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EX-32.1 - EXHIBIT 32.1 - Onstream Media CORPv232113_ex32-1.htm
EX-32.2 - EXHIBIT 32.2 - Onstream Media CORPv232113_ex32-2.htm
EX-31.1 - EXHIBIT 31.1 - Onstream Media CORPv232113_ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - Onstream Media CORPv232113_ex31-2.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 June 30, 2011
OR
 
o
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 o

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 o  No o

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    o
Accelerated filer   o
Non-accelerated filer     o   (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 o   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 August 5, 2011 the registrant had issued and outstanding 11,638,448 shares of common stock.
 
 
 

 

TABLE OF CONTENTS
 
PART I – FINANCIAL INFORMATION
PAGE
   
Item 1 - Financial Statements
 
   
Unaudited Consolidated Balance Sheet at June 30, 2011 and Consolidated Balance Sheet at September 30, 2010
4
   
Unaudited Consolidated Statements of Operations for the Nine and ThreeMonths Ended June 30, 2011 and 2010
5
   
Unaudited Consolidated Statement of Stockholders’ Equity for the Nine Months Ended June 30, 2011
6
   
Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2011 and 2010
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 – 72
   
Item 4 - Controls and Procedures
73
   
PART II – OTHER INFORMATION
 
   
Item 1 – Legal Proceedings
74
   
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
74
   
Item 3 – Defaults upon Senior Securities
75
   
Item 4 – Removed and Reserved
75
   
Item 5 – Other Information
75
   
Item 6 - Exhibits
75
   
Signatures
76
 
 
2

 

CERTAIN CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

 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 our 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. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of June 30, 2011, unless otherwise stated. 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.

When used in this Annual Report, the terms "we", "our", and "us” refers to Onstream Media Corporation, a Florida corporation, and its subsidiaries.
 
 
3

 
 
PART I – FINANCIAL INFORMATION
Item 1 - Financial Statements
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

   
June 30,
2011 (unaudited)
   
September 30,
2010
 
ASSETS
 
CURRENT ASSETS:
           
Cash and cash equivalents
  $ 370,769     $ 825,408  
Accounts receivable, net of allowance for doubtful accounts of $299,914 and $363,973, respectively
     2,657,489        2,805,420  
Prepaid expenses
    464,133       316,591  
Inventories and other current assets
     126,154        125,000  
Total current assets
    3,618,545       4,072,419  
PROPERTY AND EQUIPMENT, net
    2,676,601       2,854,263  
INTANGIBLE ASSETS, net
    914,210       1,284,524  
GOODWILL, net
    12,396,948       12,396,948  
OTHER NON-CURRENT ASSETS
     104,263        104,263  
Total assets
  $ 19,710,567     $ 20,712,417  
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
CURRENT LIABILITIES:
           
Accounts payable
  $ 1,748,245     $ 2,553,366  
    Accrued liabilities
    1,340,466       1,066,960  
    Amounts due to directors and officers
    514,993       374,124  
Deferred revenue
    102,538       141,788  
Notes and leases payable –  current portion, net of discount
    2,068,526       1,904,214  
    Convertible debentures, net of discount
    559,992       1,626,796  
Total current liabilities
    6,334,760       7,667,248  
Notes and leases payable, net of current portion and discount
    60,129       120,100  
Convertible debentures, net of discount
    758,567       815,629  
Detachable warrants, associated with sale of common shares and Series A-14 Preferred
     305,266        386,404  
Total liabilities
     7,458,722        8,989,381  
                 
COMMITMENTS AND CONTINGENCIES
               
                 
STOCKHOLDERS' EQUITY:
               
Series A-13 Convertible Preferred stock, par value $.0001 per share, authorized 170,000 shares, 35,000 issued and outstanding
     3        3  
Series A-14 Convertible Preferred stock, par value $.0001 per share, authorized 420,000 shares, 420,000 issued and outstanding
     42        42  
Common stock, par value $.0001 per share; authorized 75,000,000 shares, 10,534,163 and 8,384,570 issued and outstanding, respectively
     1,053        838  
Additional paid-in capital
    138,681,995       135,453,812  
Unamortized discount
    (183,747 )     (297,422 )
Accumulated deficit
     (126,247,501 )      (123,434,237 )
Total stockholders’ equity
     12,251,845        11,723,036  
Total liabilities and stockholders’ equity
  $ 19,710,567     $ 20,712,417  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
4

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

   
Nine Months Ended
June 30,
   
Three Months Ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
REVENUE:
 
 
         
 
       
    Audio and web conferencing
  $ 5,598,118     $ 5,038,769     $ 1,947,602     $ 1,796,247  
    Webcasting
    4,694,866       4,450,214       1,686,296       1,576,672  
    DMSP and hosting
    1,532,467       1,568,112       474,314       500,739  
    Network usage
    1,442,542       1,415,935       495,432       521,298  
    Other
     83,789        160,535        21,556        35,802  
Total revenue
     13,351,782        12,633,565        4,625,200        4,430,758  
                                 
COSTS OF REVENUE:
                               
    Audio and web conferencing
    1,743,590       1,456,388       576,290       461,573  
    Webcasting
    1,206,779       1,165,288       412,806       373,372  
    DMSP and hosting
    727,251       713,668       210,651       225,890  
    Network usage
    645,050       597,066       216,565       214,752  
    Other
     71,367        271,650        17,430       65,569  
Total costs of revenue
     4,394,037        4,204,060       1,433,742       1,341,156  
                                 
GROSS MARGIN
     8,957,745        8,429,505       3,191,458       3,089,602  
                                 
OPERATING EXPENSES:
                               
General and administrative:
                               
         Compensation
    6,558,735       6,368,200       2,162,279       2,115,488  
         Professional fees
    1,434,726       1,532,406       424,863       614,293  
     Other
    1,629,460       1,731,718       571,877       620,514  
    Impairment loss on goodwill and other intangible assets
     -        3,100,000        -        -  
    Depreciation and amortization
     1,117,425        1,537,729        363,987       421,568  
Total operating expenses
     10,740,346        14,270,053        3,523,006       3,771,863  
                                 
Loss from operations
     (1,782,601 )      (5,840,548 )      (331,548 )      (682,261 )
                                 
OTHER EXPENSE, NET:
                               
    Interest expense
    (1,024,117 )     (962,644 )     (480,265 )     (424,715 )
    Gain from adjustment of derivative liability to fair value
     81,138       -        283,144       -  
    Other income, net
    51,627       128, 101       42,958       33,090  
                                 
Total other expense, net
     (891,352 )      (834,543 )      (154,163 )      (391,625 )
                                 
Net loss
  $ (2,673,953 )   $ (6,675,091 )   $ (485,711 )   $ (1,073,886 )
                                 
Loss per share – basic and diluted:
                               
Net loss per share
  $ (0.28 )   $ (0.87 )   $ (0.05 )   $ (0.14 )
Weighted average shares of common stock outstanding – basic and diluted
      9,514,683         7,635,390         10,307,645         7,880,691  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
5

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
NINE MONTHS ENDED JUNE 30, 2011
(unaudited)
 
   
Series A- 13
Preferred Stock
   
Series A- 14
Preferred Stock
   
Common Stock
   
Additional Paid-in Capital
   
Accumulated
       
   
Shares
   
Amount
   
Shares
   
Amount
   
Shares
   
Amount
   
Gross
   
Discount
   
Deficit
   
Total
 
                                                             
Balance, September 30, 2010
    35,000     $ 3       420,000     $ 42       8,384,570     $ 838     $ 135,453,812     $ (297,422 )   $ (123,434,237 )   $ 11,723,036  
Conversion of debt to common shares
    -       -       -       -       805,938       80       989,140       -       -       989,220  
Sale of common shares
    -       -       -       -       830,000       83       740,439       -       -       740,522  
Issuance of options for employee services
    -       -       -       -       -       -       726,689       -       -       726,689  
Issuance of common shares and options for consultant services
    -       -       -       -       390,576       39       584,370       -       -       584,409  
Issuance of common shares for interest
    -       -       -       -       105,579       11       121,514       -       -       121,525  
Increase in value of common shares underlying Series A-13 preferred, arising from adjustment of conversion rate in connection with note refinancing
      -         -         -         -         -         -         46,084         -         -         46,084  
Dividends on Series A-13
    -       -       -       -       17,500       2       19,947       1,687       (7,636 )     14,000  
Dividends on Series A-14
    -       -       -       -       -       -       -       111,988       (131,675 )     (19,687 )
Net loss
    -       -       -       -       -       -       -       -       (2,673,953 )     (2,673,953 )
                                                                                 
Balance, June 30, 2011
    35,000     $ 3       420,000     $ 42       10,534,163     $ 1,053     $ 138,681,995     $ (183,747 )   $ (126,247,501 )   $ 12,251,845  

The accompanying notes are an integral part of these consolidated financial statements.
 
 
6

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

   
Nine months Ended
June 30,
 
   
2011
   
2010
 
             
CASH FLOWS FROM OPERATING ACTIVITIES:
           
    Net loss
  $ (2,673,953 )   $ (6,675,091 )
    Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
               
        Impairment loss on goodwill and other intangible assets
    -       3,100,000  
        Depreciation and amortization
    1,117,425       1,537,729  
        Professional fee expenses paid with equity, including amortization of deferred expenses for prior period issuances
    421,147       570,492  
        Compensation expenses paid with options and other equity
    859,941       635,109  
        Other expenses paid with equity
    42,218       -  
        Amortization of discount on convertible debentures
    151,794       302,330  
        Amortization of discount on notes payable
    158,162       174,798  
        Interest expense paid in common shares and options
    322,106       96,546  
        Bad debt expense
    342       125,057  
        Gain from adjustment of derivative liability to fair value
    (81,138 )     -  
        Gain from settlements of obligations and sales of equipment
    (34,270 )     (122,531 )
        Net cash provided by (used in) operating activities, before changes in current assets and liabilities
    283,774       (255,561 )
        Changes in current assets and liabilities:
               
Decrease (Increase) in accounts receivable
    147,590       (711,860 )
(Increase) in prepaid expenses
    (11,182 )     (44,761 )
(Increase) Decrease in inventories and other current assets
    (1,155 )     76,962  
(Decrease) Increase in accounts payable, accrued liabilities and amounts due to directors and officers
    (323,096 )      514,815  
(Decrease) in deferred revenue
    (39,250 )     (31,226 )
Net cash provided by (used in) operating activities
  $ 56,681     $ (451,631 )
                 
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Acquisition of property and equipment
  $ (740,074 )   $ (862,024 )
Narrowstep acquisition costs (written off to expense in March 2009)
    -       (115,000 )
Net cash used in investing activities
  $ (740,074 )   $ (977,024 )
 
(Continued)
 
 
7

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

 (continued)

   
Nine months Ended
June 30,
 
   
2011
   
2010
 
CASH FLOWS FROM FINANCING ACTIVITIES:
           
    Proceeds from sale of common shares, net of expenses
  $ 740,522     $ -  
    Proceeds from notes payable, net of expenses
    1,019,241       1,254,192  
    Proceeds from convertible debentures
    -       1,067,500  
    Proceeds from sale of A-13 preferred shares, net of expenses
    -       (6,747 )
    Repayment of notes and leases payable
    (1,094,254 )     (960,539 )
    Repayment of convertible debentures
    (436,755 )      (130,000 )
Net cash provided by financing activities
  $ 228,754     $ 1,224,406  
                 
NET DECREASE IN CASH AND CASH EQUIVALENTS
  $ (454,639 )   $ (204,249 )
                 
CASH AND CASH EQUIVALENTS, beginning of period
    825,408       541,206  
                 
CASH AND CASH EQUIVALENTS, end of period
  $ 370,769     $ 336,957  
                 
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
               
       Cash payments for interest
  $ 392,055     $ 388,970  
 
               
                 
SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
                 
       Issuance of shares and options for consultant services
  $ 584,409     $ 616,854  
       Issuance of options for employee services
  $ 726,689     $ 635,109  
       Issuance of common shares and warrants for interest and fees
  $ 121,525     $ 493,048  
       Issuance of common shares upon debt conversion
  $ 989,220     $ -  
       Increase in value of common shares underlying Series A-13 preferred, arising from adjustment of conversion rate in connection with note refinancing
  $ 46,084     $ -  
       Issuance of common shares, or right to obtain common shares, for financing fees
  $ -     $ 116,250  
       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
  $ 21,000     $ 14,000  
       Issuance of common shares for dividends payable on A-13 preferred shares
  $ 19,949     $ -  
       Elimination of obligation for previously accrued or declared dividends payable on A-13 preferred shares
  $ 15,051     $ -  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
8

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
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 corporate audio and web communications, virtual event technology and social media marketing, provided primarily to corporate (including large as well as small to medium sized businesses), education and government customers.

The Digital Media Services Group consists primarily of our Webcasting division, our DMSP (“Digital Media Services Platform”) division and our MP365 (“MarketPlace365”) division. The DMSP division includes the related UGC (“User Generated Content”) and Smart Encoding divisions.

The Webcasting division, which operates primarily from Pompano Beach, Florida and has its main sales facility in New York City, provides an array of corporate-oriented, web-based media services to the corporate market including live audio and video webcasting and on-demand audio and video streaming for any business, government or educational entity. The Webcasting division generates revenue primarily through production and distribution fees.

The DMSP division, which operates primarily from 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 DMSP division generates revenues primarily from monthly subscription fees, plus charges for hosting, storage and professional services. Our UGC division, which also operates as Auction Video (see note 2) and operates primarily from Colorado Springs, Colorado, 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 San Francisco, California, provides both automated and manual encoding and editorial services for processing digital media. This division also provides hosting, storage and streaming services for digital media, which are provided via the DMSP.

The MP365 division, which operates primarily from Pompano Beach, Florida with additional operations in San Francisco, California, enables publishers, associations, tradeshow promoters and entrepreneurs to self-deploy their own online virtual marketplaces using the MarketPlace365® platform. The MP365 division generates revenues primarily from monthly booth fees charged to MP365 promoters.

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 the New York City 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.

The EDNet division, which operates primarily from 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 generates revenues primarily from network access and usage fees as well as sale, rental and installation of equipment.
 
 
9

 


ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
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 $126.2 million as of June 30, 2011. Our operations have been financed primarily through the issuance of equity and debt. For the year ended September 30, 2010, we had a net loss of approximately $9.3 million, although cash used in operations for that period was approximately $197,000. For the nine months ended June 30, 2011, we had a net loss of approximately $2.7 million, although cash provided by operations for that period was approximately $57,000. Although we had cash of approximately $371,000 at June 30, 2011, our working capital was a deficit of approximately $2.7 million at that date.

During March and April 2011, we took actions which reduced quarterly compensation and other expenses by approximately $75,000 for the third quarter of fiscal 2011 and we expect will reduce those expenses by another approximately $25,000 for the fourth quarter of fiscal 2011. Based on our results for the three months ended June 30, 2011, and these expected compensation and other expense reductions, we estimate that future revenues at the levels experienced for the three months ended June 30, 2011 would adequately fund our anticipated ongoing cash expenditures (including monthly principal and interest payments on the Rockridge Note, interest payable in cash on the Line and other debts and capital expenditures).  However, we have historically experienced a seasonal decrease in our revenues and a corresponding increase in cash used by operations in the fourth fiscal quarter, which we expect will continue to be the case in the fourth quarter of fiscal 2011. Furthermore, even if we were to maintain this revenue level, we will also require additional debt or equity financing of approximately $750,000 through September 30, 2011 for repayment of the Equipment Notes (see note 4) plus past due trade payables and other liabilities that we believe are necessary to pay to continue our operations. This requirement is in addition to the approximately $584,000 proceeds we received from sales of equity to LPC in July and August 2011 (see note 6).

If we were to achieve future revenue in excess of the levels experienced in the third quarter of fiscal 2011, or if any of the holders of the Equipment Notes elected to convert a portion of the existing debt to equity as allowed for under the terms, the required financing could be less than this $750,000. However, if we did not achieve this revenue level, or if our operating expenses, cash interest or capital expenditures are higher than anticipated, the required financing could be greater than this $750,000.

We have implemented and continue to implement specific actions, including hiring additional sales personnel, developing new products and initiating new marketing programs, geared towards achieving revenue increases. The costs associated with these actions were contemplated in the above calculations.  However, in the event we are unable to achieve the required 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, 2012. We will closely monitor our revenue and other business activity to determine if and when 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
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Liquidity (continued)

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. On September 17, 2010, we entered into a Purchase Agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to purchase our common and preferred shares, and 1.6 million common shares (including those issuable upon conversion of the preferred shares we sold to them) were included in a prospectus supplement filed by us with the SEC in connection with a takedown under the Shelf Registration. The Purchase Agreement was amended in April 2011 to increase the number of common shares that LPC agreed to purchase (at our option) and an additional 2.5 million common shares were included in a second prospectus supplement filed by us with the SEC in connection with a takedown under the Shelf Registration.

On September 24, 2010, we received $824,044 net proceeds (after deducting fees and legal, accounting and other out-of-pocket costs incurred by us) related to our issuance under that Purchase Agreement of the equivalent of 770,000 common shares (including those issuable upon conversion of preferred shares). During the nine months ended June 30, 2011, we sold LPC an additional 830,000 shares of our common stock under that Purchase Agreement for net proceeds of $740,522. Since June 30, 2011, we sold an additional 600,000 shares of our common stock to LPC under that Purchase Agreement for net proceeds of $583,673.  LPC remains committed to purchase, at our sole discretion, up to an additional 1.9 million shares of our common stock in installments over the remaining term of the Purchase Agreement, generally at prevailing market prices, but subject to the specific restrictions and conditions in the Purchase Agreement, including but not limited to a minimum market price of $0.75 per share.

There is no assurance that we will sell additional shares to LPC under the Purchase Agreement or that we will sell additional shares to any other party under the Shelf Registration, or if we do make such sales what the timing or proceeds will be. 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, which in the case of LPC has been obtained but would need to be requested with respect to any other purchaser.

On January 4, 2011, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”) irrevocably agreeing to provide us, within twenty (20) days after our notice given on or before December 31, 2011, aggregate cash funding of up to $500,000, which may be requested in multiple tranches. Mr. Charles Johnston, one of our directors, is the president of J&C. This Funding Letter was obtained solely to demonstrate our ability to obtain short-term funds in the event other funding sources are not available, but does not represent any obligation to accept such funding on these terms and is not expected by us to be exercised. Cash provided under the Funding Letter would be in exchange for our issuance of (a) a note or notes with interest payable monthly at 15% per annum and principal payable on the earlier of a date twelve months from funding or July 1, 2012 and (b) our issuance of 1 million unregistered common shares, which shares would be prorated in the case of partial funding. The note or notes would be unsecured and subordinated to all of our other debts, except to the extent such the terms of such debts would allow pari passu status. Furthermore, the note or notes would not be subject to any provisions, other than with respect to priority of payments or collateral, of our other debts. Upon receipt by us of an equivalent amount in dollars of investment from any other source after the date of this Funding Letter, other than funding received in connection with the LPC Purchase Agreement, this Funding Letter will be terminated.
 
 
11

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Liquidity (continued)

Our continued existence is dependent upon our ability to raise capital and to market and sell our services successfully. However, there are no assurances whatsoever that we will be able to sell additional common shares or other forms of equity under the LPC Purchase Agreement, the Shelf Registration or otherwise and/or that we will be able to borrow further funds under the Funding Letter or otherwise and/or that we will increase our revenues and/or control our expenses to a level sufficient to provide positive cash flow. 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.

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.

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 reduce 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.
 
 
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ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 Lehmann Note, 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) are (or were) 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.

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.
 
 
13

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Fair Value Measurements (continued)

We have determined that there are no Level 1 inputs for determining the fair value of the Lehmann Note, 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 Lehmann Note, 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 Lehmann Note, 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 Lehmann Note, 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 September 30, 2009, March 31, 2010, June 30, 2010, September 30, 2010, March 31, 2011 or June 30, 2011 (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 nine and three months ended June 30, 2011 and 2010, respectively.

In accordance with the Financial Instruments topic of the ASC, 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. We have elected not to measure eligible financial assets and liabilities at fair value.

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.
 
 
14

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

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 goods 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.
 
 
15

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition (continued)

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 June 30, 2011 and September 30, 2010 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.

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.

 
16

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Revenue Recognition (continued)

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 classified in our financial statements under Professional Fees or under Other General and Administrative Operating Expenses, were approximately $539,000 and $339,000 for the nine months ended June 30, 2011 and 2010, respectively, and were approximately $183,000 and $133,000 for the three months ended June 30, 2011 and 2010, respectively. These amounts include third party marketing consultant fees and third party sales commissions, but do not include commissions or other compensation to our employee sales staff.
 
 
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ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Income Taxes

As part of the process of preparing our consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within our consolidated balance sheet. We then assess the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we establish a valuation allowance. To the extent we establish a valuation allowance or change this allowance in a period, we include an expense or a benefit within the tax provision in our statement of operations.

We have approximately $93 million in Federal net operating loss carryforwards as of June 30, 2011, approximately $8 million which expire in fiscal years 2011 through 2012 and approximately $85 million which expire in fiscal years 2018 through 2030.  Our utilization of approximately $20 million of the net operating loss carryforwards, acquired from the 2001 acquisition of EDNet and the 2002 acquisition of MOD and included in this $93 million total, against future taxable income may be limited as a result of ownership changes and other limitations.

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 $35.2 million as of June 30, 2011, 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 nine and three months ended June 30, 2011 and 2010.  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 June 30, 2011 and September 30, 2010, respectively, 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 nine and three months ended June 30, 2011 and 2010. The tax years ending September 30, 2007 and thereafter remain subject to examination by Federal and various state tax jurisdictions.
 
 
18

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Net Loss per Share

For the nine and three months ended June 30, 2011 and 2010, net loss per share is based on the net loss divided by the weighted average number of shares of common stock outstanding. 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 3,322,539 and 2,029,606 at June 30, 2011 and 2010, respectively.

In addition, the potential dilutive effects of the following convertible securities outstanding at June 30, 2011 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 175,000 shares of ONSM common stock, (ii) 420,000 shares of Series A-14 Convertible Preferred Stock which could potentially convert into 420,000 shares of ONSM common stock (iii) $500,000 of convertible notes which in aggregate could have potentially converted into up to 104,167 shares of our common stock (and of which $50,000 was subsequently repaid, $50,000 was subsequently converted into 55,556 common shares and $350,000 was subsequently given the right to convert into up to 388,889 common shares – see note 4), excluding interest, (iv) the right to receive 366,667 restricted shares of our common stock for an origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us, (v) the $914,967 convertible portion of the Rockridge Note which could have potentially converted into up to 381,236 shares of our common stock and (vi) the $200,000 CCJ Note, which could have potentially converted into up to 100,000 shares of our common stock (and of which $90,000 was subsequently converted into 100,000 common shares – see note 4).

Furthermore, if we were to 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 could be converted into restricted shares of our common stock, which would have been 172,903 shares as of June 30, 2011 (in addition to the 381,236 shares noted above).

The potential dilutive effects of the following convertible securities outstanding at June 30, 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 have potentially converted into 116,667 shares of ONSM common stock, (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), (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 have potentially converted into up to 208,333 shares of our common stock, (v) the $200,000 CCJ Note, which could have potentially converted into up to 66,667 shares of our common stock, (vi) the $198,000 remaining outstanding balance of the Greenberg Note, which could have potentially converted into up to 82,500 shares of our common stock, (vii) the $422,000 outstanding balance of the Wilmington Notes, which could have potentially converted into up to 179,272 shares of our common stock and  (viii) the $250,000 outstanding balance of the Lehmann Note, which could potentially have potentially converted into up to 122,549 shares of our common stock.
 
 
19

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

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 $978,000 and $779,000 as of June 30, 2011 and September 30, 2010, respectively, related to salaries, commissions, taxes, vacation and other benefits earned but not paid as of those dates.

Equity Compensation to Employees and Consultants

We have a stock based compensation plan (the “Plan”) for our employees, directors and consultants. 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 nine and three months ended June 30, 2011 and 2010 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. For  Plan options that were granted and thus valued under the Black-Scholes model during the three months ended June 30, 2011, the expected volatility rate was approximately 94%, the risk-free interest rate was approximately 1.5% and the expected term was approximately 4 years. For Plan options that were granted and thus valued under the Black-Scholes model during the three months ended March 31, 2011, the expected volatility rate was approximately 94%, the risk-free interest rate was approximately 1.5% and the expected term was approximately 4 years. There were no Plan options granted during the three months ended December 31, 2010. There were no 2007 options granted during the six months ended June 30, 2010. For Plan options that were granted (or extended) and thus valued under the Black-Scholes model during the three months ended December 31, 2009, the expected volatility rate was approximately 88%, the risk-free interest rate was approximately 2.5% and the expected term was approximately 5 years.

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 June 30, 2011. For Non-Plan options that were granted and thus valued under the Black-Scholes model during the three months ended March 31, 2011, the expected volatility rate was approximately 94%, the risk-free interest rate was approximately 1.5% and the expected term was 4 years. There were no Non-Plan options granted during the three months ended December 31, 2010. There were no Non-Plan options granted during the six months ended June 30, 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 approximately 91 to 97%, the risk-free interest rate was approximately 1.9% to 2.6% and the expected term was 4 to 5 years.
 
 
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ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Equity Compensation to Employees and Consultants (continued)

In all valuations above, expected dividends were $0 and the expected term was the full term of the related options (or in the case of extended options, the incremental increase in the option term as compared to the remaining term at the time of the extension). See Note 8 for additional information related to all stock option issuances.

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 classifications between accounts payable, accrued liabilities and amounts due to directors and officers and the composition of amounts disclosed as cash payments for interest and advertising and marketing costs.

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 generally accepted accounting principles for complete financial statements and should be read in conjunction with our annual financial statements as of September 30, 2010. 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 June 30, 2011 and the results of our operations and cash flows for the nine and three months ended June 30, 2011 and 2010. 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, 2011.
 
 
21

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Effects of Recent Accounting Pronouncements

The Fair Value Measurements and Disclosures topic of the Accounting Standards Codification (“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.

In January 2010, the FASB issued ASC update number 2010-06 (“Update 2010-06”), which requires new and revised disclosures for fair value measurements, 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 and the disclosures related to the rollforward of activity for Level 3 fair value measurements are effective for our fiscal year ending 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.

In May 2011, the FASB issued updated accounting guidance related to fair value measurements and disclosures, which includes amendments that clarify the intent about the application of existing fair value measurements and disclosures, while other amendments change a principle or requirement for fair value measurements or disclosures.  This guidance is effective for our fiscal year ending September 30, 2013, is to be adopted prospectively and early adoption is not permitted.  We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.

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, although they did not have a material impact on our financial position, results of operations or cash flows.

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.
 
 
22

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)

Effects of Recent Accounting Pronouncements (continued)

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.

ASC Topic 415, Derivatives and Hedging, outlines a two-step approach to evaluate an instrument’s contingent exercise provisions, if any, and to evaluate the instrument’s settlement provisions when determining whether an equity-linked financial instrument (or embedded feature) is indexed to an entity’s own stock, which would in turn determine whether the instrument was treated as a liability to be recorded on the balance sheet at fair value and then adjusted to market in subsequent accounting periods. These provisions were first effective for our fiscal year beginning October 1, 2009. There were no outstanding instruments that this accounting would apply to as of the beginning of the fiscal year of adoption, and therefore there was no cumulative-effect adjustment recorded to the opening balance of retained earnings related to this issue. However, it was determined that this pronouncement did apply to warrants issued by us in September 2010 – see note 8.

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 were effective for our fiscal year ending September 30, 2011 and were adopted by us accordingly, on a prospective basis. These requirements are not expected to have a material impact on our financial position or results of operation.

In June 2011, the FASB issued authoritative guidance related to the presentation of comprehensive income.  The guidance requires that all non-owner changes in stockholders’ equity be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements.  The guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  This guidance is effective for our fiscal year ending September 30, 2011, is to be applied retrospectively and early adoption is permitted.  We will adopt the guidance beginning in the first quarter of fiscal year 2012 and do not believe the adoption of this guidance will have a material impact on our consolidated financial statements.
 
 
23

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

Information regarding the Company’s goodwill and other acquisition-related intangible assets is as follows:

   
June 30, 2011
   
September 30, 2010
 
   
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     $ 8,600,887     $ -     $ 8,600,887  
  Acquired Onstream
    2,521,401       -       2,521,401       2,521,401       -       2,521,401  
  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
    12,396,948       -       12,396,948       12,396,948       -       12,396,948  
                                                 
Acquisition-related intangible assets (items listed are those remaining on our books as of June 30, 2011):
 
Infinite  Conferencing  - customer lists,  trademarks and URLs
       3,181,197       ( 2,359,442 )        821,755          3,181,197       ( 2,021,321 )        1,159,876  
Auction Video - patent pending
     338,138       ( 245,683 )      92,455        321,815       ( 197,167 )      124,648  
Total intangible assets
    3,519,335       ( 2,605,125 )     914,210       3,503,012       ( 2,218,488 )     1,284,524  
                                                 
Total goodwill and other acquisition-related intangible assets
  $  15,916,283     $ (2,605,125 )   $ 13,311,158     $  15,899,960     $ (2,218,488 )   $ 13,681,472  
 
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.
 
 
24

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
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 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 have been and are amortizing these assets over useful lives ranging from 3 to 6 years - as of September 30, 2010 the assets with a useful life of three years (favorable contractual terms and employment and non-compete agreements) had been fully amortized and removed from our balance sheet.

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. 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. Furthermore, as discussed in “Testing for Impairment” below, 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 nine months ended June 30, 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.

 
25

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
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 have been and are being amortized over various lives between two to five years commencing April 2007 -  as of September 30, 2010 the assets with a useful life of two or three years (customer lists and the consulting and non-compete agreements) had been fully amortized and removed from our balance sheet.

$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 final rejections in January 2010 and June 2010. Our responses to certain of these rejections included modifications to certain claims made in the original patent application. In response to the latest rejection we filed a Notice of Appeal with the USPO on November 22, 2010 and we filed an appeal brief with the USPO on February 9, 2011. The USPO filed an Examiner's Answer to the Appeal Brief on May 10, 2011, which repeated many of the previous reasons for rejection, and we filed a response to this filing on July 8, 2011. A decision will be made as to our appeal by a three member panel based on these filings, plus oral argument at a hearing which has been requested by us but a time not yet set. The expected timing of this decision is uncertain at this time, but generally would be expected to occur during the timeframe from late 2012 to mid 2013. 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. 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.
 
 
26

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

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. 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. Furthermore, as discussed in “Testing for Impairment” below, the Acquired Onstream goodwill was determined to be further impaired as of September 30, 2010 and a $1.6 million adjustment was made to reduce the carrying value of that goodwill to approximately $2.5 million as of that date.

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.
 
 
27

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

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

Testing for Impairment (continued)

There is a two step process for impairment testing of goodwill and other intangible assets. 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, 2009. 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 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, a $3.1 million adjustment was made to reduce the carrying value of goodwill as of that date, which we reflected as a non-cash expense for the nine months ended June 30, 2010.

As the result of the decline in the price of our common stock from $1.86 per share as of March 31, 2010 to $1.03 as of June 30, 2010, it appeared that our market value (after appropriate adjustments for control premium and other considerations) was probably less than our net book value as of June 30, 2010. However, we concluded that the decline in market value as of June 30, 2010 was not of sufficient duration nor was it otherwise indicative of a triggering event that would require an interim impairment review. However, this decline continued after June 30, 2010 and resulted in a common stock price of $1.04 as of September 30, 2010 (and $0.76 as of December 23, 2010).  As a result, we determined that it was appropriate for us to evaluate whether our goodwill and other intangible assets were impaired as of September 30, 2010. We performed impairment tests on Infinite, EDNet and Acquired Onstream as of September 30, 2010, using the same methodologies discussed above.  Based on these factors, we concluded that there was no impairment of the assets of Infinite or EDNet as of that date. However, we determined that Acquired Onstream’s goodwill was impaired as of that date and based on that condition, a $1.6 million adjustment was made to reduce the carrying value of goodwill as of that date.

The market price of our common stock increased from $0.80 per share as of December 31, 2010 to $1.06 per share as of February 4, 2011 and to $1.65 per share as of March 31, 2011. Based on this recovery of the market value of our stock as compared to the valuations that were considered as part of the September 30, 2010 valuation, we concluded that there were no triggering events that would require an interim impairment review as of December 31, 2010 or as of March 31, 2011. Although the price of our common stock had declined to $1.01 per share as of June 30, 2011 and to $0.90 per share as of August 5, 2011, it had increased to as high as $1.29 per share as of July 21, 2011 and thus we concluded that the decline in market value as of June 30, 2011 was not of sufficient duration nor was it otherwise indicative of a triggering event that would require an interim impairment review.

An annual impairment review of our goodwill and other acquisition-related intangible assets will be performed as part of preparing our September 30, 2011 financial statements. The valuations of Infinite, EDNet and Acquired Onstream incorporate, among other things, our management’s estimates of future sales and operating income, which in turn take into account specific company, product and customer factors, as well as general economic conditions. Accordingly, even if our market value were to exceed our net book value at the time of this annual review for impairment, the review may result in write-downs.

 
28

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 3:  PROPERTY AND EQUIPMENT

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

   
June 30, 2011
   
September 30, 2010
       
   
Historical Cost
   
Accumulated Depreciation and Amortization
   
Net Book Value
   
Historical Cost
   
Accumulated Depreciation and Amortization
   
Net Book Value
   
Useful Lives
(Yrs)
 
Equipment and software
  $ 10,181,587     $ ( 9,720,626 )   $ 460,961     $ 10,367,283     $ ( 9,596,497 )   $ 770,786       1-5  
DMSP
    5,704,518       ( 5,123,842 )     580,676       5,890,134       ( 5,113,292 )     776,842       3-5  
Other capitalized internal use software
      2,349,150       ( 767,929 )       1,581,221         1,840,136       ( 599,753 )       1,240,383         3-5  
Travel video library
     1,368,112       ( 1,368,112 )     -        1,368,112       ( 1,368,112 )     -       N/A  
Furniture, fixtures and leasehold improvements
       545,470       ( 491,727 )        53,743          540,669       ( 474,417 )        66,252           2-7  
Totals
  $ 20,148,837     $ (17,472,236 )   $ 2,676,601     $ 20,006,334     $ (17,152,071 )   $ 2,854,263          
 
Depreciation and amortization expense for property and equipment was approximately $731,000 and $1,041,000 for the nine months ended June 30, 2011 and 2010, respectively, and approximately $235,000 and $285,000 for the three months ended June 30, 2011 and 2010, 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, and was recorded at an initial amount of approximately $2.7 million. Subsequent to the Onstream Merger, we continued to make payments under the SAIC contract and to other vendors, which were recorded as an increase in the DMSP’s carrying cost. The SAIC contract terminated by mutual agreement of the parties on June 30, 2008. Although cancellation of the contract released SAIC to offer what was 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.

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.

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 that date. Based on our determination of the fair value of the transcoder at that date, $600,000 was added to the DMSP’s carrying cost, which additional cost was depreciated over a three-year life commencing April 2007.
 
 
29

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 3:  PROPERTY AND EQUIPMENT (Continued)

On March 31, 2008 we agreed to pay $300,000 for a perpetual license for certain digital asset management software, in addition to a limited term license we purchased in 2007 for $281,250. At the time of the 2008 purchase, in addition to our previous use of this software to provide our automatic meta-tagging services in our Smart Encoding division, we expanded its use to the provision of our core DMSP services. Therefore, we recorded a portion of the 2008 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. As a result of a litigation settlement reached in June 2011 with the provider of this software, whereby we gave up all rights to the above licenses in exchange for a reduced payment, effective June 30, 2011 we reduced the DMSP’s carrying cost by this $243,750, which had a remaining unamortized portion of $85,312 as of that date. We also reduced the carrying cost of other equipment and software by $337,500, which had a remaining unamortized portion of $85,313 as of that date. The June 2011 settlement resulted in a $204,895 reduction of the accounts payable previously reflected on our financial statements in connection with these licenses. This accounts payable reduction, offset by the aggregate $170,625 write-off of the unamortized cost of these software licenses, resulted in a net amount of $34,270 reflected as other income for the three and nine months ended June 30, 2011.

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 $830,000 of employee compensation, payments to contract programmers and related costs as of June 30, 2011, including $56,000 capitalized during the nine months ended June 30, 2011, $314,000 during the year ended September 30, 2010, $274,000 during the year ended September 30, 2009 and $186,000 during the year ended September 30, 2008. As of June 30, 2011, approximately $761,000 of these Streaming Publisher 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. Streaming Publisher is a stand-alone product based on a different architecture than Store and Stream and is a primary building block of the MP365 platform, discussed below.

Other capitalized internal use software as of June 30, 2011 includes approximately $972,000 of employee compensation and payments to contract programmers for development of the MP365 platform, which enables the creation of on-line virtual marketplaces and trade shows utilizing many of our other technologies such as DMSP, webcasting, UGC and conferencing. Approximately $389,000 was capitalized during the nine months ended June 30, 2011, $435,000 during the year ended September 30, 2010 and $148,000 during the year ended September 30, 2009. $297,000 of these costs, for phase one of MP365, were first placed in service as of August 1, 2010 and are being depreciated over five years. The remaining $675,000 of these costs, for phase two of MP365, were first placed in service as of July 1, 2011 and will be depreciated over five years. This excludes costs for development of Streaming Publisher, discussed above.

Other capitalized internal use software as of June 30, 2011 includes approximately $798,000 of employee compensation and other costs for the development of iEncode software, which runs on a self-administered, webcasting appliance used to produce a live video webcast. Approximately $117,000 was capitalized during the nine months ended June 30, 2011, $180,000 during the year ended September 30, 2010, $288,000 during the year ended September 30, 2009 and $213,000 during the year ended September 30, 2008. As of June 30, 2011, $761,000 of these iEncode costs had been placed in service and are being depreciated over five years. The remainder of the costs have not been placed in service and relate primarily to new versions and/or releases of iEncode under development.
 
 
30

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT

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

Convertible Debentures

Convertible debentures consist of the following:

   
June 30,
 2011
   
September 30, 2010
 
Equipment Notes
  $ 500,000     $ 1,000,000  
CCJ Note
    200,000       200,000  
Rockridge Note (excluding portion classified under notes payable)
    914,967       1,016,922  
Greenberg Note
    -       159,000  
Wilmington Notes
    -       344,000  
Lehmann Note
    -       211,000  
Total convertible debentures
    1,614,967       2,930,922  
Less: discount on convertible debentures
    (296,408 )     (488,497 )
Convertible debentures, net of discount
    1,318,559       2,442,425  
Less: current portion, net of discount
    ( 559,992 )     ( 1,626,796 )
Convertible debentures, net of current portion
  $ 758,567     $ 815,629  

Equipment Notes

In June and July 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 had an original maturity date of June 3, 2011.

On April 4, 2011 certain of the Equipment Notes, including the note held by CCJ, were amended to allow the conversion of 25% of the original note amount into common shares, using a conversion price of $1.20 per share. As a result, we issued an aggregate of 177,086 unregistered common shares for the conversion of $212,500 of the principal outstanding under the Equipment Notes. On April 28, 2011 another one of the Equipment Notes was amended to allow the conversion of 25% of the original note amount into common shares, using a conversion price of $1.20 per share. As a result, we issued 10,417 unregistered common shares for the conversion of $12,500 of the principal outstanding under the Equipment Notes. On April 28, 2011 certain of the Equipment Notes were amended, including the note held by CCJ, to allow the conversion of another 25% of the original note amount into common shares, using a conversion price of $1.00 per share. As a result, we issued an aggregate of 225,000 unregistered common shares for the conversion of $225,000 of the principal outstanding under the Equipment Notes. On June 10, 2011 another one of the Equipment Notes was amended to allow the conversion of 25% of the original note amount into common shares, using a conversion price of $1.20 per share and to allow the conversion of another 25% of the original note amount into common shares, using a conversion price of $1.00 per share. As a result, we issued 45,833 unregistered common shares for the conversion of $50,000 of the principal outstanding under the Equipment Notes. The aggregate market value of these 458,336 shares at the times of their respective issuances exceeded the carrying value of the related Equipment Notes by $200,582, which excess was recognized as non-cash interest expense for the nine and three months ended June 30, 2011.
 
 
31

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes (continued)

Of the $500,000 remaining principal outstanding under the Equipment Notes as of June 30, 2011, $50,000 was subsequently repaid by us in cash, $50,000 was subsequently converted into 55,556 common shares, $350,000 (including the note held by CCJ) was subsequently amended to provide for a September 3, 2011 maturity date and a $0.90 per common share conversion rate (at the Investors’ option) and $50,000 was not amended to provide for a later maturity date but remains unpaid, pending the conclusion of our discussions with the holder. For this $50,000 note that was not amended, the conversion price would be 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.

The Equipment Notes are collateralized by specifically designated software and equipment owned by us with a cost basis of approximately $1.2 million, plus 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. 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 Investors initially 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. In some cases, the 2011 amendments to the Equipment Notes set a minimum conversion rate of $1.20 per common share for the final interest payment. In lieu of cash payments for interest previously due on these Equipment Notes, we elected to issue the following unregistered common shares to the Investors, which were recorded based on the fair value of those shares on the issuance date.

 
Share issuance date
 
Number of unregistered common shares
 
 
Interest period
 
Interest if paid in cash
   
Fair value of shares at issuance
 
November 11, 2008
    26,333  
June - October 2008
  $ 48,740     $ 69,520  
May 21, 2009
    49,098  
Nov 2008 - April 2009
  $ 60,000     $ 67,756  
November 11, 2009
    34,920  
May - October 2009
  $ 60,493     $ 67,040  
April 30, 2010
    44,369  
Nov 2009 - April 2010
  $ 59,507     $ 92,288  
December 2, 2010
    76,769  
May - October 2010
  $ 60,493     $ 71,395  
April 28, 2011
    28,810  
Nov 2010 – March 2011
  $ 24,986     $ 50,129  
July 21, 2011
    5,233  
Nov 2010 – June 2011
  $ 6,279     $ 6,384  

In connection with the April 4, 2011 note amendments, interest was paid on certain of those Equipment Notes through March 31, 2011 and in connection with the repayment of $50,000 in July 2011, interest was paid on certain of those Equipment Notes through June 3, 2011. A final interest payment will be made on the September 3, 2011 maturity date for all of the Equipment Notes, which in some cases will cover a period commencing November 1, 2010.
 
 
32

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes (continued)

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 was amortized as interest expense over the original three year term of the Equipment Notes. The unamortized portion of this discount was $2,046 and $57,144 at June 30, 2011 and September 30, 2010, respectively. The effective interest rate of the Equipment Notes is approximately 19.5% per annum, excluding the effect of the premium arising from our payment of interest in common shares instead of cash, based on the market prices of our common shares at the time of issuance.  Furthermore, this effective rate also does not reflect the excess of the market value of common shares, issued with respect to the conversion of certain Equipment Notes, over the carrying value of those Equipment Notes, as discussed above.

CCJ Note

On December 29, 2009, we entered into an agreement with CCJ whereby a previously received $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 none of those payments were subsequently made by us. To resolve this payment default, the CCJ Note was amended in January 2011 to prospectively increase the interest rate to 10% per annum, payable quarterly, and to require two principal payments of $100,000 each on December 31, 2011 and December 31, 2012, respectively. In connection with this amendment, we paid $16,263 in cash for the previously accrued interest. 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) $2.00 per share (which was $3.00 per share prior to the January 2011 renegotiation). On July 22, 2011, in order to reduce our near-term cash requirements, we agreed to convert $90,000 of the $100,000 December 31, 2011 principal payment to 100,000 restricted common shares. Although the market value of these shares at the time of the agreement exceeded the related principal amount by $38,000, we did not make the shares physically available to CCJ until two weeks later, by which time the market price had reduced to a level equal to the related principal amount. Accordingly, we have determined that there was not an effective conversion premium over market and therefore there will be no recognition of additional non-cash interest expense other than the write-off of debt discount as discussed below. The remaining $10,000 principal, plus the interest due on the $90,000 from April 1, 2011 and the interest due on the $10,000 from July 22, 2011, will be payable on December 31, 2011.
 
In conjunction with and in consideration of the December 29, 2009 note transaction, the 35,000 shares of Series A-12 held by CCJ at that date were exchanged for 35,000 shares of Series A-13 plus four-year warrants for the purchase of 29,167 ONSM common shares at $3.00 per share. In conjunction with and in consideration of the January 2011 note amendment, certain terms of the 35,000 shares of Series A-13 held by CCJ at that date were modified – see note 6.
 
 
33

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

CCJ Note (continued)

The effective interest rate of the CCJ Note prior to the January 2011 amendment was 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 included 11.2% per annum related to dividends that would have accrued 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. Following the January 2011 amendment, the effective interest rate of the CCJ Note increased to approximately 78.5% per annum, reflecting the $46,084 value of the increased number of common shares underlying the Series A-13 shares as a result of the modified terms, which we recorded as a debt discount,  the increase in the periodic cash interest rate from 8% to 10% per annum and the 9.3% per annum related to dividends that could accrue to CCJ as a result of the later mandatory conversion date of the Series A-13 shares as a result of the modified terms.

The unamortized portion of the debt discount was $94,905 and $114,577 at June 30, 2011 and September 30, 2010, respectively. Through December 31, 2010, the discount was being amortized as interest expense over the original four-year term of the CCJ Note. Effective January 1, 2011, the remaining unamortized discount, plus additional discount arising from the modified terms, is being amortized as interest expense over the modified two-year term of the CCJ Note. Approximately $28,000 of the unamortized discount will be written off to interest expense in July 2011 in connection with the conversion of $90,000 debt principal to common shares, as discussed above.

Rockridge Note

A portion of the Rockridge Note ($914,967 face value, which is $715,510 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 June 30, 2011 balance sheet. This convertible portion was $1,016,922 ($736,699 net of discount) as of September 30, 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 was repayable in principal installments of $13,000 per month beginning March 1, 2010. We repaid the $159,000 principal balance due under the Greenberg Note in cash on October 1, 2010. The unamortized portion of the debt discount was $9,911 at September 30, 2010, which was written off to interest expense upon the repayment of the loan on October 1, 2010.

 
34

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

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 were repayable in aggregate principal installments of $26,000 per month beginning April 18, 2010. We repaid the $344,000 principal balance due under the Wilmington Notes on October 1, 2010 by a cash payment of $238,756 plus the issuance of 137,901 common shares, which cash and shares also included the settlement of all cash and non-cash interest and fees otherwise due.

Lehmann Note

On May 3, 2010 we borrowed $250,000 from an individual (“Lehmann”) under the terms of an unsecured subordinated convertible note (the “Lehmann Note”), which was repayable in principal installments of $13,000 per month beginning July 3, 2010. Although the note called for a final balloon payment on May 3, 2011, including remaining principal and all accrued but unpaid interest (at 10% per annum), it also provided that if we successfully concluded a subsequent financing of debt or equity in excess of $1,000,000 during the note term, the proceeds of such financing would be used to pay off any remaining balance. Accordingly, following the sale of common and preferred shares under the LPC Purchase Agreement (see note 1), we repaid the $172,000 principal balance due under the Lehmann Note on January 13, 2011 by the issuance of 200,000 common shares, which shares also included the settlement of all cash and non-cash interest and fees otherwise due, except as otherwise stated below.

The Lehmann Note provided for (i) 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 Lehmann Note, (ii) our issuance of 37,500 unregistered common shares upon receipt of the funds and (iii) our issuance of 25,000 unregistered common shares if the loan was still outstanding after 6 months, although in the event the Lehmann Note was prepaid after the first six months, the second tranche of 25,000 unregistered common shares would be cancelled on a pro-rata basis, to the extent the second six month time period had not elapsed at the time of such payoff. We did not issue the second tranche of 25,000 shares but we did issue the pro-rata earned portion, 9,700 shares, at the time of the January 13, 2011 payoff.

The effective rate of the Lehmann Note was approximately 77.0% per annum, assuming a six month loan term and excluding the finder’s fees payable by us to a third party in cash and equal to 7% of the borrowed amount. The value of the 43,142 shares initially issued to Lehmann for fees and prepaid interest plus the finder’s fees of $17,500, were reflected as a $105,509 discount against the Lehmann Note and was being amortized as interest expense primarily over the initial six month term of the Lehmann Note. The unamortized portion of the debt discount was $26,642 at September 30, 2010.  The unamortized portion of the debt discount was $5,613 at December 31, 2010, which was written off to interest expense upon the repayment of the loan on January 13, 2011.

 
35

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Notes and Leases Payable

Notes and leases payable consist of the following:

   
June 30,
 2011
   
September 30, 2010
 
Line of Credit Arrangement
  $ 1,797,288     $ 1,637,150  
Rockridge Note (excluding portion classified under convertible debentures)
     414,967        516,921  
Capitalized equipment leases
     21,987        27,328  
Total notes and leases payable
    2,234,242       2,181,399  
Less: discount on notes payable
    (105,587 )     (143,085 )
Less: consideration for funding commitment letters
     -        (14,000 )
Notes and leases payable, net of discount
    2,128,655       2,024,314  
Less: current portion, net of discount
    ( 2,068,526 )     ( 1,904,214 )
Long term notes and leases payable, net of current portion
  $ 60,129     $ 120,100  

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. In addition, from March 16, 2011 through May 16, 2011 we paid additional interest related to the Lender’s waiver of a debt covenant, as discussed in more detail below.

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, 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 and a commitment fee of $20,000 in December 2010 related to the continuation of the Line for an additional year. 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, 2011. 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 $10,938 and zero as of June 30, 2011 and September 30, 2010, respectively.
 
 
36

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Line of Credit Arrangement (continued)

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 one percent (1%) of the borrowing limit if we terminate the Line 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.

The Line is also subject to us maintaining an adequate level of receivables, based on certain formulas, as well as our compliance with a quarterly debt service coverage covenant (the “Covenant”), effective with the September 30, 2010 quarter. The Covenant, as defined in the applicable loan documents, requires that our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense, be equal to or greater than that same cash interest expense. We were in compliance with this Covenant for the September 30, 2010 quarter. The Lender waived the Covenant requirement for the December 31, 2010 quarter, but charged us additional interest of 3% per annum from the March 16, 2011 waiver date through May 16, 2011, when we demonstrated that we were in compliance with the Covenant for the March 31, 2011 quarter. We were in compliance with this Covenant for the June 30, 2011 quarter.

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, the $500,000 Wilmington Notes we issued in February 2010 and the $250,000 Lehmann Note we issued in May 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.

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.
 
 
37

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Rockridge Note (continued)

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 had an outstanding principal balance of $1,329,933 and $1,533,843 at June 30, 2011 and September 30, 2010, respectively. The note is repayable in equal monthly installments of $41,409 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. Monthly payments of $45,202 were made from November 14, 2009 through October 14, 2010, at which time the payment schedule was corrected to (i) omit the November 2010 payment and (ii) start with the new payment amount on December 14, 2010. As of June 30, 2011, $914,467 of the principal balance was convertible into our common shares, as discussed below.

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”). 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). We have recorded no accrual for this matter on our financial statements as of June 30, 2011, since we believe that the variables affecting any eventual liability cannot be reasonably estimated. However, if the closing ONSM share price of $0.90 per share on August 5, 2011 was used as a basis of calculation, the required payment would be approximately $75,000.

Legal fees totaling $55,337 were paid or accrued by us in connection with the Rockridge Agreement. The 366,667 origination fee Shares discussed above are considered earned by Rockridge 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 unamortized portion of this discount was $294,106 and $423,308 as of June 30, 2011 and September 30, 2010, respectively.
 
 
38

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Rockridge Note (continued)

The effective interest rate of the Rockridge Note was approximately 44.3% per annum, until the September 2009 amendment, when 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.

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, may be converted into a number of restricted shares of our common stock. Upon notice from Rockridge at any time 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.

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.

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

We are obligated under a capital lease for telephone equipment, with an outstanding principal balance of $21,987 and $27,328 as of June 30, 2011 and September 30, 2010, respectively. The balance is payable in monthly payments of $828 through January 2014, which includes interest at approximately 11% per annum.
 
 
39

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Funding Commitment Letters

During 2009, we received funding commitment letters (“Letters”) from certain entities agreeing to provide us funding under certain terms on or before December 31, 2010. The value of shares issued as consideration for the Letters was reflected on our balance sheet as a reduction of the carrying value of notes payable, pending inclusion as part of discount for any connected financing. However, we did not obtain financing under the Letters before they expired and accordingly this $14,000 balance on our September 30, 2010 balance sheet was written off as interest expense for the nine months ended June 30, 2011.

NOTE 5:  COMMITMENTS AND CONTINGENCIES

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.

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.

Effective October 1, 2009, a significant portion of our workforce, including the Executives, took a 10% payroll reduction, which we expect will be maintained until increased revenue levels result in positive cash flow (sufficient to cover capital expenditures and debt service). However, even though this 10% was deducted from the amounts paid to the Executives and the contractually scheduled September 28, 2010 raise was not given effect, no adjustment was made to the terms of their related employment agreements, as set forth above, to reflect these matters. A portion of the accrued liability under the caption “Amounts due to executives and officers” on our June 30, 2011 balance sheet pertains to these unresolved contractual obligations and accordingly we do not expect that the ultimate resolution of this matter will have a materially adverse effect on our financial position or results of operations.
 
 
40

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued) – 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.

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.
 
 
41

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued) – On January 14, 2011 our Compensation Committee agreed that it would approve amendments to the executive employment agreements, as well as amending the same terms as applicable to the Board members (see below), allowing for all or part of such compensation to be paid in shares at the recipient’s option, at any time if our stock is trading above $6.00 per share, without requiring that we be sold. The issuance of such shares would be to the extent permitted by applicable law and subject to shareholder and/or any other required regulatory approvals.
 

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 then 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. On June 5, 2010, one of the four outside Directors passed away and on April 18, 2011, Mr. Robert D. ("RD") Whitney was appointed to fill that outside director seat. The status of this item, both with respect to the deceased outside director and/or the new outside director, has not been further addressed by the Compensation Committee to date.

Consulting contracts – We entered into a consulting contract, effective June 1, 2009, with an individual for executive management services. This contract calls for base compensation of $200,000 per year plus a monthly travel allowance of $5,000. The contract also allows a $15,000 moving expenses reimbursement. Although the two-year contract term ended on June 1, 2011, and there has been no official renewal, we have continued to pay this individual under the same terms since that date. Termination without cause after the contract term requires six months notice (which includes a three month severance period) from the terminating party, although termination with cause requires no notice.

As of June 30, 2011, we were obligated to issue shares under certain other consulting contracts - see note 9 for details of those subsequent issuances.

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 $54,000. The leases have expiration dates ranging from 2011 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. The future minimum lease payments required under the non-cancelable portion of these leases (including the tentatively agreed on Pompano lease terms, as described below), is approximately $906,000. In addition to these commitments, we also lease equipment space at co-location or other equipment housing facilities in South Florida; Atlanta, Georgia; Jersey City, New Jersey; San Francisco, California and Colorado Springs, Colorado under varying terms. An aggregate approximately $8,000 per month related to these facilities is classified by us as rental expense with the balance of our payments to these facilities classified as costs of sales – see discussion of bandwidth and co-location facilities purchase commitment discussion below.
 
 
42

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

Lease commitments (continued) – Total rental expense (including executory costs) for all operating leases was approximately $568,000 and $642,000 for the nine months ended June 30, 2011 and 2010, respectively and approximately $197,000 and $219,000 for the three months ended June 30, 2011 and 2010, respectively.

The three-year operating lease for our principal executive offices in Pompano Beach, Florida expired September 15, 2010. The month-to-month base rental is currently approximately $21,100 (including our share of property taxes and common area expenses). We are currently in negotiations to extend this lease through September 15, 2013 and have tentatively agreed to a starting monthly base rental of approximately $21,100 (including our share of property taxes and common area expenses), 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 July 31, 2015.  The monthly base rental (including month-to-month parking) is approximately $8,900 with annual increases up to 5.1%. The lease provides one five-year renewal option at 95% of fair market value and also provides for early cancellation at any time after August 1, 2011, at our option, with six (6) months notice and a payment of no more than approximately $25,000.

The three-year operating lease for our Infinite Conferencing location in New Jersey expires October 31, 2012. The monthly base rental is approximately $11,400 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. The monthly base rental is approximately $12,000, with no increases.

Bandwidth and co-location facilities purchase commitments - 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 $209,000, such agreements expiring at various times through June 2013.

Phone system services commitment – We are a party to an agreement for services in connection with our internal corporate phone system, requiring monthly payments of approximately $2,600 per month for a three year period commencing August 2010.

Legal proceedings – We are involved in 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.

 
43

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 6:  CAPITAL STOCK

Common Stock

On October 1, 2010 we repaid the $344,000 principal balance due under the Wilmington Notes by a cash payment of $238,756 plus the issuance of 137,901 common shares valued at approximately $110,000, which cash and shares also included the settlement of all cash and non-cash interest and fees otherwise due – see note 4.

On January 11, 2011 we repaid the $172,000 principal balance due under the Lehmann Note by the issuance of 209,700 common shares, which shares also included the settlement of all accrued interest and fees otherwise due – see note 4.

During the period from April 4, 2011 through June 10, 2011, we repaid $500,000 of the principal balance due under the Equipment Notes by the issuance of 458,337 common shares – see note 4.

On December 2, 2010, we issued 76,769 common shares for interest on the Equipment Notes through November 30, 2010, and on April 28, 2011, we issued 28,810 common shares for interest on certain of the Equipment Notes through March 31, 2011 - see note 4.

On September 17, 2010, we entered into a Purchase Agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to an initial purchase of 300,000 shares of our common stock and 420,000 shares of our Series A-14 Preferred Stock (“Series A-14”), together with warrants to purchase 540,000 of our common shares. In accordance with the Purchase Agreement, LPC also received 50,000 shares of our common stock as a one-time commitment fee and a cash payment of $26,250 as a one-time structuring fee. On September 24, 2010, we received $824,044 net proceeds (after deducting fees and legal, accounting and other out-of-pocket costs incurred by us) related to our issuance under that Purchase Agreement of the equivalent of 770,000 common shares (including those issuable upon conversion of the preferred shares). See notes 6 and 8 for further details with respect to the Series A-14 and the warrants.

During the nine months ended June 30, 2011, we sold LPC an additional 830,000 shares of our common stock under that Purchase Agreement for net proceeds of $740,522. Since June 30, 2011, we sold an additional 600,000 shares of our common stock to LPC under that Purchase Agreement for net proceeds of $583,673. LPC remains committed to purchase, at our sole discretion, up to an additional 1.9 million (which quantity is after giving effect to the terms of an April 28, 2011 amendment to the Purchase Agreement) shares of our common stock in installments over the remaining term of the Purchase Agreement, generally at prevailing market prices, but subject to the specific restrictions and conditions in the Purchase Agreement.

There is no upper limit to the price LPC may pay to purchase these additional shares. The purchase of our shares by LPC will occur on dates determined solely by us and the purchase price of the shares will be fixed on the purchase date and will be equal to the lesser of (i) the lowest sale price of our common stock on the purchase date or (ii) the average of the three (3) lowest closing sale prices of our common stock during the twelve (12) consecutive business days prior to the date of a purchase by LPC.  LPC shall not have the right or the obligation to purchase any shares of our common stock from us at a price below $0.75 per share.
 
 
44

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 6:  CAPITAL STOCK (Continued)

Common Stock (continued)

The Purchase Agreement has a term of 36 months (which is after giving effect to the terms of an April 28, 2011 amendment to the Purchase Agreement) but may be terminated by us at any time after the first year at our discretion without any cost to us and may be terminated by us at any time in the event LPC does not purchase shares as directed by us in accordance with the terms of the Purchase Agreement. LPC may terminate the Purchase Agreement upon certain events of default set forth therein, including but not limited to the occurrence of a material adverse effect, delisting of our common stock and the lack of immediate relisting on one of the specified alternate markets and the lapse of the effectiveness of the applicable registration statement for more than the specified number of days. The Purchase Agreement restricts our use of variable priced financings for the greater of one year or the term of the Purchase Agreement and, in the event of future financings by us, allows LPC the right to participate under conditions specified in the Purchase Agreement.

The shares of common stock sold and issued under the Purchase Agreement and the shares of common stock issuable upon conversion of Series A-14, were sold and issued pursuant to prospectus supplements filed by us on September 24, 2010 and on July 1, 2011 with the Securities and Exchange Commission in connection with a takedown of an aggregate of 4.1 million shares from our Shelf Registration.  In connection with the Purchase Agreement, we also entered into a Registration Rights Agreement (the “Registration Rights Agreement”) with LPC, dated September 17, 2010, under which we agreed, among other things, to use our best efforts to keep the registration statement effective until the maturity date as defined in the Purchase Agreement and to indemnify LPC for certain liabilities in connection with the sale of the securities. Since there are no specified damages payable by us in the event of a default under the Registration Rights Agreement, we have determined that this is not a registration payment arrangement, as that term is defined in the Derivatives and Hedging topic (Contracts in Entity’s own Equity subtopic) of the ASC.

During the nine months ended June 30, 2011 we issued (i) 192,686 unregistered common shares valued at approximately $186,000 and (ii) 197,890 unregistered common shares under the Plan valued at approximately $208,000. These shares will be recognized as professional fees expense and as other general and administrative expense over various service periods of up to 12 months. None of these shares were issued to our directors or officers, except 30,519 shares issued to director Charles Johnston for his services as audit committee chairman for fiscal 2011. Professional fee expenses arising from these and prior issuances of shares and options for financial consulting and advisory services were approximately $421,000 and $570,000 for the nine months ended June 30, 2011 and 2010, respectively. As a result of previously issued shares and options for financial consulting and advisory services, we have recorded approximately $238,000 in deferred equity compensation expense at June 30, 2011, to be amortized over the remaining periods of service of up to 9 months. The deferred equity compensation expense is included in the balance sheet caption prepaid expenses.

On March 3, 2011 we issued 14,000 unregistered common shares for Series A-13 dividends for 2010 and on May 24, 2011 we issued 3,500 unregistered common shares for Series A-13 dividends for the first calendar quarter of 2011, as discussed in more detail below.
 
 
45

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 6:  CAPITAL STOCK (Continued)

Preferred Stock

As of June 30, 2011 and September 30, 2010, the only preferred stock outstanding was Series A-13 Convertible Preferred Stock (“Series A-13”) and Series A-14 Convertible Preferred Stock (“Series A-14”).

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. On March 2, 2011, we filed a Certificate of Designation, Preferences and Rights for the Series A-13 with the Florida Secretary of State, reflecting certain changes arising from a January 2011 agreement with CCJ Trust, as discussed below. 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 $2.00 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 payable quarterly, as well as 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) $2.00 per share or (ii) the average closing bid price of a common share for the five trading days immediately preceding the conversion.

On March 3, 2011 we satisfied $28,000 in Series A-13 dividends accrued for calendar 2010 by the issuance of 14,000 unregistered common shares, using the minimum conversion rate of $2.00 per share. These common shares were recorded in the amount of $15,820, based on their fair value at the date of issuance and the remaining portion of the previous dividend accrual, $12,180, was reversed and reflected as a decrease in the dividend expense reported by us for the nine months ended June 30, 2011. On May 24, 2011 we satisfied $7,000 in Series A-13 dividends for the first calendar quarter of 2011 by the issuance of 3,500 unregistered common shares, using the minimum conversion rate of $2.00 per share. These common shares were recorded in the amount of $4,129, based on their fair value at the date of issuance, and included in dividend expense for the nine months ended June 30, 2011. As of June 30, 2011, accrued but unpaid Series A-13 dividends of $7,000 remain reflected as a current liability on our balance sheet. On August 9, 2011 we satisfied $7,000 in Series A-13 dividends for the second calendar quarter of 2011 by the issuance of 3,500 unregistered common shares, using the minimum conversion rate of $2.00 per share.

Any shares of Series A-13 that are still outstanding as of December 31, 2012 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 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 June 30, 2011 and September 30, 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 was amortized as a dividend over the first year of the term of the Series A-13. The unamortized portion of the discount was zero and $1,687 at June 30, 2011 and September 30, 2010, respectively.
 
 
46

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 6:  CAPITAL STOCK (Continued)

Preferred Stock (continued)

Series A-13 Convertible Preferred Stock (continued)

In conjunction with and in consideration of a January 2011 note transaction entered into by us with CCJ Trust (see note 4), it was agreed that certain terms of the 35,000 shares of Series A-13 held by CCJ Trust at that date would be modified as follows - the conversion rate to common shares, as well as the minimum conversion rate for payment of dividends in common shares, was adjusted from $3.00 to $2.00 per share, the maturity date was adjusted from December 31, 2011 to December 31, 2012 and dividends will be paid quarterly instead of just upon conversion.

Series A-14 Convertible Preferred Stock

Effective September 17, 2010, our Board of Directors authorized the sale and issuance of up to 420,000 shares of Series A-14 Preferred Stock (“Series A-14”). On September 22, 2010, we filed a Certificate of Designations for the Series A-14 with the Florida Secretary of State. Series A-14 has a stated value of $1.25 per preferred share and a fixed conversion rate of $1.25 per common share.  Series A-14 has a onetime 5% dividend payable in cash on the first anniversary of the original issue date. As of June 30, 2011, we have accrued Series A-14 dividends of approximately $20,200, which is reflected as a current liability on our balance sheet.

The holders of Series A-14 may convert, at the option of the holder and subject to certain limitations, each share of Series A-14 into one fully-paid, non-assessable share of our common stock.  Any shares of Series A-14 that are still outstanding as of second annual anniversary of the original issue date shall automatically be converted into our common shares, using the same ratio.  Series A-14 is senior to our common stock but subordinate to Series A-13 and the holders of Series A-14 shall not be entitled to vote on any matters as to which holders of our common shares are entitled to vote. Series A-14 is redeemable at our option for $1.56 per share plus accrued but unpaid dividends, provided that the holder has the right to convert to common during a ten day notice period prior to such redemption.

As discussed above, on September 17, 2010, we entered into a Purchase Agreement whereby LPC agreed to an initial purchase of common stock plus shares of Series A-14. We issued 420,000 shares of Series A-14 to LPC on September 24, 2010. The shares issuable upon conversion of Series A-14 were registered for resale subject to the LPC Registration Rights Agreement.

The fair value of the warrants issued in connection with the Purchase Agreement was calculated to be approximately $386,000 using the Black-Scholes model (with the assumptions including expected volatility of 105% and a risk free interest rate of 1.08%). The common shares issued as a one-time commitment fee in connection with the Purchase Agreement were valued at approximately $55,000, based on the quoted market value on the date of issuance. The aggregate of these two items, plus the cash out-of-pocket costs incurred by us in connection with the Purchase Agreement, was allocated on a pro-rata basis between the number of common shares sold and the common shares underlying the Series A-14. The amount allocated to the Series A-14, $298,639, was recorded on our balance sheet as a discount and is being amortized as a dividend over the term of the Series A-14. The unamortized portion of the discount was $183,747 and $295,735 at June 30, 2011 and September 30, 2010, respectively. See Note 8 with respect to the recording of the warrants as a liability on our June 30, 2011 and September 30, 2010 balance sheets.
 
 
47

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 6:  CAPITAL STOCK (Continued)

Preferred Stock (continued)

Series A-14 Convertible Preferred Stock (continued)

The number of shares of ONSM common stock that can be issued upon the conversion of Series A-14 is limited to the extent necessary to ensure that following the conversion the total number of shares of ONSM common stock beneficially owned by the holder does not exceed 4.999% of our issued and outstanding common stock, although this percentage may be changed at the holder’s option upon not less than 61 days advance notice to us and provided the changed limitation does not exceed 9.99%.

 
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ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

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 and MP365 divisions of the Digital Media Services Group, as well as our corporate headquarters, are in Pompano Beach, Florida. The Webcasting division has its main sales facility in New York City. 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 area. All material sales, as well as property and equipment, are within the United States. Detailed below are the results of operations by segment for the nine and three months ended June 30, 2011 and 2010, and total assets by segment as of June 30, 2011 and September 30, 2010, respectively.

   
For the nine months ended June 30,
   
For the three months ended
June 30,
 
   
2011
   
2010
   
2011
   
2010
 
Revenue:
                       
Digital Media Services Group
  $ 6,268,002     $ 6,086,830     $ 2,180,270     $ 2,088,993  
Audio and Web Conferencing Services Group
     7,083,780        6,546,735        2,444,930        2,341,765  
Total consolidated revenue
  $ 13,351,782     $ 12,633,565     $ 4,625,200     $ 4,430,758  
                                 
Segment operating income:
                               
Digital Media Services Group
  $ 1,484,381     $ 1,457,135     $ 642,850     $ 536,150  
Audio and Web Conferencing Services Group
     2,020,147        1,760,071        795,343        745,433  
Total segment operating income
    3,504,528       3,217,206       1,438,193       1,281,583  
Depreciation and amortization
    ( 1,117,425 )     ( 1,537,729 )     ( 363,987 )     ( 421,568 )
Corporate and unallocated shared expenses
    ( 4,169,704 )     ( 4,420,025 )     ( 1,405,754 )     ( 1,542,276 )
Impairment loss on goodwill and other intangible assets
    -       ( 3,100,000 )     -       -  
Other expense, net
     ( 891,352 )      ( 834,543 )      ( 154,163 )      ( 391,625 )
Net loss
  $ ( 2,673,953 )   $ ( 6,675,091 )   $ ( 485,711 )   $ ( 1,073,886 )

   
June 30,
 2011
   
September 30, 2010
 
Assets:
           
Digital Media Services Group
  $ 6,404,003     $ 6,320,046  
Audio and Web Conferencing Services Group
    12,554,094       13,300,614  
Corporate and unallocated
     752,470        1,091,757  
Total assets
  $ 19,710,567     $ 20,712,417  

Depreciation and amortization, as well as other expense, net, and impairment loss 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
JUNE 30, 2011

NOTE 8:  STOCK OPTIONS AND WARRANTS

As of June 30, 2011, we had issued options and warrants still outstanding to purchase up to 3,322,539 ONSM common shares, including 2,135,617 shares under Plan Options; 41,962 shares under Non-Plan Options to employees and directors; 495,198 shares under Non-Plan Options to financial consultants; and 649,762 shares under 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 “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 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 Plan, for total authorization of 2,000,000 shares and on June 13, 2011 they authorized a further increase in authorized Plan shares from 2,000,000 to 4,500,000.

Detail of Plan Option activity under the 1996 Plan and the Plan for the nine months ended June 30, 2011 is as follows:

   
Number of Shares
   
Weighted Average Exercise Price
 
             
Balance, beginning of period
    1,170,843     $ 8.62  
Granted during the period
    1,008,700     $ 1.22  
Expired or forfeited during the period
     (43,926 )   $ 7.65  
Balance, end of the period
     2,135,617     $ 5.15  
                 
Exercisable at end of the period
     1,018,583     $ 8.61  

We recognized compensation expense of approximately $860,000 and $635,000 for the nine months ended June 30, 2011 and 2010, respectively, and approximately $314,000 and $191,000 for the three months ended June 30, 2011 and 2010, respectively related to Plan Options granted to employees and consultants and vesting during those periods. The unvested portion of Plan Options outstanding as of June 30, 2011 (and granted on or after our October 1, 2006 adoption of the requirements of the Compensation - Stock Compensation topic of the ASC) represents approximately $797,000 of potential future compensation expense, which excludes approximately $691,000 related to the ratable portion of those unvested options allocable to past service periods and recognized as compensation expense as of June 30, 2011.
 
 
50

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011

NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

The outstanding Plan Options for the purchase of 2,135,617 common shares all have exercise prices equal to or greater than the fair market value at the date of grant, the exercisable portion has a weighted-average remaining life of approximately 1.8 years and are further described below.

Grant date
 
 
 
 
Description
 
Total number of underlying common shares
   
Vested portion of underlying common shares
   
Exercise price per share
 
 
 
Expiration
date
Dec 2004
 
Senior management
    25,000       25,000     $ 7.26  
Aug 2014
Sept 2006
 
Directors and senior management
    100,000       100,000     $ 4.26  
Sept 2011
Sept 2006
 
Employees excluding senior management
    87,333       87,333     $ 4.26  
Sept 2011
April 2007
 
Infinite Merger – see note 2
    25,000       25,000     $ 15.00  
April 2012
 
Sept 2007
 
 
Senior management
    356,250       272,917     $ 10.38  
Sept 2012 –
 Sept 2016
Dec 2007
 
Leon Nowalsky – new director
    8,333       8,333     $ 6.00  
Dec 2011
Dec 2007
 
Employees excluding senior management
    1,667       1,667     $ 6.00  
Dec 2011
April 2008
 
Employees excluding senior management
    2,500       2,500     $ 6.00  
April 2012
May 2008
 
Consultant
    16,667       16,667     $ 6.00  
May 2013
Aug 2008
 
Employees excluding senior management
    62,500       62,500     $ 6.00  
Aug 2012
 
May 2009
 
 
Consultant
    66,667       33,333     $ 3.00  
Jun 2014 –
 Jun 2018
 
May 2009
 
 
Employees excluding senior management
     50,000       33,333     $ 3.00  
May 2013 –
 Jul 2015
Aug 2009
 
Directors and senior management
    133,334       133,334     $ 15.00  
Aug 2014
Aug 2009
 
Directors and senior management
    76,773       76,773     $ 9.42  
Aug 2014
Dec 2009
 
Directors and senior management
    114,893       114,893     $ 9.42  
Dec 2014
Jan 2011
 
Directors and senior management
    525,000       -     $ 1.23  
Jan 2015
Jan 2011
 
Employees excluding senior management
    408,700       -     $ 1.23  
Jan 2015
Jan 2011
 
Consultant
    50,000       -     $ 1.23  
Jan 2015
Jun 2011
 
RD Whitney – new director
    25,000       25,000     $ 1.00  
Jun 2015
   
Total common shares underlying  Plan Options as of June 30, 2011
     2,135,617        1,018,583            
 
On January 14, 2011 our Compensation Committee awarded 983,700 four-year options under the provisions of the 2007 Plan. These options were issued to our directors, employees and consultants, vest over two years and are exercisable at $1.23 per share, fair market value on the date of the grant. The Black-Scholes valuation of this grant is approximately $803,000, which is being recognized as non-cash compensation expense over the two year service period starting in January 2011. In January 2011, our Compensation Committee approved (subject to our shareholders’ approval in the annual shareholder meeting on June 13, 2011 of sufficient additional authorized Plan shares, which approval was received) augmenting the above grant by an equal number of options issued to the same recipients, using the same strike price as the above grant, to the extent permitted by applicable law and subject to shareholder and/or any other required regulatory approvals. The Compensation Committee is in the process of finalizing this grant.
 
 
51

 
 
ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2011
 
NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

As of June 30, 2011, there were outstanding Non-Plan Options issued to employees and directors for the purchase of 41,962 common shares, which were issued during fiscal 2005 in conjunction with the Onstream Merger (see note 2). These options are immediately exercisable at $20.26 per share and expire at various times from July 2012 to May 2013.

As of June 30, 2011, there were outstanding and fully vested Non-Plan Options issued to financial consultants for the purchase of 495,198 common shares, as follows:

Issuance period
 
Number of common shares
   
Exercise price per share
 
 
Expiration
Date
               
    March 2011
    300,000     $ 1.50  
March 2015
Nine months ended June 30, 2011
    300,000            
                   
   October 2009
    75,000     $ 3.00  
Oct 2013
   July 2010
    50,000     $ 6.00  
July 2014
Year ended September 30, 2010
    125,000            
                   
   August 2009
    16,667     $ 3.00  
Aug 2013
   September 2009
    8,333     $ 3.00  
Sept 2013
Year ended September 30, 2009