trust (“CCJ”) remitted $200,000 to us as a short term advance bearing interest at .022% per day (equivalent to approximately 8% per annum) until the date of repayment or unless the parties mutually agreed to another financing transaction(s) prior to repayment. This advance was included in accounts payable on our September 30, 2009 balance sheet.
 
On December 29, 2009, we entered into an agreement with CCJ whereby accrued interest on the above advance through that date of $5,808 was paid by us in cash and the $200,000 advance was converted to an unsecured subordinated note payable (the “CCJ Note”) at a rate of 8% interest per annum in equal monthly installments of principal and interest for 48 months plus a $100,000 principal balloon at maturity, although, with the consent of CCJ, no payments had been made as of May 7, 2010. The remaining principal balance of the CCJ Note may be converted at any time into our common shares at the greater of (i) the previous 30 day market value or (ii) $3.00 per share. In conjunction with and in consideration of this note transaction, the 35,000 shares of Series A-12 Redeemable Convertible Preferred Stock (“Series A-12”) held by CCJ at that date were exchanged for 35,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”) plus four-year warrants for the purchase of 29,167 ONSM common shares at $3.00 per share.
 
The effective interest rate of the CCJ Note is approximately 47.4% per annum, including the Black-Scholes value of the warrants of $32,518 plus the $108,500 value of the increased number of common shares underlying the Series A-13 shares versus the Series A-12 shares (see note 6), which total of $141,018 we recorded as a debt discount. The effective rate of 47.4% per annum also includes 11.2% per annum related to dividends that will accrue to CCJ as a result of the later mandatory conversion date of the Series A-13 shares versus the mandatory conversion date of the Series A-12 shares (see note 6). The unamortized portion of the debt discount, which is being amortized as interest expense over the four year term of the CCJ Note, was $132,204 at March 31, 2010.

Greenberg Note

On January 13, 2010 we borrowed $250,000 from Greenberg Capital (“Greenberg”) under the terms of an  unsecured subordinated convertible note (the “Greenberg Note”), which is repayable in principal installments of $13,000 per month beginning March 1, 2010, with the final payment on December 31, 2010, including remaining principal and all accrued but unpaid interest (at 10% per annum).  The Greenberg Note is convertible into common stock at Greenberg’s option at a price equal to 85% of the weighted average share price for the five days prior to conversion, such conversion price to be no less than $2.40 per share.

The Greenberg Note provides for (i) our issuance of 20,833 unregistered common shares upon receipt of the funds and our issuance of 20,833 unregistered common shares if the loan is still outstanding after 6 months (ii) our payment of $2,500 in legal fees incurred by Greenberg and (iii) the option to prepay up to $12,500 of interest in the form of shares, based on the weighted average share price for the five days prior, which we exercised by the issuance of 6,945 unregistered common shares.

 
31

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Greenberg Note (continued)

Furthermore, certain principals of Greenberg Capital are also principals in Triumph Small Cap Fund, which provided us with one of the Letters for $250,000, and required us to release Triumph Small Cap Fund from their commitment under that Letter as a condition of a February 2010 modification to the Greenberg Note. This modification also included Greenberg Capital’s agreement to allow up to $500,000 of subsequent subordinated financing to be issued on a pari passu basis with the Greenberg Note, which was applied to the Wilmington Notes as discussed below.
 
The value of the 27,778 shares initially issued to Greenberg for fees and prepaid interest and the value of the 4,167 common shares issued to Triumph Small Cap Fund in consideration for the Letter, plus the $2,500 paid for legal fees, were reflected as a $60,999 discount against the Greenberg Note and are being amortized as interest expense primarily over the initial six month term of the Greenberg Note. The effective rate of the Greenberg Note is approximately 50.7% per annum, assuming a one year loan term. The unamortized portion of the debt discount was $34,624 at March 31, 2010.
 
We may prepay the Greenberg Note at any time with ten days notice, provided that Greenberg may convert the outstanding balance to common shares during such ten day period. In the event the Greenberg Note is prepaid during the first six months, we shall incur a prepayment penalty of 20,833 unregistered common shares. In the event of a default, we will be obligated to pay Greenberg an additional 5% interest per month (based on the outstanding loan balance and pro-rated on a daily basis) until the default has been cured, payable in cash or unregistered common shares. If we successfully conclude a subsequent financing of debt or equity in excess of $500,000 during the term of the Greenberg Note, the proceeds of such financing will be used to pay off the remaining balance of the Greenberg Note – see note 9 with respect to the Lehmann Note.

Wilmington Notes

During February 2010 we borrowed an aggregate of $500,000 from three entities (the “Wilmington Investors”) under the terms of unsecured subordinated convertible notes (the “Wilmington Notes”), which were issued on a pari passu basis with the Greenberg Note and are repayable in aggregate principal installments of $26,000 per month beginning April 18, 2010, with the final payment on February 18, 2011, including remaining principal and all accrued but unpaid interest (at 10% per annum).  The Wilmington Notes are convertible into common stock at the option of each individual Wilmington Investor, based on our closing share price on the funding date of the Wilmington Notes, which was $2.76 with respect to $375,000 of the funding and $2.88 with respect to the balance.
 
 
32

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Wilmington Notes (continued)

The Wilmington Notes provide for (i) our issuance of an aggregate of 50,000 unregistered common shares upon receipt of the funds and our issuance of an aggregate 50,000 unregistered common shares if the loans are still outstanding after 6 months, (ii) our payment of $2,500 in legal fees incurred by the Wilmington Investors and (iii) our prepayment of the first six months of interest in the form of shares, based on our closing share price on the funding date of the Wilmington Notes. In the event the Wilmington Notes are prepaid after the first six months, the second tranche of 50,000 unregistered common shares will be cancelled on a pro-rata basis, to the extent the second six month time period has not elapsed at the time of such payoff.

We have also incurred third party finder’s fees in connection with the Wilmington Notes, such fees payable in cash equal to 7% of the borrowed amount payable.
 
The value of the 58,049 shares initially issued to the Wilmington Investors for fees and prepaid interest plus the finder’s fees of $35,000 and the $2,500 obligation for legal fees, were reflected as a $199,443 discount against the Wilmington Notes and are being amortized as interest expense primarily over the initial six month term of the Wilmington Notes. The effective rate of the Wilmington Notes is approximately 83.9% per annum, assuming a six month loan term and excluding the finder’s fees. The unamortized portion of the debt discount was $167,218 at March 31, 2010.
 
We may prepay the Wilmington Notes at any time with ten days notice, provided that the Investor may convert the outstanding balance to common shares during such ten day period. In the event of a default, we will be obligated to pay the Wilmington Investors an additional 5% interest per month (based on the outstanding loan balance and pro-rated on a daily basis) until the default has been cured, payable in cash or unregistered common shares. If we successfully conclude a subsequent financing of debt or equity in excess of $750,000 during the term of the Wilmington Notes, the proceeds of such financing will be used to pay off the remaining balance of the Wilmington Notes. The Lehmann Note was issued in May 2010 to one of the Wilmington Investors – see note 9.

Rockridge Note

A portion of the Rockridge Note ($500,000 face value, which is $350,157 net, after deducting the applicable discount) is also convertible into ONSM common shares, as discussed below, and classified under the non-current portion of Convertible Debentures, net of discount, on our March 31, 2010 balance sheet.
 
 
33

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Notes and Leases Payable

Notes and leases payable consist of the following as of March 31, 2010 and September 30, 2009, respectively:
 
   
March 31,
 2010
   
September 30, 2009
 
Line of Credit Arrangement
  $ 1,674,090     $ 1,382,015  
Rockridge Note (excluding portion classified under convertible debentures)
    1,206,152       989,187  
Capitalized equipment leases
    80,873       142,924  
Total notes and leases payable
    2,961,115       2,514,126  
Less: discount on notes payable
    (387,734 )     (393,174 )
Less: consideration for funding commitment letters
    (14,000 )     -  
Notes and leases payable, net of discount
    2,559,381       2,120,952  
Less: current portion, net of discount
    ( 1,940,719 )     ( 1,615,891 )
Long term notes and leases payable, net of current portion
  $ 618,662     $ 505,061  
 
Line of Credit Arrangement

In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender”) under which we could borrow up to an aggregate of $1.0 million for working capital, collateralized by our accounts receivable and certain other related assets. In August 2008 the maximum allowable borrowing amount under the Line was increased to $1.6 million and in December 2009 this amount was again increased to $2.0 million.

The outstanding balance bears interest at 13.5% per annum, adjustable based on changes in prime after December 28, 2009 (was prime plus 8% per annum through December 2, 2008 and prime plus 11% from that date through December 28, 2009), payable monthly in arrears. Effective December 28, 2009, we also incur a weekly monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit, payable monthly in arrears.

We paid initial origination and commitment fees in December 2007 aggregating $20,015, an additional commitment fee in August 2008 of $6,000 related to the increase in the lending limit for the remainder of the year, a commitment fee of $16,000 in December 2008 related to the continuation of the increased Line for an additional year and a commitment fee of $20,000 in December 2009 related to the continuation of the Line for an additional year as well as an increase in the lending limit. An additional commitment fee of one percent (1%) of the maximum allowable borrowing amount will be due for any subsequent annual renewal after December 28, 2010. These origination and commitment fees (plus other fees paid to Lender) are recorded by us as debt discount and amortized as interest expense over the remaining term of the loan. The unamortized portion of this discount was $28,134 and $37,082 as of March 31, 2010 and September 30, 2009, respectively.

The outstanding principal balance due under the Line may be repaid by us at any time, but no later than December 28, 2011, which may be extended by us for an extra year, subject to compliance with all loan terms, including no material adverse change, as well as concurrence of the Lender. We will incur a charge equal to two percent (2%) of the borrowing limit if we terminate the Line before June 28, 2011 and a charge equal to one percent (1%) of the borrowing limit if we terminate the Line after that date but before December 28, 2011. The outstanding principal is due on demand in the event a payment default is uncured five (5) days after written notice.

 
34

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Line of Credit Arrangement (continued)

The Line is also subject to us maintaining an adequate level of receivables, based on certain formulas, as well as our compliance, starting with the quarter ending September 30, 2010, with a quarterly debt service coverage covenant. The Lender must approve any additional debt incurred by us, other than debt incurred in the ordinary course of business (which includes equipment financing). Accordingly the Lender has approved the $1.0 million Equipment Notes we issued in June and July 2008, the $200,000 CCJ Note we issued in December 2009, the $250,000 Greenberg Note we issued in January 2010, and the $500,000 Wilmington Notes we issued in February 2010, all as discussed above, and the $2.0 million Rockridge Note we issued in April 2009 and amended in September 2009, as discussed below. The Lender also approved the $250,000 Lehmann Note we issued in May 2010 - see note 9.

Mr. Leon Nowalsky, a member of our Board of Directors, is also a founder and board member of the Lender.

Rockridge Note

In April 2009 we received $750,000 from Rockridge Capital Holdings, LLC (“Rockridge”), an entity controlled by one of our largest shareholders, in accordance with the terms of a Note and Stock Purchase Agreement (the “Rockridge Agreement”) that we entered into with Rockridge dated April 14, 2009. In June 2009, we received an additional $250,000 from Rockridge in accordance with the Rockridge Agreement, for total borrowings thereunder of $1.0 million. On September 14, 2009, we entered into Amendment Number 1 to the Agreement (the “Amendment”), as well as an Allonge to the Note (the “Allonge”), which allowed us to borrow up to an additional $1.0 million from Rockridge, resulting in cumulative allowable borrowings of up to $2.0 million. We borrowed $500,000 of the additional $1.0 million on September 18, 2009 and the remaining $500,000 on October 20, 2009.

In connection with this transaction, we issued a Note (the “Rockridge Note”), which is collateralized by a first priority lien on all of our assets, such lien subordinated only to the extent higher priority liens on assets, primarily accounts receivable and certain designated software and equipment, are held by certain of our other lenders. We also entered into a Security Agreement with Rockridge that contains certain covenants and other restrictions with respect to the collateral.

The Rockridge Note, after giving effect to all borrowings under the Amendment and the Allonge, is repayable in equal monthly installments of $45,202 extending through August 14, 2013 (the “Maturity Date”), which installments include principal (except for a $500,000 balloon payable on the Maturity Date) plus interest (at 12% per annum) on the remaining unpaid balance. The Rockridge Agreement, as amended, also provides that Rockridge may receive an origination fee upon not less than sixty-one (61) days written notice to us, payable by our issuance of 366,667 restricted shares of our common stock (the “Shares”).
 
 
35

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Rockridge Note (continued)

The Rockridge Agreement provides that on the Maturity Date we shall pay Rockridge up to a maximum of $75,000, based on the sum of (i) the cash difference between the per share value of $1.20 (the “Minimum Per Share Value”) and the average sale price for all previously sold Shares (whether such number is positive or negative) multiplied by the number of sold Shares and (ii) for the Shares which were not previously sold by Rockridge, the cash difference between the Minimum Per Share Value and the market value of the Shares at the Maturity Date (whether such number is positive or negative) multiplied by the number of unsold Shares, up to a maximum shortfall amount of $75,000 in the aggregate for items (i) and (ii). The closing ONSM share price was $1.99 per share on May 7, 2010.

Legal fees totaling $55,337 were paid or accrued by us as of September 30, 2009 in connection with the Rockridge Agreement. The 366,667 origination fee Shares discussed above were earned by Rockridge as of September 30, 2009 and had a fair market value of approximately $626,000 at the date of the Rockridge Agreement or the Amendment, as applicable. The value of these Shares plus the legal fees paid or accrued were reflected as a $681,337 discount against the Rockridge Note (as well as a corresponding increase in additional paid-in capital for the value of the Shares), which is being amortized as interest expense over the term of the Rockridge Note.

The effective interest rate of the Rockridge Note was approximately 44.3% per annum, until the September 2009 amendment, at which time it was reduced to approximately 28.0% per annum. These rates exclude the potential effect of a premium to market prices if the balloon payment is satisfied in common shares instead of cash as well as the potential effect of any appreciation in the value of the Shares at the time of issuance beyond their value at the date of the Rockridge Agreement or the Amendment, as applicable. The unamortized portion of this discount was $509,443 and $490,902 as of March 31, 2010 and September 30, 2009, respectively.

Upon notice from Rockridge at any time and from time to time prior to the Maturity Date up to $500,000, (representing the current balloon payment of the outstanding principal of the Rockridge Note and which balloon payment was $375,000 as of September 30, 2009) may be converted into a number of restricted shares of our common stock. Upon notice from Rockridge at any time after September 4, 2010 and prior to the Maturity Date, up to fifty percent (50%) of the outstanding principal amount of the Rockridge Note (excluding the balloon payment subject to conversion per the previous sentence) may be converted into a number of restricted shares of our common stock. If we sell all or substantially all of our assets, or at any time after September 4, 2011 and prior to the Maturity Date, the remaining outstanding principal amount of the Rockridge Note may be converted by Rockridge into a number of restricted shares of our common stock.
 
 
36

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Rockridge Note (continued)

The above conversions are subject to a minimum of one month between conversion notices (unless such conversion amount exceeds $25,000) and will use a conversion price of eighty percent (80%) of the fair market value of the average closing bid price for our common stock for the twenty (20) days of trading on the NASDAQ Capital Market (or such other exchange or market on which our common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share.  We will not effect any conversion of the Rockridge Note, to the extent Rockridge and Frederick DeLuca, after giving effect to such conversion, would beneficially own in excess of 9.9% of our outstanding common stock (the “Beneficial Ownership Limitation”).  The Beneficial Ownership Limitation may be waived by Rockridge upon not less than sixty-one (61) days prior written notice to us unless such waiver would result in a violation of the NASDAQ shareholder approval rules. Since the market value of an ONSM common share was $1.38 as of the date of the Rockridge Agreement and $2.34 as of the date of the Amendment, we determined that the above provisions did not constitute a beneficial conversion feature for purposes of calculating the related discount recorded by us.

Furthermore, in the event of any conversions of principal to ONSM shares by Rockridge (i) the $500,000 balloon payment will be reduced by the amount of any such conversions and (ii) the interest portion of the monthly payments under the Rockridge Note for the remaining months after any such conversion will be adjusted to reflect the outstanding principal being immediately reduced for amount of the conversion. We may prepay the Rockridge Note at any time. The outstanding principal is due on demand in the event a payment default is uncured ten (10) business days after Rockridge’s written notice to us.

Capitalized Equipment Leases

During July 2007, we entered into a capital lease for audio conferencing equipment, which had an outstanding principal balance of $50,231 and $109,151 as of March 31, 2010 and September 30, 2009, respectively. The balance is payable in equal monthly payments of $10,172 through August 2010, which includes interest at approximately 5% per annum, plus an optional final payment based on fair value, but not to exceed $16,974. During January 2009, we entered into a capital lease for telephone equipment, which had an outstanding principal balance of $30,642 and $33,773 as of March 31, 2010 and September 30, 2009, respectively. The balance is payable in equal monthly payments of $828 through January 2014, which includes interest at approximately 11% per annum.
 
Funding Commitment Letters

The value of shares issued as consideration for Letters – see note 1 – is reflected on our balance sheet as a reduction of the carrying value of notes payable and will be included as part of the discount for any financing received in connection with the related Letter and amortized as interest expense over the term of that financing. In the event related financing is not received by the expiration date of any particular Letter, the corresponding amount will be written off as interest expense at that time. The balance of this item is $14,000 as of March 31, 2010.
 
 
37

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES

Narrowstep acquisition termination and litigation – On May 29, 2008, we entered into an Agreement and Plan of Merger (the “Merger Agreement”) to acquire Narrowstep, Inc. (“Narrowstep”), which Merger Agreement was amended twice (on August 13, 2008 and on September 15, 2008). The terms of the Merger Agreement, as amended, allowed that if the acquisition did not close on or prior to November 30, 2008, the Merger Agreement could be terminated by either us or Narrowstep at any time after that date provided that the terminating party was not responsible for the delay. On March 18, 2009, we terminated the Merger Agreement and the acquisition of Narrowstep.

On December 1, 2009, Narrowstep filed a complaint against us in the Court of Chancery of the State of Delaware, alleging breach of contract, fraud and three additional counts and is seeking (i) $14 million in damages, (ii) reimbursement of an unspecified amount for all of its costs associated with the negotiation and drafting of the Merger Agreement, including but not limited to attorney and consulting fees, (iii) the return of Narrowstep’s equipment alleged to be in our possession, (iv) reimbursement of an unspecified amount for all of its attorneys fees, costs and interest associated with this action and (v) any further relief determined as fair by the court. After reviewing the complaint document, we have determined that Narrowstep has no basis in fact or in law for any claim and accordingly, this matter has not been reflected as a liability on our financial statements. On December 18, 2009, we were served with a summons and on February 1, 2010 we filed a motion requesting dismissal of the breach of contract and fraud counts as well as two of the other three counts, as well as our brief in support of the motion filed on February 18, 2010. Narrowstep’s response was filed on March 29, 2010 and we filed our reply on April 13, 2010. The Court’s decision, which may be preceded by a hearing at the Court’s discretion, is pending. Regardless of the ultimate decision with regard to the motion to dismiss, we intend to vigorously defend against all claims. Furthermore, we do not expect the ultimate resolution of this matter to have a material adverse impact on our financial position or results of operations.

Other legal proceedings – We are involved in other litigation and regulatory investigations arising in the ordinary course of business. While the ultimate outcome of these matters is not presently determinable, it is the opinion of our management that the resolution of these outstanding claims will not have a material adverse effect on our financial position or results of operations.

Registration payment arrangements – We included the 8% Subordinated Convertible Debentures and the related $9.00 warrants on a registration statement which was declared effective by the SEC on July 26, 2006. We are only required to expend commercially reasonable efforts to keep the registration statement continuously effective. However, in the event the registration statement or the ability to sell shares thereunder lapses for any reason for 30 or more consecutive days in any 12 month period or more than twice in any 12 month period, the purchasers of the 8% Subordinated Convertible Debentures may require us to redeem any shares obtained from the conversion of those notes and still held, for 115% of the market value for the previous five days. The same penalty provisions apply if our common stock is not listed or quoted, or is suspended from trading on an eligible market for a period of 20 or more trading days (which need not be consecutive). Due to the fact that that there is no established mechanism for reporting to us changes in the ownership of these shares after  they are originally issued, we are unable to quantify how many of these shares are still held by the original recipient and thus subject to the above provisions. Regardless of the above, we believe that the applicability of these provisions would be limited by equity and/or by statute to a certain timeframe after the original security purchase. All of these debentures were converted to common shares on or before March 31, 2007 and the related $9.00 warrants have all expired.

 
38

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Registration payment arrangements (continued) – We included the common shares underlying the 8% Senior Convertible Debentures, including the Additional 8% Convertible Debentures (AIR), and the related $9.90 warrants, on a registration statement declared effective by the SEC on June 29, 2005. These debentures provide cash penalties of 1% of the original purchase price for each month that (a) our common shares are not listed on the NASDAQ Capital Market for a period of 3 trading days (which need not be consecutive) or (b) the common shares underlying those securities and the related warrants are not saleable subject to an S-3 or other registration statement then effective with the SEC. The latter penalty only applies for a five-year period beginning with the June 29, 2005 registration statement effective date and does not apply to shares saleable under Rule 144(k). Regardless of the above, we believe that the applicability of these provisions would be limited by equity and/or by statute to a certain timeframe after the original security purchase - all of these debentures were converted to common shares on or before March 31, 2007 and the related $9.90 warrants have all expired.

During March and April 2007, we sold an aggregate of 814,815 restricted common shares for total gross proceeds of approximately $11.0 million. These shares were included in a registration statement declared effective by the SEC on June 15, 2007.  We are required to maintain the effectiveness of this registration statement until the earlier of the date that (i) all of the shares have been sold, (ii) all the shares have been transferred to persons who may trade such shares without restriction (including our delivery of a new certificate or other evidence of ownership for such securities not bearing a restrictive legend) or (iii) all of the shares may be sold at any time, without volume or manner of sale limitations pursuant to Rule 144(k) or any similar provision (in the opinion of our counsel). In the event such effectiveness is not maintained or trading in the shares is suspended or if the shares are delisted for more than five (5) consecutive trading days then we are liable for a compensatory payment (pro rated on a daily basis) of one and one-half percent (1.5%) per month until the situation is cured, such payment based on the purchase price of the shares still held and provided that such payments may not exceed ten percent (10%) of the initial purchase price of the shares with respect to any one purchaser. Regardless of the above, we believe that the applicability of these provisions would be limited by equity and/or by statute to a certain timeframe after the original security purchase.

We have concluded that the arrangements discussed in the preceding three paragraphs are registration payment arrangements, as that term is defined in the Derivatives and Hedging topic (Contracts in Entity’s own Equity subtopic) of the ASC. Based on our satisfactory recent history of maintaining the effectiveness of our registration statements and our NASDAQ listing, as well as stockholders’ equity in excess of the NASDAQ listing standards as of March 31, 2010, we have concluded that material payments under these registration payment arrangements are not probable and that no accrual related to them is necessary under the requirements of the Contingencies topic of the ASC.

Registration rights - We granted demand registration rights, effective six months from the date of a certain October 2006 convertible note, for any unregistered common shares issuable thereunder. Upon such demand, we would have 60 days to file a registration statement, using our best efforts to promptly obtain the effectiveness of such registration statement. 166,667 of the 282,416 total principal and interest shares issued in November and December 2006 and subject to these rights were included in a registration statement declared effective by the SEC on June 15, 2007 and as of May 7, 2010 we have not received any demand for the registration of the balance.

 
39

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Registration rights (continued) – We granted a major shareholder demand registration rights, effective six months from the January 2007 modification date of a certain convertible note, for any unregistered common shares issuable thereunder. Upon such demand, we would have 60 days to file a registration statement, using our best efforts to promptly obtain the effectiveness of such registration statement. 130,765 of the 464,932 shares issued in March 2007 and subject to these rights were included in a registration statement declared effective by the SEC on June 15, 2007 and as of May 7, 2010 we have not received any demand for the registration of the balance.

As the two notes discussed above do not provide for damages or penalties if we do not comply with these registration rights, we have concluded that these rights do not constitute registration payment arrangements. Furthermore, since the unregistered shares were originally issued in March 2007 or before, they may be saleable, in whole or in part, under Rule 144. In any event, we have determined that material payments in relation to these rights are not probable and therefore no accrual related to them is necessary under the requirements of the Contingencies topic of the ASC.

We granted piggyback registration rights in connection with 16,667 shares and 36,667 options issued to consultants prior to June 15, 2007, which shares and options were not included on the registration statement declared effective by the SEC on that date, nor were they include on the subsequent Shelf Registration declared effective by the SEC on April 30, 2010 – see note 1. As these options and shares do not provide for damages or penalties in the event we do not comply with these registration rights, we have concluded that these rights do not constitute registration payment arrangements. In any event, we have determined that material payments in relation to these rights are not probable and therefore no accrual related to them is necessary under the requirements of the Contingencies topic of the ASC.

We granted piggyback registration rights in connection with 47,500 shares and 25,000 options issued to consultants, as well as 29,167 warrants issued in connection with a financing prior to April 30, 2010, which shares and options were not included on the Shelf Registration declared effective by the SEC on that date – see note 1. As the 47,500 shares and the 29,167 warrants do not provide for damages or penalties in the event we do not comply with these registration rights, we have concluded that these rights do not constitute registration payment arrangements. Although the 25,000 options include cashless exercise rights until they are registered, and therefore do constitute registration payment arrangements, since the exercise price of $10.38 per share was significantly in excess of the market price of $1.86 per share as of March 31, 2010, we have concluded that no accrual related to these rights is necessary as of that date under the requirements of the Contingencies topic of the ASC.

Employment contracts and severance – On September 27, 2007, our Compensation Committee and Board of Directors approved three-year employment agreements with Messrs. Randy Selman (President and CEO), Alan Saperstein (COO and Treasurer), Robert Tomlinson (Chief Financial Officer), Clifford Friedland (Senior Vice President Business Development) and David Glassman (Senior Vice President Marketing), collectively referred to as “the Executives”. On May 15, 2008 and August 11, 2009 our Compensation Committee and Board approved certain corrections and modifications to those agreements, which are reflected in the discussion of the terms of those agreements below. The agreements provide that the initial term shall automatically be extended for successive one (1) year terms thereafter unless (a) the parties mutually agree in writing to alter the terms of the agreement; or (b) one or both of the parties exercises their right, pursuant to various provisions of the agreement, to terminate the employment relationship.

 
40

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued) – The agreements provide initial annual base salaries of $253,000 for Mr. Selman, $230,000 for Mr. Saperstein, $207,230 for Mr. Tomlinson and $197,230 for Messrs. Friedland and Glassman, plus 10% annual increases through December 27, 2008 and 5% per year thereafter. In addition, each of the Executives receives an auto allowance payment of $1,000 per month, a “retirement savings” payment of $1,500 per month and an annual reimbursement of dues or charitable donations up to $5,000.  We also pay insurance premiums for the Executives, including medical, life and disability coverage. These agreements contain certain non-disclosure and non-competition provisions and we have agreed to indemnify the Executives in certain circumstances.

As part of the above employment agreements, and in accordance with the terms of the “2007 Equity Incentive Plan” approved by our shareholders in their September 18, 2007 annual meeting, we granted Plan Options to each of the Executives to purchase an aggregate of 66,667 shares of our common stock at an exercise price of $10.38 per share, the fair market value at the date of the grant, which shall be exercisable for a period of four (4) years from the date of vesting. The options vest in installments of 16,667 per year, starting on September 27, 2008, and they automatically vest upon the happening of the following events: (i) change of control (ii) constructive termination, and (iii) termination other than for cause, each as defined in the employment agreements. Unvested options automatically terminate upon (i) termination for cause or (ii) voluntary termination.  In the event the agreement is not renewed or the Executive is terminated other than for cause, the Executives shall be entitled to require us to register the vested options.

As part of the above employment agreements, the Executives were eligible for a performance bonus, based on meeting revenue and cash flow objectives over a two year period ended September 30, 2009. Accordingly, we granted Plan Options to each of the Executives to purchase an aggregate of 36,667 shares of ONSM common stock at an exercise price of $10.38 per share, the fair market value at the date of the grant, exercisable for a period of four (4) years from the date of vesting. The performance objectives were met for the quarter ended December 31, 2007 but they were not met for the remaining three quarters of fiscal 2008 nor were they met for the fiscal year ended September 30, 2008. The performance objectives were met for the quarter ended June 30, 2009 but they were not met for the remaining three quarters of fiscal 2009 nor were they met for the fiscal year ended September 30, 2009. Therefore, an aggregate of 4,583 options out of a potential 36,667 performance options vested for each Executive during fiscal year 2008 and 2009, with the remainder expiring.  In the event the agreement is not renewed or the Executive is terminated other than for cause, the Executive shall be entitled to require us to register the vested options.
 
 
41

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued) – On August 11, 2009, our Compensation Committee agreed to a new performance bonus program for the Executives under the following terms: Up to one-half of the shares will be eligible for vesting on a quarterly basis and the rest annually, with the total grant allocable over a two-year period ending September 30, 2011. Vesting of the quarterly portion will be subject to achievement of increased revenues over the prior quarter as well as positive and increased net cash flow per share (defined as cash provided by operating activities per our statement of cash flow, measured before changes in working capital components and not including investing or financing activities) for that quarter. We will negotiate with the Executives in good faith as to how revenue increases from specific acquisitions are measured. Vesting of the annual portion will be subject to meeting the above cash flow requirements on a year-over-year basis, plus a revenue growth rate of at least 20% for the fiscal year over the prior year. In the event of quarter to quarter decreases in revenues and cash flow, the options will not vest for that quarter but the unvested quarterly options will be added to the available options for the year, vested subject to achievement of the applicable annual goal. One-half of the applicable quarterly or annual bonus options will be earned/vested if the cash flow target is met but the revenue target is not met In the event options did not vest based on the quarterly or annual goals, they will immediately expire. In the event the agreement is not renewed or the Executive is terminated other than for cause, the Executive shall be entitled to require us to register the vested options. The Compensation Committee has also agreed that a performance bonus program will continue after this two-year period, with the specific bonus parameters to be negotiated in good faith between the parties at least ninety (90) days before the expiration of the program then in place.

This program was subject only to the approval by our shareholders of a sufficient increase in the number of authorized 2007 Plan options, which occurred in the March 25, 2010 shareholder meeting. However, the granting and pricing of the above performance bonus options by the Board is still pending, subject to further discussions between the Board and the Executives.  Furthermore, the performance objectives were not met for the first two quarters of fiscal 2010.

Under the terms of the above employment agreements, upon a termination subsequent to a change of control, termination without cause or constructive termination, each as defined in the agreements, we would be obligated to pay each of the Executives an amount equal to three times the Executive’s base salary plus full benefits for a period of the lesser of (i) three years from the date of termination or (ii) the date of termination until a date one year after the end of the initial employment contract term. We may defer the payment of all or part of this obligation for up to six months, to the extent required by Internal Revenue Code Section 409A. In addition, if the five day average closing price of the common stock is greater than or equal to $6.00 per share on the date of any termination or change in control, all options previously granted the Executive(s) will be cancelled, with all underlying shares (vested or unvested) issued to the executive, and we will pay all related taxes for the Executive(s).  If the five-day average closing price of the common stock is less than $6.00 per share on the date of any termination or change in control, the options will remain exercisable under the original terms.
 
 
42

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued) – Under the terms of the above employment agreements, we may terminate an Executive’s employment upon his death or disability or with or without cause. To the extent that an Executive is terminated for cause, no severance benefits are due him. If an employment agreement is terminated as a result of the Executive’s death, his estate will receive one year base salary plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his death. If an employment agreement is terminated as a result of the Executive’s disability, as defined in the agreement, he is entitled to compensation in accordance with our disability compensation for senior executives to include compensation for at least 180 days, plus any bonus or other compensation amount or benefit then payable or that would have been otherwise considered vested or earned under the agreement during the one-year period subsequent to the time of his disability.

The above employment agreements also provide that in the event we are sold for a Company Sale Price that represents at least $6.00 per share (adjusted for recapitalization including but not limited to splits and reverse splits), the Executives will receive, as a group, cash compensation of twelve percent (12.0%) of the Company Sale Price, payable in immediately available funds at the time of closing such transaction. The Company Sale Price is defined as the number of Equivalent Common Shares outstanding at the time we are sold multiplied by the price per share paid in such Company Sale transaction. The Equivalent Common Shares are defined as the sum of (i) the number of common shares issued and outstanding, (ii) the common stock equivalent shares related to paid for but not converted preferred shares or other convertible securities and (iii) the number of common shares underlying “in-the-money” warrants and options, such sum multiplied by the market price per share and then reduced by the proceeds payable upon exercise of the “in-the-money” warrants and options, all determined as of the date of the above employment agreements but the market price per share used for this purpose to be no less than $6.00. The 12.0% is allocated in the employment agreements as two and one-half percent (2.5%) each to Messrs. Selman, Saperstein, Friedland and Glassman and two percent (2.0%) to Mr. Tomlinson.

Our general policy is to not include severance or minimum employment periods in employment contracts, with the exception of the above employment contracts with the Executives. However, as of March 31, 2010, we have arrangements with three (3) employees requiring minimum payments of approximately $160,000 for wages, taxes and benefits over the approximately eight month period after that date.

Other compensation – In addition to the 12% allocation of the Company Sale Price to the Executives, as discussed above, on August 11, 2009 our Compensation Committee determined that an additional three percent (3.0%) of the Company Sale Price would be allocated, on the same terms, with two percent (2.0%) allocated to the four outside Directors (0.5% each), as a supplement to provide appropriate compensation for ongoing services as a director and as a termination fee, one-half percent (0.5%) allocated to one additional executive-level employee and the remaining one-half percent (0.5%) to be allocated by the Board and our management at a later date, which will be primarily to compensate other executives not having employment contracts, but may also include additional allocation to some or all of these five senior Executives.

 
43

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Consultant contracts – We entered into a consulting contract, effective June 1, 2009, with an individual for executive management services to be performed for our Infinite division. This contract calls for base compensation of $175,000 per year, plus $25,000 commission per year provided certain current revenue levels are maintained. In addition we will pay a travel allowance of $5,000 per month for up to the first thirteen months and a one-time $15,000 moving expenses reimbursement. As part of the contract, we also granted a four-year term (from vesting) option to purchase 66,667 common ONSM shares, vesting over four years at 16,667 per year and exercisable at $3.00 per share - see note 8. The contract is renewable by mutual agreement of the parties with six months notice to the other. Termination of the contract without cause after the end of the two-year contract term requires six months notice (which includes a three month severance period) from the terminating party, although termination with cause requires no notice.

We have entered into various agreements for financial consulting and advisory services which, if not terminated as allowed by the terms of such agreements, will require the issuance after March 31, 2010 of approximately 70,000 unregistered shares. The services related to these shares will be provided over periods up to 12 months, and will result in a professional fees expense of approximately $139,000 over that service period, based on the current $1.99 market value of an ONSM common share as of May 7, 2010.

Lease commitments – We are obligated under operating leases for our five offices (one each in Pompano Beach, Florida, San Francisco, California and Colorado Springs, Colorado and two in the New York City area), which call for monthly payments totaling approximately $58,700. The leases have expiration dates ranging from 2010 to 2013 (after considering our rights of termination) and in most cases provide for renewal options. Most of the leases have annual rent escalation provisions. Future minimum lease payments required under these non-cancelable leases (including the tentatively agreed on Pompano lease terms) as of March 31, 2010, excluding the capital lease obligations discussed in note 4, total approximately $1.6 million. Total rental expense (including executory costs) for all operating leases was approximately $423,000 and $440,000 for the six months ended March 31, 2010 and 2009 and (ii) $220,000 and $207,000 for the three months ended March 31, 2010 and 2009, respectively.

The three-year operating lease for our principal executive offices in Pompano Beach, Florida expires September 15, 2010. The monthly base rental is currently approximately $22,500 (including our share of property taxes and common area expenses). We are currently in negotiations to extend this lease for an additional three years, and have tentatively agreed to a starting monthly base rental of approximately $20,200 (including our share of property taxes and common area expenses), which would also be retroactive to the lease year ending September 15, 2010, plus two percent (2%) annual increases. The proposed extension would provide one two-year renewal option, with a three percent (3%) rent increase in year one.

The five-year operating lease for our office space in San Francisco expires April 30, 2014.  The monthly base rental (including month-to-month parking) is approximately $16,800 with annual increases up to 4.4%. The lease provides one five-year renewal option at 95% of fair market value and also provides for early cancellation at any time after April 30, 2010, at our option, with six (6) months notice and a payment of no more than approximately $44,000.
 
 
44

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Lease commitments (continued) – The three-year operating lease for our Infinite Conferencing location in New Jersey expires October 31, 2012. The monthly base rental is approximately $10,800 with five percent (5%) annual increases. The lease provides one two-year renewal option, with no rent increase.

The three-year operating lease for office space in New York City expires January 31, 2013, although both we and the landlord have the right to terminate the lease without penalty, upon nine (9) months notice given any time after February 1, 2011.   The monthly base rental is approximately $10,000, with no increases.

Bandwidth and co-location facilities purchase commitments - We are a party to a bandwidth services agreement with a national CDN (content delivery network) provider, which expires on December 31, 2010, includes a minimum purchase commitment of approximately $200,000 per year (based on June 30 anniversary dates) and requires us to use that provider for at least 80% of our content delivery needs. We are in compliance with this agreement, based on comparing our purchases through March 31, 2010 to the corresponding pro-rata share of that commitment. We have also entered into various agreements for our purchase of bandwidth and use of co-location facilities, for an aggregate minimum purchase commitment of approximately $372,000, such agreements expiring at various times through December 2011.

 
45

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 6:  CAPITAL STOCK

Common Stock

A 1-for-6 reverse stock split of the outstanding shares of our common stock was effective on April 5, 2010. Except as otherwise indicated, all related amounts reported in these consolidated financial statements, including common share quantities, convertible debenture conversion prices and exercise prices of options and warrants, have been retroactively adjusted for the effect of this reverse stock split.

During the six months ended March 31, 2010, we issued 159,267 unregistered common shares valued at approximately $341,505 and which will be recognized as professional fees expense for financial consulting and advisory services over various service periods of up to 12 months. None of the shares were issued to our directors or officers.

During the six months ended March 31, 2010, we issued options to purchase our common shares, in exchange for financial consulting and advisory services, such options valued at approximately $102,000. Other than options to purchase 19,982 shares at $9.42 per share issued to certain of our directors to replace expired options and valued at approximately $12,000 (see note 8), none of the other options were issued to our directors or officers. Professional fee expenses arising from these and prior issuances of shares and options for financial consulting and advisory services were approximately (i) $246,000 and $115,000 for the six months ended March 31, 2010 and 2009 and (ii) $77,000 and $5,000 for the three months ended March 31, 2010 and 2009, respectively.

As a result of previously issued shares and options for financial consulting and advisory services, we have recorded approximately $367,000 in deferred equity compensation expense at March 31, 2010, to be amortized over the remaining periods of service of up to 10 months. The deferred equity compensation expense is included in the balance sheet captions prepaid expenses and other non-current assets.

During the six months ended March 31, 2010, we issued shares and options for interest and fees on convertible debentures as follows - (i) 34,917 unregistered common shares valued at $67,040 for interest on the Equipment Notes, (ii) 85,826 unregistered common shares valued at $213,194 for prepaid interest and financing fees on the Greenberg Note and the Wilmington Notes and (iii) warrants having a Black-Scholes value of approximately $33,000 in connection with the CCJ Note. See note 4.

During the six months ended March 31, 2010, we issued 12,500 unregistered common shares valued at $21,250 in connection with funding commitment letters (“Letters”) – see note 1. 41,667 of the 366,667 restricted shares payable to Rockridge as an origination fee (see note 4) related to borrowings during the six months ended March 31, 2010 and were reflected as a $95,000 increase in paid in capital for that period.

During the six months ended March 31, 2010, we issued 58,333 unregistered common shares in connection with the conversion of Series A-12, as discussed in more detail below.
 
 
46

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 6:  CAPITAL STOCK (continued)

Preferred Stock

As of September 30, 2009, the only preferred stock outstanding was Series A-12 Redeemable Convertible Preferred Stock (“Series A-12”). As of March 31, 2010, the only preferred stock outstanding was Series A-13 Convertible Preferred Stock (“Series A-13”).

Series A-12 Redeemable Convertible Preferred Stock

Effective December 31, 2008, our Board of Directors authorized the sale and issuance of up to 100,000 shares of Series A-12 Redeemable Convertible Preferred Stock (“Series A-12”). On January 7, 2009, we filed a Certificate of Designation, Preferences and Rights for the Series A-12 with the Florida Secretary of State. The Series A-12 had a coupon of 8% per annum, a stated value of $10.00 per preferred share and a conversion rate of $6.00 per common share. Dividends were paid in advance, in the form of our common shares. The holders of Series A-12 could require redemption by us under certain circumstances, as outlined below, but any shares of Series A-12 that were still outstanding as of December 31, 2009 automatically converted into our common shares. Holders of Series A-12 were not entitled to registration rights.

Effective December 31, 2008, we sold two (2) investors an aggregate of 80,000 shares of Series A-12, with the purchase price paid via (i) the surrender of an aggregate of 60,000 shares of Series A-10 held by those two investors and having a stated value of $10.00 per A-10 share in exchange for an aggregate of 60,000 shares of Series A-12 plus (ii) the payment of additional cash aggregating $200,000 for an aggregate of 20,000 shares of Series A-12 (“Additional Shares”). One of the investors was CCJ Trust.

In accordance with the terms of the Series A-12, dividends were payable in advance in the form of ONSM common shares, using the average closing bid price of those shares for the five trading days immediately preceding the Series A-12 purchase closing date. Accordingly, we issued 39,216 common shares as payment of $64,000 dividends for the one year period ending December 31, 2009, which was recorded on our balance sheet as additional paid-in capital and discount and amortized as a dividend over the one-year term of the Series A-12.
 
In accordance with the terms of the Series A-12, after six months the holders could require us, to the extent legally permitted, to redeem any or all Series A-12 shares purchased as Additional Shares at the additional purchase price of $10.00 per share.  Shares of Series A-12 acquired in exchange for shares of Series A-10 had no redemption rights. On April 14, 2009, we entered into a Redemption Agreement with one of the holders of the Series A-12, CCJ Trust, under which the holder redeemed 10,000 shares of Series A-12 in exchange for our payment of $100,000 on April 16, 2009. The remaining potentially redeemable 10,000 shares of Series A-12 was reflected as a $98,000 current liability on our September 30, 2009 balance sheet ($100,000 stated value, net of a pro-rata share of the total unamortized discount), which was reclassified to equity as of December 31, 2009 when it was converted into common shares, along with the remaining shares of Series A-12 owned by the same holder and having a stated value of $250,000.

In conjunction with and in consideration of a December 29, 2009 note transaction entered into by us with CCJ Trust, the 35,000 shares of Series A-12 held by CCJ Trust at that date were exchanged for 35,000 shares of Series A-13. See note 4.
 
 
47

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 6:  CAPITAL STOCK (continued)

Preferred Stock (continued)

Series A-13 Convertible Preferred Stock

Effective December 17, 2009, our Board of Directors authorized the sale and issuance of up to 170,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”). On December 23, 2009, we filed a Certificate of Designation, Preferences and Rights for the Series A-13 with the Florida Secretary of State. The Series A-13 has a coupon of 8% per annum, an assigned value of $10.00 per preferred share and a conversion rate of $3.00 per common share. Series A-13 dividends are cumulative and must be fully paid by us prior to the payment of any dividend on our common shares. Series A-13 dividends are declared quarterly but are payable at the time of any conversion of A-13, in cash or at our option in the form of our common shares, using the greater of (i) $3.00 per share or (ii) the average closing bid price of a common share for the five trading days immediately preceding the conversion.

Any shares of Series A-13 that are still outstanding as of December 31, 2011 will automatically convert into our common shares. Series A-13 may also be converted before that date at our option, provided that the closing bid price of our common shares has been at least $9.00 per share, on each of the twenty (20) trading days ending on the third business day prior to the date on which the notice of conversion is given. Series A-13 is subordinate to Series A-12 but is senior to all other preferred share classes that may be issued by us. Except as explicitly required by applicable law, the holders of Series A-13 shall not be entitled to vote on any matters as to which holders of our common shares are entitled to vote. Holders of Series A-13 are not entitled to registration rights.

35,000 shares of Series A-13 were outstanding as of March 31, 2010. We incurred $6,747 of legal fees and other expenses in connection with the issuance of these shares, which was recorded on our balance sheet as a discount and will be amortized as a dividend over the remaining term of the Series A-13.
 
NOTE 7:  SEGMENT INFORMATION

Our operations are comprised within two groups, Digital Media Services and Audio and Web Conferencing Services. The primary operating activities of the Webcasting division of the Digital Media Services Group, as well as our corporate headquarters, are in Pompano Beach, Florida. The primary operating activities of the Smart Encoding division of the Digital Media Services Group and the EDNet division of the Audio and Web Conferencing Services Group are in San Francisco, California. The primary operating activities of the DMSP and UGC divisions of the Digital Media Services Group are in Colorado Springs, Colorado. The primary operating activities of the Infinite division of the Audio and Web Conferencing Services Group are in the New York City metropolitan area. All material sales, as well as property and equipment, are within the United States.

 
48

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010


NOTE 7:  SEGMENT INFORMATION (continued)

Below are the results of our operations by segment for the six and three months ended March 31, 2010 and 2009, and total assets by segment as of March 31, 2010 and September 30, 2009.

   
For the six months ended
March 31
   
For the three months ended
March 31
 
   
2010
   
2009
   
2010
   
2009
 
Revenue:
                       
Digital Media Services Group
  $ 3,997,837     $ 4,024,131     $ 2,003,274     $ 1,983,660  
Audio and Web Conferencing Services Group
     4,204,970        4,737,727        2,130,420       2,399,001  
Total consolidated revenue
  $ 8,202,807     $ 8,761,858     $ 4,133,694     $ 4,382,661  
                                 
Segment operating income:
                               
Digital Media Services Group
    920,985       420,700       352,491       227,885  
Audio and Web Conferencing Services Group
     1,014,638        1,551,169        553,878        817,762  
Total segment operating income
    1,935,623       1,971,869       906,369       1,045,647  
                                 
Depreciation and amortization
    (1,116,161 )     (2,011,451 )     (548,800 )     (918,075 )
Corporate and unallocated shared expenses
    (2,877,749 )     (2,784,103 )     (1,411,403 )     (1,413,962 )
Write off deferred acquisition costs
    -       (540,007 )     -       (540,007 )
Impairment loss on goodwill and other intangible assets
    (3,100,000 )     (5,500,000 )     -       -  
Other expense, net
     ( 442,918 )      (228,873 )      (206,330 )      (120,771 )
                                 
Net loss
  $ (5,601,205 )   $ (9,092,565 )   $ (1,260,164 )   $ (1,947,168 )
 
   
March 31,
 2010
   
September 30,
2009
 
Assets:
           
Digital Media Services Group
  $ 8,315,582     $ 7,747,921  
Audio and Web Conferencing Services Group
    13,342,065       16,796,925  
Corporate and unallocated
     1,217,231        939,127  
Total assets
  $ 22,874,878     $ 25,483,973  

Depreciation and amortization, as well as write off of deferred acquisition costs and impairment losses on goodwill and other intangible assets, are not utilized by our primary decision makers for making decisions with regard to resource allocation or performance evaluation.

 
49

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 8:  STOCK OPTIONS AND WARRANTS

As of March 31, 2010, we had issued options and warrants still outstanding to purchase up to 2,043,398 ONSM common shares, including 1,564,676 Plan Options; 41,962 Non-Plan Options to employees and directors; 276,156 Non-Plan Options to financial consultants; and 160,604 warrants issued in connection with various financings and other transactions.

On February 9, 1997, our Board of Directors and a majority of our shareholders adopted the 1996 Stock Option Plan (the "1996 Plan"), which, including the effect of subsequent amendments to the 1996 Plan, authorized up to 750,000 shares available for issuance as options and up to another 333,333 shares available for stock grants. On September 18, 2007, our Board of Directors and a majority of our shareholders adopted the 2007 Equity Incentive Plan (the “2007 Plan”), which authorized the issuance of up to 1,000,000 shares of ONSM common stock pursuant to stock options, stock purchase rights, stock appreciation rights and/or stock awards for employees, directors and consultants. The options and stock grants authorized for issuance under the 2007 Plan were in addition to those already issued under the 1996 Plan, although we may no longer issue additional options or stock grants under the 1996 Plan, which expired on February 9, 2007. On March 25, 2010, our Board of Directors and a majority of our shareholders approved a 1,000,000 increase in the number of shares authorized for issuance under the 2007 Equity Incentive Plan (the “2007 Plan”), for total authorization of 2,000,000 shares.

Detail of Plan Option activity under the 1996 Plan and the 2007 Plan for the six months ended March 31, 2010 is as follows:

   
Number of
Shares
   
Weighted
Average
Exercise Price
 
             
Balance, beginning of period
    1,506,458    
$
7.92  
Granted during the period
    124,884    
$
9.42  
Expired or forfeited during the period
     (66,666 )  
$
5.25  
Balance, end of the period
     1,564,676    
$
8.13  
                 
Exercisable at end of the period
     1,274,120    
$
8.27  

We recognized compensation expense of approximately (i) $444,000 and $430,000 for the six months ended March 31, 2010 and 2009 and (ii) $182,000 and $251,000 for the three months ended March 31, 2010 and 2009, respectively, related to Plan Options granted to employees and vesting during those periods. The unvested portion of Plan Options outstanding as of March 31, 2010 (and granted on or after our October 1, 2006 adoption of the requirements of the Compensation - Stock Compensation topic of the ASC) represents approximately $1,056,000 of potential future compensation expense, which excludes approximately $364,000 related to the ratable portion of those unvested options allocable to past service periods and recognized as compensation expense as of March 31, 2010.

 
50

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2010
 
NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

The 1,564,676 outstanding Plan Options all have exercise prices equal to or greater than the fair market value at the dat