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EX-32.1 - EXHIBIT 32.1 - Onstream Media CORPexhibit32_1.htm
 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

                     (Mark One)

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

For the quarterly period ended June 30, 2014

OR

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

For the transition period from _________ to _________

 

Commission file number 000-22849

 

Onstream Media Corporation

(Exact name of registrant as specified in its charter)

 

65-0420146

(IRS Employer Identification No.)

 

Florida

(State or other jurisdiction of incorporation or organization)

 

1291 SW 29 Avenue, Pompano Beach, Florida 33069

(Address of principal executive offices)

 

954-917-6655

(Registrant's telephone number)

 

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

 

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

 

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

 

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

 

Large accelerated filer    (   )                                                                                                            Accelerated filer   (   )

Non-accelerated filer     (    )   (Do not check if a smaller reporting company)             Smaller reporting company   (X)

 

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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.  As of August 8, 2014 the registrant had issued and outstanding 21,869,580 shares of common stock. 

 

1

 


 

 

 
TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

PAGE

 

 

Item 1 - Financial Statements

 

 

 

Unaudited Consolidated Balance Sheet at June 30, 2014 and Consolidated Balance Sheet at September 30, 2013

4

 

 

Unaudited Consolidated Statements of Operations for the Nine and Three Months Ended June 30, 2014 and 2013

5

 

 

Unaudited Consolidated Statement of Stockholders’ Equity for the Nine Months Ended June 30, 2014

6

 

 

Unaudited Consolidated Statements of Cash Flows for the Nine Months Ended June 30, 2014 and 2012

7

 

 

Notes to Unaudited Consolidated Financial Statements

8 – 73

 

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

74 – 102

 

 

Item 4T - Controls and Procedures

103

 

 

PART II – OTHER INFORMATION

 

 

 

Item 1 – Legal Proceedings

104

 

 

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

105

 

 

Item 3 – Defaults upon Senior Securities

106

 

 

Item 4 – Mine Safety Disclosures

106

 

 

Item 5 – Other Information

106

 

 

Item 6 - Exhibits

106

 

 

Signatures

106

 

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 our products and services and/or our ability to obtain financing or other investment), 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, 2014, 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 Quarterly 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,

2014

 

September 30,

2013

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

CURRENT ASSETS:

 

 

 

 

 

Cash and cash equivalents

$

599,837

 

$

257,018

Accounts receivable, net of allowance for doubtful accounts

of $202,445 and $234,879, respectively

 

2,288,143

 

 

2,175,505

Prepaid expenses

 

191,969

 

 

142,307

Inventories and other current assets

 

131,128

 

 

140,585

Total current assets

 

3,211,077

 

 

2,715,415

Property and Equipment, net

 

1,908,266

 

 

2,047,633

Intangible Assets, net

 

572,162

 

 

669,543

Goodwill, net

 

8,358,604

 

 

8,358,604

Other Non-Current Assets

 

165,960

 

 

136,215

Total assets

$

14,216,069

 

$

13,927,410

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

CURRENT LIABILITIES:

 

 

 

 

 

Accounts payable

$

1,961,358

 

$

1,927,430

Accrued liabilities

 

1,781,935

 

 

1,527,435

Amounts due to directors and officers

 

744,130

 

 

409,410

Deferred revenue

 

114,873

 

 

152,696

Notes and leases payable – current portion, net of discount

 

3,376,127

 

 

2,198,858

Convertible debentures – current portion, net of discount

 

1,457,891

 

 

587,198

Total current liabilities

 

9,436,314

 

 

6,803,027

Accrued liabilities – non-current portion

 

-

 

 

354,813

Notes and leases payable, net of current portion and discount

 

13,142

 

 

759,932

Convertible debentures, net of current portion and discount

 

-

 

 

548,796

Total liabilities

 

9,449,456

 

 

8,466,568

COMMITMENTS AND CONTINGENCIES

 

 

 

 

 

STOCKHOLDERS' EQUITY:

 

 

 

 

 

Common stock, par value $.0001 per share; authorized 75,000,000 shares, 21,634,580

and 19,345,744 issued and outstanding, respectively

 

2,162

 

 

1,933

Common stock committed for issue – 2,541,667 and 2,291,667 shares, respectively

 

254

 

 

229

Additional paid-in capital

 

144,952,818

 

 

144,385,772

Obligation to repurchase common shares

 

(420,233)

 

 

(164,000)

Accumulated deficit

 

(139,768,388)

 

 

(138,763,092)

Total stockholders’ equity

 

4,766,613

 

 

5,460,842

Total liabilities and stockholders’ equity

$

14,216,069

 

$

13,927,410

 

 

 

 

 

 

 

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

REVENUE:

 

 

 

 

 

 

 

 

 

 

Audio and web conferencing

$

7,143,122

 

$

6,849,678

 

$

2,439,117

 

$

2,369,937

Webcasting

 

3,484,966

 

 

3,863,667

 

 

1,316,931

 

 

1,268,936

Network usage

 

1,438,937

 

 

1,529,051

 

 

455,380

 

 

521,086

DMSP and hosting

 

706,131

 

 

718,607

 

 

235,931

 

 

242,069

Other

 

120,804

 

 

184,438

 

 

37,971

 

 

68,374

Total revenue

 

12,893,960

 

 

13,145,441

 

 

4,485,330

 

 

4,470,402

 

 

 

 

 

 

 

 

 

 

 

 

COSTS OF REVENUE:

 

 

 

 

 

 

 

 

 

 

 

Audio and web conferencing

 

1,948,290

 

 

1,913,242

 

 

644,756

 

 

660,557

Webcasting

 

910,318

 

 

1,074,188

 

 

310,497

 

 

319,894

Network usage

 

623,698

 

 

744,031

 

 

197,033

 

 

220,968

DMSP and hosting

 

122,732

 

 

103,071

 

 

47,056

 

 

34,185

Other

 

22,822

 

 

49,665

 

 

4,272

 

 

12,878

Total costs of revenue

 

3,627,860

 

 

3,884,197

 

 

1,203,614

 

 

1,248,482

 

 

 

 

 

 

 

 

 

 

 

 

GROSS MARGIN

 

9,266,100

 

 

9,261,244

 

 

3,281,716

 

 

3,221,920

 

 

 

 

 

 

 

 

 

 

 

 

OPERATING EXPENSES:

 

 

 

 

 

 

 

 

 

 

 

General and administrative:

 

 

 

 

 

 

 

 

 

 

 

Compensation (excluding equity)

 

5,505,988

 

 

6,030,654

 

 

1,786,479

 

 

2,074,773

Compensation paid with common shares and other equity

 

417,351

 

 

1,551,138

 

 

113,950

 

 

133,569

Professional fees

 

1,032,490

 

 

1,054,628

 

 

327,087

 

 

260,529

Other

 

1,743,283

 

 

1,899,478

 

 

587,450

 

 

629,800

Depreciation and amortization

 

662,667

 

 

1,008,193

 

 

227,456

 

 

303,512

Total operating expenses

 

9,361,779

 

 

11,544,091

 

 

3,042,422

 

 

3,402,183

 

 

 

 

 

 

 

 

 

 

 

 

(Loss) income from operations

 

(95,679)

 

 

(2,282,847)

 

 

239,294

 

 

(180,263)

 

 

 

 

 

 

 

 

OTHER (EXPENSE) INCOME, NET:

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

(1,531,057)

 

 

(975,796)

 

 

(630,120)

 

 

(340,197)

Debt extinguishment loss

 

(132,427)

 

 

(143,251)

 

 

-

 

 

-

Gain from litigation settlement

 

741,554

 

 

-

 

 

741,554

 

 

-

Other income (expense), net

 

12,313

 

 

(2,938)

 

 

9,394

 

 

217

Total other (expense) income, net

 

(909,617)

 

 

(1,121,985)

 

 

120,828

 

 

(339,980)

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income

$

(1,005,296)

 

$

(3,404,832)

 

$

360,122

 

$

(520,243)

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share - basic

$

(0.04)

 

$

(0.20)

 

$

0.02

 

$

(0.03)

Net income per share – fully diluted

 

 

 

 

 

 

$

0.02

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average shares of common stock outstanding – basic

 

22,763,248

 

 

17,448,815

 

 

23,590,587

 

 

20,704,496

Weighted average shares of common stock outstanding – fully diluted

 

 

 

 

 

 

 

23,590,587

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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

 

5

 


ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

NINE MONTHS ENDED JUNE 30, 2014

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Common Stock

Committed for Issue

 

Additional

Paid-In

Capital

 

Obligation to

Repurchase Common

 Shares

 

Accumulated

Deficit

 

 

 

 

Shares

 

Par

 

Shares

 

Par

 

 

 

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance, September 30, 2013

19,345,744

 

$

1,933

 

2,291,667

 

$

229

 

$

144,385,772

 

$

(164,000)

 

$

(138,763,092)

 

$

5,460,842

Issuance of common shares for employee services

250,000

 

 

25

 

250,000

 

 

25

 

 

97,450

 

 

-

 

 

-

 

 

97,500

Issuance of common shares for consultant services

491,502

 

 

49

 

-

 

 

-

 

 

96,921

 

 

-

 

 

-

 

 

96,970

Issuance of common shares for interest, financing fees and finders fees

1,547,334

 

 

155

 

-

 

 

-

 

 

372,675

 

 

-

 

 

-

 

 

372,830

Obligation to repurchase common shares

-

 

 

-

 

-

 

 

-

 

 

-

 

 

(256,233)

 

 

-

 

 

(256,233)

Net loss

-

 

 

-

 

-

 

 

-

 

 

-

 

 

-

 

 

(1,005,296)

 

 

(1,005,296)

Balance, June 30, 2014

21,634,580

 

$

2,162

 

2,541,667

 

$

254

 

$

144,952,818

 

$

(420,233)

 

$

(139,768,388)

 

$

4,766,613

 

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,

 

 

2014

 

2013

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

$

(1,005,296)

 

$

(3,404,832)

Adjustments to reconcile net loss to net cash provided by (used in) operating activities:

 

 

 

 

 

Depreciation and amortization

 

662,667

 

 

1,008,193

Professional fee expenses paid with equity, including amortization of deferred expenses for prior period issuances

 

128,860

 

 

190,042

Compensation expenses paid with common shares and other equity

 

417,351

 

 

1,551,138

Amortization of discount on convertible debentures

 

338,516

 

 

95,153

Amortization of discount on notes payable

 

384,256

 

 

216,719

Debt extinguishment loss

 

132,427

 

 

143,251

Gain on litigation settlement

 

(741,554)

 

 

-

Gain from adjustment of derivative liability to fair value

 

-

 

 

(27,480)

Bad debt expense and other

 

58,740

 

 

111,500

Net cash provided by (used in) operating activities, before changes in current assets and liabilities other than cash

 

375,967

 

 

(116,316)

Changes in current assets and liabilities other than cash:

 

 

 

 

 

(Increase) decrease in accounts receivable

 

(171,380)

 

 

142,860

(Increase) in prepaid expenses

 

(81,305)

 

 

(107,876)

(Increase) decrease in inventories and other current assets

 

1,964

 

 

9,839

Increase in accounts payable, accrued liabilities and amounts due to directors and officers

 

411,306

 

 

433,498

(Decrease) in deferred revenue

 

(37,824) 

 

 

21,250

Net cash provided by operating activities

 

498,728

 

 

383,255

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Acquisition of property and equipment

 

(425,918)

 

 

(727,945)

Intella2 acquisition (see note 2)

 

-

 

 

(657,324) 

Net cash (used in) investing activities

 

(425,918) 

 

 

(1,385,269) 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from notes payable, net of expenses

 

1,545,071

 

 

2,361,222

Proceeds from convertible debentures, net of expenses

 

459,604

 

 

695,000

Repayment of notes and leases payable

 

(1,482,611)

 

 

(1,561,300)

Repayment of convertible debentures

 

(252,055) 

 

 

(480,237) 

Net cash provided by financing activities

 

270,009

 

 

1,014,685

 

 

 

 

 

 

NET INCREASE IN CASH AND CASH EQUIVALENTS

 

342,819

 

 

12,671

CASH AND CASH EQUIVALENTS, beginning of period

 

257,018

 

 

359,795

CASH AND CASH EQUIVALENTS, end of period

$

599,837

 

$

372,466

 

 

 

 

 

 

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:

 

 

 

 

 

Cash payments for interest

$

808,286

 

$

663,924

 

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

 

 

 

 

 

Issuance of common shares for consultant services

$

96,970

 

$

178,302

Issuance of common shares for interest and financing fees

$

372,830

 

$

727,700

Issuance of shares and options for employee services

$

97,500

 

$

1,885,075

Issuance of right to obtain common shares for financing fees

$

-

 

$

78,750

Increase in value of common shares underlying Series A-13 preferred, arising from

adjustment of conversion rate in connection with financing commitment letter

$

-

 

$

107,442

Declaration of dividends payable on A-13 preferred shares

$

-

 

$

3,500

Issuance of common shares for dividends payable on A-13 preferred shares

$

-

 

$

2,713

Elimination of obligation for previously accrued or declared dividends payable

on A-13 preferred shares

$

-

 

$

14,787

 Issuance of common shares upon conversion of debt

$

-

 

$

175,000

 Issuance of common shares upon conversion of Series A-13 preferred

$

-

 

$

175,000

 Issuance of common shares upon conversion of Series A-14 preferred

$

-

 

$

200,000

 Reclassification from liability to additional paid-in capital arising from modification of

detachable warrant associated with sale of common shares and Series A-14 preferred

$

-

 

$

53,894

Initial estimated present value of future obligations for cash payments in connection

with the Intella2 acquisition (see note 2)

$

-

 

$

704,452

Agreement to repurchase common shares

$

256,233

 

$

84,000

Satisfaction of short-term obligations with note payable issuances

$

-

 

$

418,233

Issuance of note for equipment purchase

$

 

 

$

43,953

 

 

 

 

 

 

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

  

7

 


 

 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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 Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division, our Onstream Conferencing Corporation (“OCC”) division and our EDNet division. Our Infinite division, which operates primarily from the New York City area, and our OCC division, which operates primarily from San Diego, California, generate 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.

 

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

 

The Webcasting division, which operates primarily from Pompano Beach, Florida and has a sales and support 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. As of October 1, 2013, the Webcasting division became responsible for sales of the MarketPlace365 service. 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. 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. 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.

 

 

8

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Liquidity

 

Our 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 $139.8 million as of June 30, 2014. Our operations have been financed primarily through the issuance of equity and debt, including convertible debt and debt combined with the issuance of equity.

 

For the year ended September 30, 2013, we had a net loss of approximately $7.2 million, although cash provided by operating activities for that period was approximately $504,000. For the nine months ended June 30, 2014, we had a net loss of approximately $1.0 million, although cash provided by operating activities for that period was approximately $499,000. Although we had cash of approximately $600,000 at June 30, 2014, we had a working capital deficit of approximately $6.2 million at that date.

 

During the period from June 2013 through January 2014 we made certain headcount reductions representing approximately $1.1 million in annualized savings, which we expect will reduce our compensation expenditures by approximately $199,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our compensation expenditures by approximately $159,000 in aggregate for the first seven months of fiscal 2015 as compared to the corresponding prior year period. Effective June 2014, we also renegotiated a supplier contract representing approximately $252,000 in annualized savings, which we expect will cumulatively reduce our cost of sales by approximately $63,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our cost of sales by approximately $168,000 in aggregate for the first eight months of fiscal 2015 as compared to the corresponding prior year period.

 

During the nine months ended June 30, 2014, our revenues were not sufficient to fund our total cash expenditures (operating, capital and debt service) and as a result we obtained additional funding from the Working Capital Notes and Sigma Note 2 and we also restructured the payment terms of Sigma Note 1 and certain other notes – see note 4. However, primarily because of our expectations with respect to our recent and anticipated introductions of several new or enhanced products, we expect to achieve revenue growth in the fourth quarter of fiscal 2014 as well as fiscal 2015, as compared to corresponding prior year periods. However, in the event we are unable to achieve the necessary revenue increases to fund our total cash expenditures, we believe that identified decreases in our current level of expenditures that we have already planned to implement or could implement (in addition to the already implemented cost savings discussed above and including a significant reduction in our software development costs and capital equipment purchases) and the raising of additional capital in the form of debt and/or equity and/or the sales of assets or operations would be sufficient to fund our operations through June 30, 2015. 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. The Executives have agreed to defer a portion of their compensation in the past, to the extent we needed that cash to meet other operating expenses – see note 5 for details – and, in the event of extremely critical or urgent requirements in the future, are expected to continue to do so.

 

 

9

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Liquidity (continued)

 

On February 6, 2014, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”), agreeing to provide us, within twenty (20) days after our notice on or before December 31, 2014, aggregate cash funding of up to $800,000. Mr. Charles Johnston, a former ONSM director, 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. 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, 2015 and (b) 7.5 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 funds in excess of $5.0 million as a result of a single transaction for the sale of all or a part of its operations or assets, this Funding Letter will be terminated. $25,000 paid by us as consideration for the Funding Letter was deducted from the proceeds of the Working Capital Notes – see note 4.

 

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 and/or that we will be able to borrow further funds other than under the Line or the Funding Letter and/or that we will be able to sell assets or operations and/or that we will be able to 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.

 

The resolution of debt and other obligations becoming due within the twelve months ended June 30, 2015 (the end of the one year time frame on which our liquidity analysis and conclusions above were based), and in particular those becoming due during October through December 2014, represents a future unknown contingency. These include Sigma Note 1, which is repayable with monthly principal and interest payments on the last day of October and November 2014 plus a final principal and interest payment on December 18, 2014, such payments aggregating $1,022,314 and Sigma Note 2, for which a single $559,447 principal and interest payment is due on October 31, 2014. See note 4 for further details of these and other obligations payable during that period.

 

10

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

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., Onstream Conferencing Corporation, AV Acquisition, Inc., Auction Video Japan, Inc., HotelView Corporation and Media On Demand, Inc. All significant intra-entity 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.

 

11

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Fair Value Measurements

 

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.

 

We have determined that the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, amounts due to directors and officers and deferred revenue approximate fair value due to the short maturity of the instruments. We have also determined that the carrying amounts of certain notes and other debt approximate fair value due to the short maturity of the instruments, as well as the market value interest rates they carry – these include the Line and the equipment lease.

 

We have determined that the Rockridge Note, the CCJ Note, the Equipment Notes, the Subordinated Notes, the Intella2 Investor Notes, the Investor Notes, the Fuse Note, Sigma Note 1, Sigma Note 2, the Working Capital Notes and the USAC Note (the “Instruments”), discussed in note 4, meet the definition of a financial instrument as contained in the Financial Instruments topic of the Accounting Standards Codification (“ASC”), as this definition includes a contract that imposes a contractual obligation on us to deliver cash to the other party to the contract and/or exchange other financial instruments with the other party to the contract on potentially unfavorable terms. Accordingly, these items are (or were) financial liabilities subject to the accounting and disclosure requirements of the Fair Values Measurements and Disclosures topic of the ASC, whereby such liabilities are presented at fair value, which 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.

 

 

12

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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 Instruments. However, we have determined that the fair value of the Instruments may be determined using Level 2 inputs, as follows: the fair market value interest rate paid by us under the Line, as discussed in note 4. We have also determined that the fair value of the Instruments 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, interest rates and other related expenses such as finders and origination fees observed in our ongoing and active negotiations with various financing sources, including the terms of transactions engaged in by us that are not eligible to be Level 2 inputs because of the non-comparable duration of the transaction as compared to the transaction being valued. Level 3 inputs currently used by us in our fair value calculations with respect to the Instruments include finders and origination fees ranging between 10% and 14% per annum and periodic interest rate premiums arising from less favorable collateral and/or payment priority, as compared to the Line, ranging between 6% and 21% per annum.

 

Using the inputs described above, we have determined that there was no material difference between the carrying value and the fair value of the Instruments as of June 30, 2014, March 31, 2014, September 30, 2013, June 30, 2013, March 31, 2013 or September 30, 2012 and therefore no adjustment with respect to fair value was made to our consolidated financial statements as of those dates or for the nine and three months ended June 30, 2014 and 2013.

 

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. As provided by ASC 350-20-35 (“Intangibles – Goodwill and Other – Goodwill - Subsequent Measurement”), we follow a two-step process for impairment testing of goodwill. The first step of this test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment, 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. As allowed by ASC 350-20-35-3, we first assess the qualitative factors set forth in that authoritative guidance to determine whether it is more likely than not that the fair value of a reporting unit is more or less than its carrying amount and to use such qualitative assessment as a basis of determining whether it would be necessary to perform the two-step goodwill impairment testing process described above.

 

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 at least annually.

 

13

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Long-lived assets

 

Property and equipment

 

Property and equipment are recorded at cost, less accumulated depreciation. Leases, including those for office space as well as those for computers and equipment, are evaluated for capitalization in accordance with the four criteria set forth in ASC 840-10-25-1 (“Leases – Overall – Recognition”). Property and equipment under capital leases are stated at the lower of the present value of the minimum lease payments at the beginning of the lease term or the fair value at the inception of the lease. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization expense on assets acquired under capital leases is included in depreciation expense. The costs of leasehold improvements are amortized over the lesser of the lease term or the life of the improvement.

 

Software

 

Software developed for internal use, including the Digital Media Services Platform (“DMSP”) and iEncode and other webcasting software, is included in property and equipment – see notes 2 and 3.  Such amounts are accounted for in accordance with the Intangibles – Goodwill and Other topic of the ASC and 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.

 

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.

 

 

14

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Revenue Recognition

 

Revenues from sales of goods and services are recognized when (i) persuasive evidence of an arrangement between us and the customer exists, (ii) the 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 Infinite and OCC divisions of the Audio and Web Conferencing Services Group generate revenues from audio conferencing and web conferencing services, plus recording and other ancillary services.  Infinite and OCC own telephone switches used for audio conference calls by its customers, which are generally charged for those calls based on a per-minute usage rate. Infinite provides online webconferencing services to its customers, charging either a per-minute rate or a monthly subscription fee allowing a certain level of usage. Audio conferencing and web conferencing revenue is recognized based on the timing of the customer’s use of those services.

 

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

 

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

 

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

 

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

 

 

15

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Revenue Recognition (continued)

 

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, 2014 and September 30, 2013 was immaterial in relation to our recorded liabilities at those dates.

 

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.

 

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.

 

Deferred revenue represents amounts billed to or received from customers for audio and web conferencing, webcasting 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.

 

We add to our customer billings for certain services an amount to recover Universal Service Fund (“USF”) contributions which we have determined that we will be obligated to pay to the Federal Communications Commission (“FCC”), related to those particular services. This additional billing to our customers is not reflected as revenue by us, but rather is recorded as a liability on our books at the time of such billing, which liability is relieved upon our remittance of USF contributions as they are billed to us by USAC, an administrative and collection agency of the FCC - see notes 4 and 5.

 

16

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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 $86 million in Federal net operating loss carryforwards (NOLs) as of June 30, 2014, which (i) expire in fiscal years 2018 through 2033, (ii) include approximately $20 million acquired in connection with 2001 and 2002 acquisitions and (iii) may be limited as to our future use as the result of previous or future ownership changes and other limitations. We had a deferred tax asset of approximately $32.3 million as of June 30, 2014 and approximately $32.2 million as of September 30, 2013, primarily resulting from these NOLs. 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. A full valuation allowance has been recorded related to the deferred tax asset due to the uncertainty of realizing the benefits of certain NOLs 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.

 

As a result of the NOLs as discussed above, no income tax benefit was recorded in our consolidated statement of operations as a result of the net tax losses for the nine months ended June 30, 2014 and the nine and three months ended June 30, 2013.  Furthermore, although our statement of operations reflected net income for the three months ended June 30, 2014, we expect that our statement of operations for fiscal 2014 will reflect a net loss, and therefore no income tax expense was recorded in our consolidated statement of operations for the three months ended June 30, 2014.

 

The primary differences between the net loss or income for book and the net loss or income 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, expenses for stock options issued in payment for consultant and employee services but not exercised by the recipients, expenses related to shares issued or committed to be issued in payment for consultant and employee services, until such shares are issued and eligible for resale by the recipient, and interest accretion expense when related to liabilities for capital transactions such as share repurchases and asset purchases.

 

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, 2014 and September 30, 2013 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, 2014 and 2013. The tax years ending September 30, 2008 and thereafter remain subject to examination by Federal and various state tax jurisdictions.

 

17

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Net (Loss) Income per Share

 

For the nine and three months ended June 30, 2014 and 2013, basic net loss or income per share is based on the net loss or income divided by the basic weighted average number of shares of common stock outstanding, including the impact of 2,541,667 shares of common stock committed to be issued for compensation to certain Executives and for a loan origination fee, but not yet issued, as of June 30, 2014 and as of June 30, 2013 – see notes 4 and 5.

 

Since our statement of operations for the nine months ended June 30, 2014 and for the nine and three months ended June 30, 2013 reflects a net loss, the effect of common stock equivalents for those periods would be anti-dilutive and thus all such equivalents were excluded from the calculation of basic weighted average shares outstanding for those periods. Since our statement of operations for the three months ended June 30, 2014 reflects net income, we are required to calculate and present fully diluted net income per share for that period. However, all common stock equivalents were also excluded from the calculation of weighted average shares outstanding on a fully diluted basis for that period, since the options and warrants outstanding during that period had per share exercise prices in excess of the range of the market price of an ONSM common share during that period and the impact of assumed conversions of each of the convertible securities outstanding during that period was also determined to be anti-dilutive.

 

The total outstanding options and warrants thus excluded from the calculation of weighted average shares outstanding represented underlying common shares of 1,174,532 and 1,397,667 at June 30, 2014 and 2013, respectively.

 

The convertible securities outstanding at June 30, 2014 but excluded from the calculation of weighted average shares outstanding for the nine and three months ended June 30, 2014 are as follows: (i) the $395,000 portion of the outstanding balance of Sigma Note 1, which could potentially convert into up to 395,000 shares of our common stock, (ii) the $528,941 outstanding balance of Sigma Note 2, which could potentially convert into up to 528,941 shares of our common stock, (iii) the $400,000 outstanding balance of the Rockridge Note, which could potentially convert into up to 166,667 shares of our common stock, (iv) the $200,000 outstanding balance of the Fuse Note, which could potentially convert into up to 400,000 shares of our common stock and (iv)  the $200,000 portion of the outstanding balance of the Intella2 Investor Notes issued to Fuse Capital LLC, which could potentially convert into up to 400,000 shares of our common stock.

  

In addition, the convertible securities outstanding at June 30, 2013 but excluded from the calculation of weighted average shares outstanding for the nine and three months ended June 30, 2013 are as follows: (i) the $395,000 portion of the outstanding balance of Sigma Note 1, which could potentially convert into up to 395,000 shares of our common stock, (ii) the $572,879 outstanding balance of the Rockridge Note, which could have potentially converted into up to 238,700 shares of our common stock, (iii) the $200,000 outstanding balance of the Fuse Note, which could potentially convert into up to 400,000 shares of our common stock and (iv)  the $200,000 portion of the outstanding balance of the Intella2 Investor Notes issued to Fuse Capital LLC, which could potentially convert into up to 400,000 shares of our common stock.

 

18

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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 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 $1.2 million and $818,000 as of June 30, 2014 and September 30, 2013, 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. In accordance with the Compensation – Stock Compensation topic of the ASC, we measure compensation cost for all share-based payments, including employee stock options, at fair value, using the modified-prospective-transition method. Under this method, compensation cost recognized for the nine and three months ended June 30, 2014 and 2013 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. There were no Plan options granted during the nine months ended June 30, 2014 or 2013.

 

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 nine months ended June 30, 2014 or 2013.

 

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

 

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 $477,000 and $539,000 for the nine months ended June 30, 2014 and 2013, respectively, and approximately $161,000 and $199,000 for the three months ended June 30, 2014 and 2013, 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.

 

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 or income equals comprehensive loss or income for all periods presented.

 

19

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Valuation of Derivatives

 

In accordance with ASC Topic 815, Derivatives and Hedging, we follow 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 our own stock, which would in turn determine whether the instrument was treated as a liability to be recorded on our balance sheet at fair value. We have determined that this treatment was applicable to a warrant issued by us in September 2010 – see note 8.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year presentation, including calculation of weighted average shares of common stock outstanding – basic and diluted - to include common stock committed for issue.

 

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, inventory reserves, depreciation and amortization lives and methods, goodwill and other impairment allowances, income taxes and related reserves and contingent liabilities, including contingent purchase prices for acquisitions, contingent compensation arrangements and USF contributions. Such estimates are reviewed on an ongoing basis and actual results could be materially affected by those estimates.

 

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 accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with our annual financial statements as of September 30, 2013. 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, 2014, the results of our operations for the nine and three months ended June 30, 2014 and 2013 and our cash flows for the nine months ended June 30, 2014 and 2013. The results of operations and cash flows for the interim periods are not necessarily indicative of the results of operations or cash flows that can be expected for the year ending September 30, 2014.

 

 

20

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Effects of Recent Accounting Pronouncements

 

In July 2013, the FASB issued ASU 2013-11 (Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists), which provides that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available, in which case the unrecognized tax benefit should be presented in the financial statements as a liability. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013, with early adoption permitted.  We believe that our implementation of this guidance will have no material impact on our consolidated financial statements.

 

In May 2014, the FASB issued ASU 2014-09 (Revenue from Contracts with Customers (Topic 606)), which requires an entity to recognize revenue from the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance addresses in particular contracts with more than one performance obligation as well as the accounting for some costs to obtain or fulfill a contract with a customer and provides for additional disclosures with respect to revenues and cash flows arising from contracts with customers. With respect to public entities, this update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and early adoption is not permitted.  We believe that our implementation of this guidance will have no material impact on our consolidated financial statements.

 

In June 2014, the FASB issued ASU 2014-12 (Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could be Achieved after the Requisite Service Period), which requires that a performance target which affects vesting and which could be achieved after the requisite service period be treated as a performance condition. This update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015, with early adoption permitted.  We are currently evaluating the impact of the implementation of this guidance on our consolidated financial statements.

 

21

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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, 2014

 

September 30, 2013

 

Gross

Carrying

Amount 

 

Accumulated

Amortization

 


Net Book

Value

 

Gross

Carrying

Amount 

 

Accumulated

Amortization

 


Net Book

Value

 

 

 

 

 

 

 

 

 

 

 

 

Goodwill:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Infinite Conferencing

$

6,400,887

 

$

-

 

$

6,400,887

 

$

6,400,887

 

$

-

 

$

6,400,887

EDNet

 

1,271,444

 

 

-

 

 

1,271,444

 

 

1,271,444

 

 

-

 

 

1,271,444

Intella2

 

411,656

 

 

-

 

 

411,656

 

 

411,656

 

 

-

 

 

411,656

Acquired Onstream

 

271,401

 

 

-

 

 

271,401

 

 

271,401

 

 

-

 

 

271,401

Auction Video

 

3,216

 

 

-

 

 

3,216

 

 

3,216

 

 

-

 

 

3,216

Total goodwill

 

8,358,604

 

 

-

 

 

8,358,604

 

 

8,358,604

 

 

-

 

 

8,358,604

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Acquisition-related intangible assets (items listed are those that were not fully amortized as of September 30, 2013):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Intella2 - customer lists, trade names, URLs and

non-compete

 

759,848

 

 

(187,686)

 

 

572,162

 

 

759,848

 

 

(90,305)

 

 

669,543

Total intangible assets

 

759,848

 

 

( 187,686)

 

 

572,162

 

 

759,848

 

 

( 90,305)

 

 

669,543

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total goodwill and other acquisition-related

intangible assets

$

9,118,452

 

$

(187,686)

 

$

8,930,766

 

$

9,118,452

 

$

(90,305)

 

$

9,028,147

 

Intella2 – November 30, 2012

 

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”). The acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail. The Intella2 assets and operations were purchased by Onstream Conferencing Corporation, our wholly owned subsidiary, and are being managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The total purchase price of the Intella2 assets and operations was approximately $1.4 million, of which we paid approximately $713,000 in cash to Intella2 through June 30, 2014. Prior to the litigation settlement discussed below, additional purchase price payments would be based on the following remaining obligations incurred in connection with the Intella2 purchase:

 

 

22

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Intella2 – November 30, 2012 (continued)

 

(i)                  Additional payment equal to the excess of eligible revenues for the twelve months ending November 30, 2013 over $713,000, provided that such additional payment would be no less than $187,000 and no more than $384,000.

 

(ii)                Additional payment equal to fifty percent (50%) of the excess of eligible revenues for the twelve months ending November 30, 2013 over $1,098,000, provided that such additional payment would be no more than $300,000. Eligible revenues for purposes of items (i) and (ii) exclude free conferencing business revenues and non-recurring revenues and are further defined in the Asset Purchase Agreement dated November 30, 2012.

 

(iii)              70% of the future free conferencing business revenues, net of applicable expenses, through November 30, 2017, after which we have agreed to pay an amount equal to such payments for the last two months of that period, with no further obligation to Intella2 in that regard. The 70% will be adjusted to 50% if the free conferencing business revenues, net of applicable expenses, are less than $40,000 for two consecutive quarters, and will be adjusted back to 70% if that amount returns to more than $40,000 for two consecutive quarters.

 

On November 26, 2013, Intella2 and its owner Paul Cohen filed a civil lawsuit in Florida naming Onstream Media Corporation, Onstream Conferencing Corporation and Infinite Conferencing as defendants. The action alleged breach of contract with respect to payment of certain components of the purchase price for the Intella2 acquisition and related commissions and sought money damages as well as declaratory relief declaring Mr. Cohen’s related non-compete agreement with us unenforceable. On December 31, 2013 we filed our response to this lawsuit, which contained various objections to the lawsuit allegations as well as a number of counterclaims. On July 29, 2014, the parties entered into a settlement agreement and on August 4, 2014, the lawsuit was dismissed with prejudice by the court. Under the terms of the settlement agreement, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014, and we also agreed to pay him $20,000 ($10,000 per month in July and August) with respect to such activity before July 1, 2014. We also agreed to transfer certain computer equipment already owned by us and used to support the free conferencing business, with an estimated net book value of $20,000, to Mr. Cohen. Free conferencing revenues were $153,000 and $44,000 for the nine and three months ended June 30, 2014, respectively. No further purchase price or other amounts will be payable by us under the agreements entered into at the time of the November 30, 2012 acquisition, including the Asset Purchase Agreement, the Total Free Conferencing Business Revenue Share Agreement and the Master Agent and Non-Compete Agreement. Per the settlement agreement, Mr. Cohen’s non-compete agreement was cancelled and replaced by mutual agreements as to non-disparagement and non-solicitation.

 

Prior to adjustment for the litigation settlement, the unpaid portion of the purchase price reflected as an accrued liability on our financial statements through June 30, 2014 was approximately $782,000. This represented the remaining unpaid portion of the purchase price of approximately $705,000, as determined as of the time of the initial purchase, plus accretion of approximately $74,000 reflected as interest expense on our statement of operations for the year ended September 30, 2013 and accretion of approximately $53,000 reflected as interest expense on our statement of operations for the nine months ended June 30, 2014 and less approximately $50,000 of payments made to Intella2 after closing through June 30, 2014, which were considered to be payment of the accretion (i.e., interest) instead of the purchase price (i.e., principal).

 

23

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Intella2 – November 30, 2012 (continued)

 

Authoritative accounting guidance allows one year from the acquisition date to make adjustments to the purchase price, in the event that such adjustments are based on facts and circumstances that existed as of the acquisition date. However, changes resulting from facts and circumstances arising after the acquisition date, or after the one year timeframe, are recognized in operating results. Based on the litigation settlement, which was reached more than one year after the acquisition date and was based on facts and circumstances arising after the acquisition date, we reduced the approximately $782,000 estimated liability for the unpaid portion of the purchase price to an estimated liability of $40,000, classified as current, which resulted in our recognition of other income of approximately $742,000 for the nine and three months ended June 30, 2014.

 

ASC 350-20-40 (“Derecognition”) requires that when a portion of a reporting unit that constitutes a business is disposed of, the goodwill associated with that business is included in the carrying amount of the business in determining the disposal gain or loss. Allocating a portion of the audio and web conferencing reporting unit goodwill to the free conferencing business requires the determination of the proceeds received for that free conferencing business and what percentage that represents of the audio and web conferencing reporting unit goodwill. In addition to the value of the transferred free conferencing business, the litigation settlement also contemplated the amounts claimed by us as due from Intella2 for damages and Intella2’s claims for amounts earned and payable under the acquisition documents. Since the litigation settlement did not assign specific values to these three items, we allocated the approximately $742,000 litigation settlement gain between those three items based on the gross amounts of the claims made by us and Intella2, as well as the value of the transfer of the free conferencing business, which was based on our current discounted cash flow analysis. We concluded that the portion of the audio and web conferencing reporting unit goodwill allocable to the free conferencing business was immaterial and no adjustment of that goodwill was required.

 

The fair value of certain intangible assets (customer lists, trade names, URLs (internet domain names) and employment and non-compete agreements) acquired as part of the Intella2 acquisition was determined by our management to be approximately $760,000 at the time of the acquisition. This fair value was primarily based on the discounted projected cash flows related to these assets for the three to seven years immediately following the acquisition on a stand-alone basis without regard to the Intella2 acquisition, as projected by our management and Intella2’s former 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. The fair value of certain tangible assets (primarily equipment) acquired as part of the Intella2 acquisition was determined by our management to be approximately $246,000 at the time of the acquisition. This fair value was primarily based on management’s inspection of and evaluation of the condition and utility of the equipment, as well as comparable market values of similar used equipment when available. We are depreciating and amortizing these tangible and intangible assets over useful lives ranging from three to seven years. The approximately $1.4 million purchase price exceeded the fair values we assigned to Intella2’s tangible and intangible assets (net of liabilities at fair value) by approximately $412,000, which we recorded as goodwill. We evaluated the carrying value of the Intella2 goodwill as part of our annual review performed as of September 30, 2013, with no write-downs required to date. However, since the litigation settlement discussed above resulted in the discontinuance of a significant portion of the business acquired by us from Intella2, we considered that to be a “triggering event” that would require us to make an interim review of the carrying value of the Intella2 goodwill as of June 30, 2014, as discussed in “Testing for Impairment” below.

 

24

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

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.

 

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 amortized these assets over useful lives ranging from 3 to 6 years - as of September 30, 2013 all of these assets 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. As of December 31, 2008, this initially recorded goodwill was determined to be impaired and a $900,000 adjustment was made to reduce its carrying value to approximately $11.1 million.  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. As of December 31, 2009, the Infinite goodwill was determined to be further impaired and a $2.5 million adjustment was made to reduce the carrying value of that goodwill to approximately $8.6 million. 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. Furthermore, as discussed in “Testing for Impairment” below, the Infinite goodwill was determined to be further impaired as of September 30, 2013 and a $2.2 million adjustment was made to reduce the carrying value of that goodwill to approximately $6.4 million as of that date. This adjustment was reflected in our results of operations for the year ended September 30, 2013 (zero for the nine and three months ended June 30, 2013) as a charge for impairment of goodwill.

 

25

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

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 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. 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.

 

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, future cost savings for Auction Video services and the consulting and non-compete agreements entered into with the former executives and owners of Auction Video were valued in aggregate at $1.4 million and were amortized over various lives between two to five years commencing April 2007 -  as of September 30, 2013 all of these assets had been fully amortized and removed from our balance sheet. $600,000 was assigned as the value of the video ingestion and flash transcoder and added to the DMSP’s carrying cost for financial statement purposes – see note 3.

 

Subsequent to this 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 proprietary Onstream technology. In April 2008, we revised the original patent application primarily for the purpose of splitting it into two separate applications, which, while related, would be evaluated separately by the U.S. Patent and Trademark Office (“USPTO”).

 

With respect to the claims pending in the first of the two applications, the USPTO 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 USPTO on November 22, 2010 and we filed an appeal brief with the USPTO on February 9, 2011. The USPTO 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. On July 7, 2014, the USPTO issued a notice setting the hearing on this application before the Patent Trial and Appeal Board on September 18, 2014. We confirmed our intent to attend, and make an oral presentation at, that hearing by our response filed with the USPTO on July 25, 2014.

 

 

26

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Auction Video – March 27, 2007 (continued)

 

With respect to the claims pending in the second of the two applications, the USPTO issued a non-final rejection in June 2011 (which was reissued in January 2012) and a final rejection in June 2012. With respect to the June 2012 rejection, we filed a pre-appeal brief conference request on September 7, 2012 and the USPTO responded on September 27, 2012 with a decision to proceed to appeal. We filed a Request for Continuing Examination with the USPTO on April 5, 2013, which the USPTO responded to on June 12, 2013 with a non-final rejection. Our response to that non-final rejection was filed on November 12, 2013, which the USPTO responded to on January 10, 2014 with a final rejection. In response to this final rejection, we filed a Notice of Appeal on April 8, 2014 and we filed the related appeal brief on June 9, 2014.

 

Regardless of the ultimate outcome, our management has determined that an adverse decision with respect to these patent applications would not have a material adverse effect on our financial position or results of operations, since all of the previous costs incurred by us in connection with the patents have been amortized to expense as of September 30, 2013 and are being expensed as incurred subsequent to that date. 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.

 

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 we 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 for fixed assets, working capital and workforce retraining. See note 3.

 

27

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Acquired Onstream – December 23, 2004 (continued)

 

The approximately $10.0 million purchase price we paid for 100% of Acquired Onstream exceeded the fair values we assigned to Acquired Onstream’s tangible and intangible assets (net of liabilities at fair value) by approximately $8.4 million, which we recorded as goodwill as of the purchase date. As of December 31, 2008, this initially recorded goodwill was determined to be impaired and a $4.3 million adjustment was made to reduce the carrying value of that goodwill to approximately $4.1 million. As of September 30, 2010, the Acquired Onstream goodwill was determined to be further impaired and a $1.6 million adjustment was made to reduce the carrying value of that goodwill to approximately $2.5 million. As of September 30, 2011, the Acquired Onstream goodwill was determined to be further impaired and a $1.7 million adjustment was made to reduce the carrying value of that goodwill to approximately $821,000. As of September 30, 2012, the Acquired Onstream goodwill was determined to be further impaired and a $550,000 adjustment was made to reduce the carrying value of that goodwill to approximately $271,000. We have continued to evaluate the carrying value of the Acquired Onstream goodwill on an annual basis, with no further write-downs required to date.

 

EDNet – July 25, 2001

 

Prior to 2001, we recorded goodwill of approximately $750,000 resulting from the acquisition of 51% of EDNet, which we were initially amortizing on a straight-line basis over 15 years. As of July 1, 2001, we adopted SFAS 142, Goodwill and Other Intangible Assets, which addressed the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition. This standard required that goodwill no longer be amortized, and instead be tested for impairment on a periodic basis. When we acquired the remaining 49% of EDNet on July 25, 2001 the transaction generated approximately $2.3 million in goodwill which when combined with the unamortized portion of the initial goodwill resulted in total EDNet goodwill of approximately $2.8 million. Based on our goodwill impairment tests as of September 30, 2002 we determined that the EDNet goodwill was impaired by approximately $728,000 and therefore the goodwill was written down to approximately $2.1 million. Based on our goodwill impairment tests as of September 30, 2004 we determined that the EDNet goodwill was impaired by approximately $470,000 and therefore the goodwill was written down to approximately $1.6 million. Based on our goodwill impairment tests as of September 30, 2005 we determined that the EDNet goodwill was impaired by approximately $330,000 and therefore the goodwill was written down to approximately $1.3 million.   We have continued to evaluate the carrying value of the EDNet goodwill on an annual basis, with no further write-downs required to date.

 

EDNet’s operations are heavily dependent on the use of ISDN phone lines (“ISDN”), which are only available from a limited number of suppliers. The two telecommunication companies which are the primary suppliers of ISDN to EDNet have made recent public indications of intentions to restrict, or even eventually eliminate, their provision of ISDN. Such actions could have a significant adverse impact on our future evaluations of the carrying value of EDNet goodwill, especially if alternative ISDN suppliers cannot be identified or if an alternative such as Internet based technology is not available or economically feasible as a basis to continue the EDNet operations. However, these two companies have not announced definitive timetables for taking any extensive actions with regard to restricting ISDN and therefore we have not assumed any such actions would take place within the timeframe of our discounted cash flow analyses used by us for these evaluations to date.

 

28

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Testing for Impairment  

 

In accordance with ASC Topic 350, Intangibles – Goodwill and Other, which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, goodwill must be tested for impairment on a periodic basis, at a level of reporting referred to as a reporting unit. Although other intangible assets are being amortized to expense over their estimated useful lives, the unamortized balances are still subject to review and adjustment for impairment. There is a two-step process for impairment testing of goodwill 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.

 

The provisions of ASC 350-20-35-3 in certain cases would allow us to forego the two-step impairment testing process based on certain qualitative evaluation - see note 1.  However, based on our assessment as of September 30, 2013 of relevant events and circumstances as listed in ASC 350-20-35-3C, we determined that we were not eligible to employ qualitative evaluation to forego the two-step impairment testing process with respect to our reporting units as of September 30, 2013, as it was not more likely than not that impairment loss had not occurred. These relevant events and circumstances included certain macroeconomic conditions, including access to capital and the ongoing decrease in the ONSM share price.

 

The material portion of our goodwill and other intangible assets are contained in the EDNet reporting unit, the Acquired Onstream/DMSP reporting unit and the audio and web conferencing reporting unit, which includes the Infinite Conferencing and the OCC/Intella2 divisions. Our reporting units were identified based on the requirements of ASC 350-20-35-33 through 350-20-35-46. According to ASC 350-20-35-34, a component of an operating segment is a reporting unit if that component represents a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. This is the case for the EDNet division, the Acquired Onstream/DMSP division, the Infinite Conferencing division and the OCC/Intella2 division. However, ASC 350-20-35-35 provides that two or more components of an operating segment shall be aggregated and deemed a single reporting unit if the components have similar economic characteristics. This is the case for the Infinite Conferencing division and the OCC/Intella2 division, since they are both in the business of audio and web conferencing sold primarily to business customers. Although EDNet is in the same operating segment as the Infinite Conferencing division and the OCC/Intella2 division, it is not considered to be part of the audio and web conferencing reporting unit since EDNet offers a specialized telephone service to the entertainment industry (movies, television, advertising) that also uses a specific type of phone line (ISDN) that is different from the standard telephone lines used by the Infinite Conferencing division and the OCC/Intella2 division.

As part of the two-step process discussed above, our management performed discounted cash flow (“DCF”) analyses to determine whether the goodwill of our reporting units was potentially impaired and the amount of such impairment. Our management determined the rates and assumptions, including the discount rates and the probability of future revenues and costs, used by it to perform these analyses and also considered macroeconomic and other conditions such as: our credit rating, stock price and access to capital; a decline in market-dependent multiples in absolute terms; telecommunications industry growth projections; internet industry growth projections; entertainment industry growth projections (re EDNet customer base); our historical sales trends and our technological accomplishments compared to our peer group.

 

 

29

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Testing for Impairment (continued)

 

We analyzed our corporate payroll and other costs to determine their relevance to the reporting units, and to the extent relevant, we allocated such costs when preparing the projections used by us in the above analyses. We determined that approximately 72% of our corporate costs (excluding non-cash expenses) were allocable to our reporting units, including those without goodwill or other intangible assets. The non-allocable corporate costs related to various public company related requirements and expenses as well as the costs of evaluating new business opportunities and products outside the existing divisions.

 

Based on these evaluations, we determined that it was more likely than not that the fair values of the EDNet and Acquired Onstream reporting units were more than their respective carrying amounts as of September 30, 2013 since the carrying value of the each of those reporting units (after reduction for interest-bearing debt) was less than or not material different than the result of the respective DCF analysis. However, we were unable to arrive at the same conclusion as a result of our evaluation of the audio and web conferencing reporting unit, since the carrying value exceeded the results of the DCF analysis (after reduction for interest-bearing debt) for that reporting unit.

 

Accordingly, we performed further calculations in order to determine the amount of the impairment of the goodwill of the audio and web conferencing reporting unit and determined that the carrying value of the audio and web conferencing reporting unit exceeded the results of the DCF analysis (after reductions for interest bearing debt and for an allocation of that amount to recognize an increase in the recorded value of the audio and web conferencing reporting unit customer lists to an updated fair value) for that reporting unit by approximately $2.2 million. Accordingly, this difference was the amount by which the goodwill of the audio and web conferencing reporting unit was impaired as of September 30, 2013, and a $2.2 million adjustment was made to reduce the carrying value of the audio and web conferencing reporting unit’s goodwill as of that date. This adjustment was further allocated to our Infinite division. The increase in the recorded value of the audio and web conferencing reporting unit customer lists to an updated fair value as discussed above was not reflected on our books, since in accordance with GAAP that calculation is solely for purposes of determining impairment of goodwill and is not for the purpose of adjusting the carrying value of other intangible assets.

 

In order to address whether any further consideration of ONSM’s share price was needed with respect to impairment testing, we performed an analysis to compare our book value (after the impairment adjustment for the audio and web conferencing reporting unit discussed above) to our market capitalization as of September 30, 2013, including adjustments for (i) paid-for but not issued common shares, such as the Rockridge Shares (see note 4) and the Executive Shares (see note 5) and (ii) an appropriate control premium. Based on this analysis, we concluded that there were no conditions with respect to our market capitalization as of September 30, 2013 which would require further evaluation with respect to the carrying values of our reporting units.   

 

30

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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

 

Testing for Impairment (continued)

 

An annual impairment review of our goodwill and other acquisition-related intangible assets will be performed as part of preparing our September 30, 2014 financial statements. Until that time, we are reviewing certain factors to determine whether a triggering event has occurred that would require an interim impairment review. Those factors include, but are not limited to, 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 and the market price of our common stock. Since the July 2014 litigation settlement discussed above resulted in the discontinuance of a significant portion of the business acquired by us from Intella2, we considered that to be a “triggering event” that would require us to make an interim review of the carrying value of the goodwill of the audio and web conferencing reporting unit (which includes the Intella2 goodwill) as of June 30, 2014. Accordingly, we updated five-year projections that were used in the DCF analysis prepared for the review of the goodwill of the audio and web conferencing reporting unit as of September 30, 2013, taking into account the impact of the litigation settlement as well as other changes since those projections were initially prepared. Based on our determination that the updated projections resulted in anticipated cash flow materially equal to or greater than the initial projections, we concluded that no further evaluation or adjustment with respect to the carrying value of the goodwill of the audio and web conferencing reporting unit was necessary as of June 30, 2014.

 

Although the closing ONSM share price declined from $0.27 per share at September 30, 2013 to $0.20 per share as of June 30, 2014, the comparison of our book value to our market capitalization as of June 30, 2014, including adjustments for (i) paid-for but not issued common shares, such as the Rockridge Shares (see note 4) and the Executive Shares (see note 5) and (ii) an appropriate control premium, supported our conclusion that there were no conditions with respect to our market capitalization as of June 30, 2014 which would require further evaluation with respect to the carrying values of our reporting units. The closing ONSM share price was $0.18 per share on August 8, 2014.

 

31

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 3:  PROPERTY AND EQUIPMENT

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2014

 

September 30, 2013

 

 

 

Historical

Cost

 

Accumulated Depreciation and Amortization

 

Net Book

Value

 

Historical

Cost

 

Accumulated Depreciation and Amortization

 

Net Book

Value

 

Useful Lives (Yrs)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Equipment and software

$

11,080,346

 

$

(10,617,054)

 

$

463,292

 

$

11,030,480

 

$

(10,414,992)

 

$

615,488

 

1-5

DMSP

 

6,189,042

 

 

(5,640,359)

 

 

548,683

 

 

6,033,167

 

 

(5,503,423)

 

 

529,744

 

5

Other capitalized internal use

software

 

2,225,497

 

 

(1,378,848)

 

 

846,649

 

 

2,009,397

 

 

(1,175,176)

 

 

834,221

 

3-5

Travel video library

 

1,368,112

 

 

(1,368,112)

 

 

-

 

 

1,368,112

 

 

(1,368,112)

 

 

-

 

N/A

Furniture, fixtures and leasehold

improvements

 

610,856

 

 

(561,214)

 

 

49,642

 

 

609,423

 

 

(541,243)

 

 

68,180

 

2-7

Totals

$

21,473,853

 

$

(19,565,587)

 

$

1,908,266

 

$

21,050,579

 

$

(19,002,946)

 

$

2,047,633

 

 

                                       

 

Depreciation and amortization expense for property and equipment was approximately $565,000 and $663,000 for the nine months ended June 30, 2014 and 2013, respectively, and $182,000 and $239,000 for the three months ended June 30, 2014 and 2013, 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. A partially completed version of 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. Subsequently, we continued to develop the DMSP, making payments under the SAIC contract and to other vendors, as well as to our own development staff as discussed below, which were recorded as an increase in the DMSP’s carrying cost. A limited version of the DMSP was first placed in service in November 2005. “Store and Stream” was the first version of the DMSP sold to the general public, starting in October 2006. In connection with our purchase of Auction Video in March 2007 (see note 2), $600,000 of the purchase price was attributed to a video ingestion and flash transcoder and added to 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.

 

32

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 3:  PROPERTY AND EQUIPMENT (Continued)

 

As of June 30, 2014 we have capitalized as part of the DMSP approximately $1.3 million of employee compensation, payments to contract programmers and related costs for development of “Streaming Publisher”, a second version of the DMSP with additional functionality although it also is a stand-alone product based on a different architecture than Store and Stream. As of June 30, 2014, approximately $1.2 million of these costs had been placed in service, including approximately $410,000 for the initial release in September/October 2009, approximately $231,000 for a subsequent release in April/May 2010, approximately $109,000 for storefront applications placed in service between August 2013 and January 2014, approximately $52,000 for a subsequent release in January 2014 and approximately $125,000 for a subsequent release in May 2014. The balance of these costs not in service relate primarily to new features of the DMSP under development.

 

As of June 30, 2014 we have capitalized as part of other internal use software approximately $1.6 million of employee compensation and other costs for the development of webcasting applications. As of June 30, 2014, approximately $1.3 million of these costs have been placed in service, including approximately $444,000 placed in service in December 2009 for the initial release of iEncode software, which runs on a self-administered, webcasting appliance used to produce a live video webcast, approximately $352,000 placed in service in January 2013 for a new release of our basic webcasting platform and approximately $99,000 and $221,000 placed in service in October 2013 and July 2014, respectively, for enhancements to that new release. The remaining costs, not placed in service, relate primarily to new features of the webcasting platform under development.

 

All capitalized development costs placed in service are being depreciated over five years.

 

33

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT

 

Debt includes convertible debentures and notes payable (including capitalized lease obligations).

 

Convertible Debentures

 

Convertible debentures consist of the following:

 

 

June 30,

2014

 

September 30,

2013

Sigma Note 1 (excluding portion in notes payable)

$

395,000

 

$

395,000

Sigma Note 2

 

528,941

 

 

-

Sigma Notes (excluding portion in notes payable)

 

923,941

 

 

395,000

Rockridge Note

 

400,000

 

 

590,381

Fuse Note

 

200,000

 

 

200,000

Intella2 Investor Notes (excluding portion in notes payable)

 

200,000

 

 

200,000

Total convertible debentures

 

1,723,941

 

 

1,385,381

Less: discount on convertible debentures

 

(266,050)

 

 

(249,387)

Convertible debentures, net of discount

 

1,457,891

 

 

1,135,994

Less: current portion, net of discount

 

( 1,457,891)

 

 

( 587,198)

Convertible debentures, net of current portion and discount

$

-

 

$

548,796


Sigma Note 1

 

On March 21, 2013 (the “Sigma Closing”) we closed a transaction with Sigma Opportunity Fund II, LLC (“Sigma”), under which we would receive up to $800,000 pursuant to a senior secured note (“Sigma Note 1”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Thermo Credit and Rockridge. Sigma remitted $600,000 (net of fees and expenses discussed below) to us at the Sigma Closing, and the funding of the remaining $200,000 (“Contingent Financing”) was subject to us meeting certain revenue and operating cash flow targets for either the three months ended June 30, 2013 or the six months ended September 30, 2013, as well as making all scheduled principal and interest payments on our indebtedness to Sigma and our other lenders.


On June 14, 2013, Sigma Note 1 was amended to provide that we would receive immediate additional funding of $345,000, which would be in lieu of the $200,000 Contingent Financing. Furthermore, this $345,000 would be subject to the same terms as the Contingent Financing, in that it would be repayable as a balloon payment due on December 18, 2014 and prior to repayment, along with the previous balloon payment of $50,000 for a total balloon payment of $395,000, would be convertible into restricted common shares, at Sigma’s option, using a conversion rate of $1.00 per share.  After the amendment the total gross proceeds received under Sigma Note 1 was $945,000. Interest, computed at 17% per annum on the outstanding principal balance, was payable in monthly installments commencing April 30, 2013 and principal was payable in monthly installments commencing June 30, 2013. The required payments were made through November 30, 2013.

 

34

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Sigma Note 1 (continued)

 

On February 28, 2014, the terms of Sigma Note 1 were amended so that principal and interest payments otherwise due on Sigma Note 1, starting with the December 31, 2013 payment and ending with the September 30, 2014 payment, were eliminated and replaced with monthly principal and interest payments on the last day of October and November 2014 plus a final principal and interest payment on the December 18, 2014 maturity date of Sigma Note 1. As of February 28, 2014, the outstanding principal balance under Sigma Note 1 was approximately $895,000 (including previously accrued but unpaid interest made a part of that balance) and interest at 17% per annum will continue to accrue on the outstanding principal balance, compounding monthly and added to the respective note principal amount until paid.

 

After giving effect to the February 28, 2014 modification, the payments due under Sigma Note 1 are as follows:

 

October 31, 2014

$50,000 principal plus $13,991 interest

November 30, 2014

$50,000 principal plus $13,282 interest

December 18, 2014

$887,599 principal (including previously accrued interest made part of principal) plus $7,441 interest

 

Sigma Note 1 may be prepaid by us at any time, provided, however, that if Sigma Note 1 is prepaid during the twelve months immediately following the Sigma Closing, we shall pay an additional 90 days of interest on the then outstanding principal as of such prepayment date. If following the Sigma Closing we receive proceeds from the sale of a business unit and/or in connection with the issuance of additional equity, debt or convertible debt capital in the amounts listed in the table below, calculated on an aggregate basis subsequent to the Sigma Closing (“Aggregate Capital Raise”), we are required to immediately repay to Sigma the indicated amount (“Early Repayment Amount”), applied first toward repayment of interest and then toward principal.

 

Aggregate Capital Raise

Early Repayment Amount

$500,000 to $1,000,000

Lesser of outstanding principal plus interest or 25% of Capital Raise

$1,000,001 to $2,000,000

Lesser of outstanding principal plus interest or 50% of Capital Raise (reduced by any amounts previously repaid as a result of a Capital Raise transaction)

$2,000,001 or Higher

All outstanding principal plus Interest must be paid

 

The Aggregate Capital Raise excludes (i) advances received by us against accounts receivable from Thermo Credit pursuant to the Line, or any successor agreement entered into on materially the same terms, (ii) up to $330,000 of additional subordinated financing obtained by us on materially the same as certain previously-agreed terms and (iii) the additional amounts received in June 2013 from Sigma.

 

35

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Sigma Note 1 (continued)

 

The February 28, 2014 amendment also provided that upon our receipt of funds in excess of $2.0 million as a result of the sale of any portion of our business, however structured, including, without limitation, sale of assets, subsidiaries or business units, and/or (ii) the issuance of additional equity, debt or convertible debt capital, and/or (iii) our consolidation or merger with or into another entity, all outstanding principal and interest with respect to Sigma Note 1 will be due.

 

In connection with the initial March 2013 financing, we issued 300,000 restricted common shares to Sigma and agreed to reimburse up to $30,000 of Sigma’s legal and other expenses related to this financing, $27,500 of which was paid by us at the Sigma Closing. We also issued 60,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and agreed to pay them a $75,000 advisory fee, in connection with an Advisory Services Agreement we entered into with Sigma Capital effective March 18, 2013. $55,000 of the cash fee was paid by us at the Sigma Closing and the remaining $20,000 was paid over the next four months.  We also paid finders and other fees to other third parties in connection with this transaction, which totaled 60,000 restricted common shares and $12,000 cash. In connection with the June 2013 amendment, we issued 325,000 restricted common shares to Sigma and made payments aggregating $45,000 to Sigma and Sigma Capital, representing an administrative fee plus reimbursement of Sigma’s other cost and expenses related to this financing. We also issued 125,000 restricted common shares to Sigma Capital.

 

The value of the common stock issued, plus the amount of cash paid for related financing fees and expenses, in connection with the initial March 2013 financing and the June 2013 amendment, was reflected as a $511,188 discount against Sigma Note 1 (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 56% per annum through February 28, 2014 (which was 60% per annum for the period prior to the June 2013 amendment). Effective February 28, 2014, a portion of the value of the common shares issued and the fees paid in connection with Sigma Note 2, aggregating $124,655, was allocated to Sigma Note 1 and that amount is being amortized as interest over the remaining term of Sigma Note 1. When combined with the amortization of the remaining unamortized discount arising from the initial March 2013 financing and the June 2013 amendment, the resulting effective interest rate as of February 28, 2014 is approximately 66% per annum, which would increase in the event an Early Repayment Amount was required, as discussed above.

 

 The aggregate unamortized portion of the debt discount recorded against Sigma Note 1 was $191,587 and $348,823 (including $103,386 and $196,068 related to the portion of this debt classified as a note payable) as of June 30, 2014 and September 30, 2013, respectively.

 

36

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Sigma Note 1 (continued)

 

Although we concluded that there was less than a 10% difference between the present value of the cash flows of Sigma Note 1 after its June 2013 modification (including the Black-Scholes value of the additional conversion rights granted) versus the present value of the cash flows before the modification, which 10% is the threshold over which extinguishment accounting is required under the provisions of ASC 470-50-40, ASC 470-50-40 also provides that if a substantive conversion feature is added to an instrument, the modified terms are considered substantially different and extinguishment accounting is required. However, since the ONSM closing price of $0.30 per share at the time the additional conversion rights were granted under the modification was significantly less than the $1.00 per share conversion price, and the Black-Scholes value of such conversion right was determined by us to be approximately $6,700, which we concluded was immaterial, we determined that it was not reasonably possible that the conversion feature would be exercised and thus determined the conversion feature to not be substantive. Accordingly, accounting for this modification as an extinguishment of debt was not required.

 

We also concluded that there was less than a 10% difference between the present value of the cash flows of Sigma Note 1 after its February 2014 modification (including an allocation of a portion of the common shares issued and fees paid in connection with Sigma Note 2) versus the present value of the cash flows before the modification, and accordingly, accounting for this modification as an extinguishment of debt was not required.

 

For so long as Sigma Note 1 is outstanding, if at any time after the Sigma Closing we issue additional shares of common stock (other than as a result of common stock equivalents already issued prior to the Issuance Date) or common stock equivalents in an amount which exceeds, in the aggregate, 25% of our fully diluted shares (as defined) as of the Sigma Closing, whether through one or multiple issuances, then provided the proceeds of such issuance are not being used to pay all outstanding amounts owed under Sigma Note 1, we shall issue to Sigma and Sigma Capital, respectively, such number of shares of common stock as is necessary for Sigma and Sigma Capital to maintain the same beneficial ownership percentage of our capital stock, on a fully diluted basis, after the additional shares issuance as they had immediately before the additional shares issuance.  If, at the time of any additional share issuance, Sigma has not converted all or a portion of the amount of Sigma Note 1 eligible for conversion to common shares, we shall reserve for future issuance to Sigma upon any subsequent conversion, and shall issue to Sigma upon any subsequent conversion, such number of shares of common stock as to which Sigma would have been entitled hereunder had Sigma converted the unconverted amount immediately prior to the additional shares issuance. Notwithstanding the above, this provision shall only apply to beneficial ownership resulting from transactions related to Sigma Note 1 or the March 18, 2013 Advisory Services Agreement and shall not apply to our issuance of common stock or common stock equivalents in connection with our acquisition of another entity or the material portion of the assets of another entity, which transaction results in operating cash flow in excess of any related debt service.

 

37

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Sigma Note 2

 

We completed another transaction with Sigma on February 28, 2014, under which we borrowed $500,000 (from which were deducted certain fees and we repaid certain debt as discussed below) pursuant to a senior secured note (“Sigma Note 2”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Rockridge and Thermo Credit LLC. The $500,000 principal, plus $59,447 interest (based on 17% per annum compounding monthly), is due on October 31, 2014. Sigma shall have the right to convert Sigma Note 2 (including the accrued interest thereon), in its entirety or partially, and at its option, into our common shares at a price of $1.00 per share. Upon our receipt of funds in excess of $2.0 million as a result of the sale of any portion of our business, however structured, including, without limitation, sale of assets, subsidiaries or business units, and/or (ii) the issuance of additional equity, debt or convertible debt capital, and/or (iii) our consolidation or merger with or into another entity, all outstanding principal and interest with respect to Sigma Note 2 will be due.

 

In connection with the February 28, 2014 closing and funding of Sigma Note 2, we issued 350,000 restricted common shares to Sigma as well as reimbursed $11,354 of Sigma’s legal and other expenses related to this financing. In connection with a February 28, 2014 Advisory Services Agreement, we also issued 150,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and paid them a $167,857 advisory fee, of which $107,857 was withheld from the gross proceeds of Sigma Note 2 at the time of the February 28, 2014 funding to us and the $60,000 balance was paid in installments of $15,000 per month commencing April 1, 2014.  In accordance with the terms of the Sigma Note 2 financing, if by June 30, 2014 we had not signed a definitive agreement calling for receipt of funds in excess of $2.0 million as a result of the sale of all or a part of our operations or assets, we would be obligated to issue Sigma and Sigma Capital, in aggregate, another 300,000 restricted common shares plus pay Sigma Capital an additional cash fee of $100,000. Since those conditions were not met, on June 30, 2014 we recorded the issuance of those additional shares as well as a liability for the additional cash fee, which we paid in July 2014.

 

The value of the common stock issued, plus the amount of cash paid for related financing fees and expenses, was reflected as a $124,655 discount against Sigma Note 1 and a $329,556 discount against Sigma Note 2 (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 115% per annum. This effective rate would increase in the event an early repayment was required, as discussed above. The aggregate unamortized portion of the debt discount recorded against Sigma Note 2 was $168,128 as of June 30, 2014.

 

38

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Sigma Note 2 (continued)

 

Per the terms of the Sigma Note 2 financing, and prior to the termination as discussed below, Sigma and Sigma Capital had the joint right as of December 18, 2014 and for one year thereafter, to require us to purchase up to 1 million of our common shares held by them, at $0.25 per share (the “Sigma Put Right”). Our obligation under the Sigma Put Right was collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Thermo Credit and Rockridge. We issued Sigma and Sigma Capital an aggregate of 500,000 ONSM common shares on February 28, 2014, which resulted in total holdings by them at that date of 950,000 ONSM common shares, which they still held as of June 30, 2014. In addition, we have recorded the issuance of an additional 300,000 ONSM common shares to them as of June 30, 2014. Accordingly, our financial statements reflect an approximately $214,000 liability as of June 30, 2014, representing the present value of our potential $250,000 liability as of that date for the repurchase of 1 million common shares.

 

Effective August 13, 2014, Sigma and Sigma Capital agreed that the Sigma Put Right was terminated and as a result the related liability discussed above will be reversed by us, effective for our balance sheet as of September 30, 2014. In connection with such termination, we agreed that the right previously granted to us in connection with the Sigma Note 2 financing and extending through December 18, 2015, to purchase any and all of our common shares that were issued to Sigma and still held by them at the higher of (i) a 20% discount to the 15 trading day volume-weighted average share price (“VWAP”) or (ii) $0.25 per share, would also be terminated. We also agreed to pay the expenses of Sigma and Sigma Capital, which we estimate will be $2,000, in connection with their private sale of the 1,250,000 ONSM common shares held by them.

 

In connection with the issuance of the Sigma Note 2, an agreement was executed between Sigma and Rockridge, which included Rockridge’s agreement (along with our agreement) that Sigma has the right, but not the obligation, to repay the Rockridge Note at face value at any point after October 14, 2014, and always in case of a default on Sigma Note 1, Sigma Note 2 or the Rockridge Note. Such repayment amount would be added to the principal of Sigma Note 1, would accrue interest at 17% per annum and such amount plus accrued interest would be payable by us on December 18, 2014. In the event of such repayment by Sigma, Sigma would receive fees in cash and shares calculated on a pro-rata basis comparable to the terms of Sigma Note 2, based on the amount repaid to Rockridge and the amount of time the repaid debt would be unpaid by us after such repayment. For example, if $400,000 were repaid to Rockridge by Sigma on October 14, 2014, we would owe Sigma a fee of approximately $30,000 cash plus approximately 106,000 common shares.

 

39

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Rockridge Note

 

In April and June 2009 we borrowed $1.0 million 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”) between Rockridge and us. On September 14, 2009, we entered into Amendment Number 1 to the Agreement and an Allonge to the Note, under which we borrowed an additional $1.0 million, resulting in cumulative borrowings by us under the Rockridge Agreement, as amended, of $2.0 million. In connection with this transaction, we issued a note (the “Rockridge Note”) bearing interest at 12% per annum and 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 other lenders. We also entered into a Security Agreement with Rockridge containing covenants and restrictions with respect to the collateral.

 

Prior to a second Allonge to the Note dated December 12, 2012 (the “December 2012 Allonge”), the balance was payable in monthly principal and interest installments of $41,409 through August 14, 2013 plus a balloon payment of $505,648 on September 14, 2013. In accordance with the December 2012 Allonge, the balance outstanding was payable in monthly principal and interest installments of $41,322 through September 14, 2014. However, since we concluded that there was less than a 10% difference between the present value of the cash flows of the Rockridge Note after the December 2012 modification (including an increase in  the loan origination fee as discussed below) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were not considered substantially different and therefore accounting for that modification as an extinguishment of debt was not required.

 

In accordance with an agreement reached with Rockridge in October 2013, the remaining principal balance outstanding under the Rockridge Note, and the related interest, was payable in two (2) equal monthly installments of $21,322, commencing on October 14, 2013 plus nine (9) equal monthly installments of $45,322, commencing on December 14, 2013 plus a final payment of $188,989 due on September 14, 2014. Since we concluded that there was less than a 10% difference between the present value of the cash flows of the Rockridge Note after the October 2013 modification versus the present value of the cash flows under the payment terms in place one year earlier, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were not considered substantially different and therefore accounting for that modification as an extinguishment of debt was not required. The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification.

 

We made the first three payments required under the October 2013 agreement as set forth above and then on February 28, 2014 we made a principal payment of $119,615 (plus accrued interest), in exchange for Rockridge’s agreement that we would only be obligated to pay interest on a monthly basis until our repayment of the remaining outstanding principal of $400,000 on October 14, 2014 (the “Maturity Date”). We also agreed to pay the outstanding principal plus any accrued interest upon our receipt of proceeds in excess of $5 million related to the sale of any of our business units or subsidiaries.

 

40

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Rockridge Note (continued)

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the Rockridge Note after the February 28, 2014 modification and the present value of the cash flows under the payment terms in place one year earlier, under the provisions of ASC 470-50-40, the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2014 (zero for the three months then ended). This $43,620 debt extinguishment loss was calculated as the excess of the $519,615 acquisition cost of the new debt (face value of the note) over the net carrying amount of the extinguished debt immediately before the modification, which was $475,995 ($519,615 face value of the note less $43,620 unamortized discount). The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification.

 

Upon notice from Rockridge at any time and from time to time prior to the Maturity Date the outstanding principal balance may be converted into a number of restricted shares of our common stock. These 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, although such limitation may be waived by Rockridge upon not less than sixty-one (61) days prior written notice to us and provided such waiver would not 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) they will first be applied to reduce monthly payments starting with the latest 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.

 

41

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Rockridge Note (continued)

 

The Rockridge Agreement, as amended, provides that (i) Rockridge may receive an origination fee upon not less than sixty-one (61) days written notice to us, payable by our issuance of 591,667 restricted shares of our common stock (the “Shares”) and (ii) on the Maturity Date we shall pay Rockridge up to a maximum of $75,000 valuation adjustment (the “Shortfall Payment”) related to the Shares. The Shortfall Payment would be calculated as 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 of $75,000 in the aggregate.

 

As of October 1, 2012, we determined that our share price had remained below $1.20 per share for a sufficient period that accrual of a liability for the Shortfall Payment was appropriate.  Therefore, we recorded the $32,000 present value of this obligation as a liability as of October 1, 2012, which increased to $61,000 as of September 30, 2013, as a result of the accretion of $29,000 as interest expense for the year then ended and increased further to approximately $71,000 as of June 30, 2014, as a result of the accretion of approximately $10,000 as interest expense for the nine months then ended. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, the required Shortfall Payment would be $75,000.

 

The fair market value of the first 366,667 Shares, determined to be approximately $626,000 at the date of the Rockridge Agreement under which Rockridge became entitled to such shares, plus legal fees of $55,337 we paid in connection with the Rockridge Agreement, were reflected as the initial $681,337 discount against the Rockridge Note and amortized as interest expense over the term of the Rockridge Note through the date of the December 2012 Allonge. The fair market value of the additional 225,000 origination fee Shares arising from the December 2012 Allonge was recorded as additional discount of approximately $79,000 and, along with the unamortized portion of the initial discount, was being amortized as interest expense over the remaining term of the Rockridge Note, commencing in January 2013. The $32,000 present value of the anticipated Shortfall Payment was recorded as additional discount and, along with the other components of discount discussed above, was being amortized as interest expense over the remaining term of the Rockridge Note, commencing in October 2012. Corresponding increases in common stock committed for issue (at par value) and additional paid-in capital were also recorded for the value of the Shares. The remaining unamortized discount of $43,620 was included in the debt extinguishment loss recognized for the nine months ended June 30, 2014, as discussed above. The unamortized portion of the discount was zero and $70,538 as of June 30, 2014 and September 30, 2013, respectively.

 

 

42

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Rockridge Note (continued)

 

The effective interest rate of the Rockridge Note was initially approximately 44.3% per annum, until the September 2009 amendment, which reduced it to approximately 28.0% per annum, the December 2012 Allonge, which increased it to approximately 29.1% per annum, and the accrual of the Shortfall Payment, which increased it to approximately 31.1% per annum. Effective February 28, 2014, as a result of the inclusion of the remaining unamortized discount in a debt extinguishment loss, the effective rate was reduced to approximately 12% per annum. These rates do not give effect to any difference between the sum of the value of the Shares at the time of issuance plus the Shortfall Payment, as compared to the recorded value of the Shares on our books, nor do they give effect to the variance between the conversion price versus market prices that might be applicable if any portion of the principal is satisfied with common shares issued upon conversion instead of cash.

 

Fuse Note

 

On November 15, 2012 we issued an unsecured subordinated note to Fuse Capital LLC (“Fuse”) in consideration of cash proceeds of $100,000. Total interest of $20,000 was payable in applicable monthly installments starting December 15, 2012, and the principal balance was due on May 15, 2013. An origination fee was paid to Fuse by the issuance of 35,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $14,000. This amount was reflected as a discount and was being amortized as interest expense over the six month term. Effective March 19, 2013 we issued an unsecured subordinated note to Fuse in the amount of $200,000 (the “Fuse Note”) in consideration of $100,000 of additional cash proceeds to us plus the cancellation of the November 15, 2012 note with a still outstanding balance of $100,000. The Fuse Note, which is convertible into restricted common shares at Fuse’s option using a rate of $0.50 per share, was payable as follows: interest only (at 12% per annum) during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year.

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the November 15, 2012 note after its modification (by virtue of its inclusion in the Fuse Note dated March 19, 2013) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2013 (zero for the three months then ended). This $31,170 debt extinguishment loss was calculated as the excess of the $126,000 acquisition cost of the new debt ($100,000 face value of the portion of the March 19, 2013 note replacing the November 15, 2012 note plus the $26,000 fair value of the corresponding pro-rata portion of the common shares issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $94,830.

 

43

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Fuse Note (continued)

 

In connection with the original issuance of the Fuse Note, we issued Fuse 80,000 restricted common shares (the “Fuse Common Stock”), which we agreed to buy back under the following terms: If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 40,000 shares of the originally issued Fuse Common Stock from Fuse at $0.40 per share. If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 80,000 shares of the originally issued Fuse Common Stock, less the amount of any shares already bought back at the one year point, from Fuse at $0.40 per share. The above only applies to the extent the Fuse Common Stock is still held by Fuse at the applicable dates. As of June 30, 2013 we determined that our share price had remained below $0.40 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, we recorded the $20,000 present value of this obligation as a liability on our financial statements as of June 30, 2013 which increased to $22,000 as of September 30, 2013, as a result of the accretion of $2,000 as interest expense for the year then ended and increased again to $26,000 as of June 30, 2014 as a result of the accretion of $4,000 as interest expense for the nine months then ended. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $32,000 would be required.

 

In connection with the original issuance of the Fuse Note, we also issued 40,000 restricted common shares to another third party for finder and other fees. The value of the Fuse Common Stock plus the value of the common stock issued for related financing fees was approximately $52,000, which was reflected as an increase in additional paid-in capital, with one half included in the debt extinguishment loss recognized for the nine months ended June 30, 2013, as discussed above, and the other half recorded as a discount against the Fuse Note. The discount portion of approximately $26,000 is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 19% per annum. The aggregate unamortized portion of the debt discount recorded against the Fuse Note was $9,721 and $19,094 as of June 30, 2014 and September 30, 2013, respectively.

 

Effective April 1, 2014 the Fuse Note was amended to provide that the $200,000 principal balance would not be payable until the March 19, 2015 maturity date, although interest would continue to be payable on a monthly basis. In exchange for this amendment, we issued 20,000 common shares to Fuse, having a fair market value of approximately $4,200, which we determined to be immaterial for recording as additional discount and subsequent periodic amortization and thus we expensed as interest for the nine and three months ended June 30, 2014. We also determined that the remaining unamortized discount as of June 30, 2014 was immaterial for purposes of evaluating this modification as to whether loan extinguishment accounting would be required.

 

Intella2 Investor Notes

 

In connection with the issuance of the Fuse Note as discussed above, we modified the terms on another $200,000 note issued to Fuse on November 30, 2012, to allow conversion of the principal balance into restricted common shares at Fuse’s option using a rate of $0.50 per share. This other $200,000 note is discussed in more detail under “Intella2 Investor Notes” in the “Notes and Leases Payable” section below.

 

44

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

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 (the “Equipment Notes”). The principal balance outstanding under the Equipment Notes was eventually reduced to $350,000 and effective October 2011, the Equipment Notes were assigned by the applicable Investors to three accredited entities (the “Noteholders”). Effective May 14, 2012 the Equipment Notes were modified, primarily to extend the principal repayment terms to a single balloon payment on July 15, 2013. On December 31, 2012 we issued an aggregate of 140,000 restricted common shares to the Noteholders in consideration of a December 12, 2012 modification of the scheduled principal payment date from July 15, 2013 to payments of $100,000 on November 15, 2013, $150,000 on December 15, 2013 and $100,000 on December 31, 2013. As part of this modification, we also agreed to issue the Noteholders an aggregate of 583,334 restricted common shares (split into two tranches in January and June 2013), to be credited upon issuance as a reduction of the outstanding Equipment Notes balance, using a price of $0.30 per share and (after both tranches are issued) which would have resulted in a Credited Value of $175,000 and a remaining outstanding Equipment Notes balance of $175,000.

 

In accordance with the December 12, 2012 modification, 291,668 shares were issued to the Noteholders on January 18, 2013. However, the terms of Sigma Note 1, which closed on March 21, 2013, required us to immediately repay from those proceeds the remaining balance due on the Equipment Notes. Such repayment was made by us with $175,000 cash and issuance of the remaining 291,666 shares to the Noteholders.

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the Equipment Notes after the December 12, 2012 modification and the present value of the cash flows under the payment terms in place one year earlier, under the provisions of ASC 470-50-40, the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2013 (zero for the three months then ended). This $68,600 debt extinguishment loss was calculated as the excess of the $399,000 acquisition cost of the new debt ($350,000 face value of the notes plus the $49,000 fair value of the 140,000 common shares issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $330,400. The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification.

 

45

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Equipment Notes (continued)

 

Although they were repaid on March 21, 2013, the terms of the Equipment Notes still provided that on the maturity dates (as established in the December 12, 2012 modification), the Recognized Value of the shares issued as part of such repayment would be calculated as the sum of the following two items – (i) the gross proceeds to the Investors from the sales of the 583,334 shares issued per the December 12, 2012 modification plus (ii) the value of those shares issued and still held by the Noteholders and not sold, using the average ONSM closing bid price per share for the ten (10) trading days prior to the applicable maturity date. If the Recognized Value exceeded the Credited Value, then we would receive 50% (fifty percent) of such excess, although the amount received by us shall not exceed $175,000. If the Credited Value exceeded the Recognized Value, then we would be obligated to pay such excess to the Noteholders. With respect to Equipment Notes held by one of the three Noteholders, the Credited Value exceeded the Recognized Value for 166,667 common shares by approximately $16,000 as of the respective November 15, 2013 maturity date. We recorded no accrual for this matter on our financial statements as of September 30, 2013, based on the immateriality of a $5,000 liability, if calculated based on the September 30, 2013 ONSM closing price of $0.27 per share. However, we recognized the actual liability of approximately $16,000 as of June 30, 2014 and as interest expense for the nine months then ended (zero for the three months then ended).

 

In connection with financing obtained by us in October and November 2013 from the other two Noteholders (see “Working Capital Notes” below), the above terms with respect to settlement of differences between the Credited Value and the Recognized Value were replaced with our agreement to buy back, to the extent permitted by law, the 416,667 common shares issued to those Noteholders, if the fair market value of the shares are not equal to at least $0.30 per share on the maturity dates of the October and November 2013 financings, which are April 24 and May 4, 2015, respectively. The above only applies to the extent the shares are still held by the Noteholders on the applicable date and the buyback obligation only applies if the Noteholders give us notice within fifteen days after the applicable maturity dates of the October and November 2013 financings. As of September 30, 2013, we determined that our share price had remained below $0.30 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, we recorded the $80,000 present value of this obligation as a liability on our financial statements as of that date, which increased to approximately $96,000 as of June 30, 2014 as a result of the accretion of approximately $16,000 as interest expense for the nine months then ended. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $125,000 would be required.

 

46

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Convertible Debentures (continued)

 

Equipment Notes (continued)

 

Furthermore, we have agreed that in the event we receive funds in excess of $5 million as a result of a single transaction for the sale of all or a part of our operations or assets, that those funds will be available to satisfy the above buyback obligation, such availability subject only to prior satisfaction of any claims held by Thermo Credit LLC, Rockridge Capital Holdings LLC, Sigma Opportunity Fund II, LLC, USAC, and certain capital leases (HP Financial and Tamco), or any assignees or successors thereto and pari passu with up to $775,000 of total indebtedness and related obligations raised and incurred by us during the first quarter of fiscal 2014. In addition, we agreed that to the extent the number of outstanding shares of our common stock exceeds 22 million shares, then we will issue the Noteholders additional shares of common stock equal to seventy-six hundredths percent (0.76%, or 0.0076) of the excess over 22 million, times the percentage of the original 416,667 common shares still held by the Noteholders on the six and twelve month anniversary dates of the October and November 2013 financings, as well as the eighteen month maturity date. For clarity, additional issuances based on any particular increase in the number of our outstanding shares over the stated limit will only be made once and so additional issuances on the second and third dates will be limited and related to increases since the first and second dates, respectively.

 

Notes and Leases Payable

 

Notes and leases payable consist of the following:

 
 

 

June 30,

2014

 

September 30,

2013

 

 

Line of Credit Arrangement

$

1,650,829

 

$

1,605,672

Sigma Note 1 (excluding portion in convertible debentures)

 

551,788

 

 

507,000

Working Capital Notes

 

620,000

 

 

-

Subordinated Notes

 

250,000

 

 

316,667

Intella2 Investor Notes (excluding portion in convertible debentures)

 

250,000

 

 

250,000

Investor Notes

 

175,000

 

 

200,000

USAC Note

 

110,510

 

 

263,398

CCJ Note

 

-

 

 

118,157

Equipment lease

 

27,912

 

 

39,330

Total notes and leases payable

 

3,636,039

 

 

3,300,224

Less: discount on notes payable

 

(246,770)

 

 

(341,434)

Notes and leases payable, net of discount

 

3,389,269

 

 

2,958,790

Less: current portion, net of discount

 

(3,376,127)

 

 

(2,198,858)

Notes and leases payable, net of current portion and discount

$

13,142

 

$

759,932

 

47

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Line of Credit Arrangement

 

In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender” or “Thermo Credit”), which arrangement has been renewed and modified from time to time, and under which we may presently borrow up to an aggregate of $2.0 million for working capital, collateralized by our accounts receivable and certain other related assets. The outstanding balance bears interest at 12.0% per annum, adjustable based on changes in prime after December 28, 2009, payable monthly. We also incur a monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit per week, payable monthly. Mr. Leon Nowalsky, a member of our Board, is also a founder and board member of the Lender.

 

Although the Line expired on December 27, 2013, we and the Lender have been actively working together to complete the documentation for the renewal of that Line and on January 13, 2014 we received a letter from the Lender confirming that they will be renewing the Line through December 31, 2015, with terms materially equivalent to the just expired Line. Those terms include a commitment fee, which is calculated as one percent (1%) per year of the maximum allowable borrowing amount and paid in annual installments. However, pending the formal renewal of the Line, we agreed in August 2014 to pay a commitment fee calculated on a pro-rata basis for eight months payable August 31, 2014 and a pro-rata monthly commitment fee thereafter.

 

The outstanding principal is due on demand in the event a payment default is uncured one (1) day after written notice. The outstanding principal balance due under the Line may be repaid by us at any time, and the term 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.

 

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”). The Covenant requires that the sum of (i) our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense and (ii) contributions to capital (less cash distributions and/or cash dividends paid during such period) and proceeds from subordinated unsecured debt, be equal to or greater than the sum of cash payments for interest and debt principal payments. We have complied with this Covenant for all applicable quarters through June 30, 2014.

 

The terms of the Line require that all funds remitted by our customers in payment of receivables be deposited directly to a bank account owned by the Lender. Once those deposited funds become available, the Lender is then required to immediately remit them to our bank account, provided that we are not in default under the Line and to the extent those funds exceed any past due principal, interest or other payments due under the Line, which the Lender may offset before remitting the balance.

 

Annual loan commitment fees paid in advance and expenses for the Lender’s quarterly on-site reviews as allowed for by the loan documents paid to the Lender are recorded by us as debt discount and amortized as interest expense over the applicable term of such fee or expense. The unamortized portion of the debt discount was zero and $11,568 as of June 30, 2014 and September 30, 2013, respectively.

 

 

48

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Line of Credit Arrangement (continued)

 

The Lender must approve any additional debt incurred by us, other than debt subordinated to the Line and debt incurred in the ordinary course of business (which includes equipment financing). The Lender approved the Equipment Notes, the Rockridge Note, the USAC Note, Sigma Note 1 and Sigma Note 2. All other debt entered into by us subsequent to the December 2007 inception of the Line has been appropriately approved by the Lender and/or was allowable under one of the exceptions noted above.

 

Sigma Note 1

 

Sigma Note 1, of which $395,000 was convertible into common stock as of June 30, 2014, is discussed in the “Convertible Debentures” section above.

 

Working Capital Notes

 

During October and November 2013 we obtained aggregate net financing proceeds of approximately $246,000 from the issuance of partially secured promissory notes to three investors (the “Working Capital Notes”), with an initial aggregate outstanding balance of $620,000 bearing interest at 15% per annum. The proceeds of the Working Capital Notes were used to repay (i) $126,000 outstanding principal and interest due on the CCJ Note issued by us on December 31, 2012, (ii) $71,812 outstanding principal and interest due on a Subordinated Note issued by us on June 1, 2012 and (iii) $26,000 outstanding principal and interest due on an Investor Note issued by us on January 2, 2013. In addition, $125,000 in origination fees and $25,000 for a Funding Commitment Letter (see note 1) were deducted from the proceeds of the Working Capital Notes.

Working Capital Note payments are interest only during the first six months (in two quarterly payments), approximately 50% of the principal in equal monthly payments plus interest during the next eleven months and the remaining 50% of the principal balance due eighteen months after the Working Capital Note issuance date. In the event that we receive funds in excess of $5 million as a result of a single transaction for the sale of all or a part of our operations or assets, the Working Capital Notes are payable in full within ten (10) days of our receipt of such funds, along with any interest due at that time.

The Working Capital Notes are expressly subordinated to the following notes issued by us and outstanding at the time of the issuance of the Working Capital Notes: Thermo Credit LLC, Rockridge Capital Holdings LLC, Sigma Opportunity Fund II, LLC, USAC, and certain capital leases (HP Financial and Tamco), or any assignees or successors thereto, subject to a cumulative maximum outstanding balance of $3.9 million. The Working Capital Notes are secured by a limited claim to our assets, pari passu with up to $775,000 of total indebtedness and related obligations raised and incurred by us during the first quarter of fiscal 2014, subject to all prior liens of the foregoing entities and limited to the extent such a lien is allowable by the terms of the loan documents executed between us and the foregoing entities.

 

49

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Working Capital Notes (continued)

 

In connection with the above financing, we issued to the holders of Working Capital Notes an aggregate of 358,334 restricted common shares (the “Working Capital Shares”), which we have agreed to buy back, to the extent permitted by law, from the holder at $0.30 per share on the maturity dates of the Working Capital Notes, if the fair market value is less than that on that date. The above only applies to the extent the Working Capital Shares are still held by the noteholder on the applicable date and the buyback obligation only applies if the noteholder gives us notice and delivers the shares within fifteen days after the applicable maturity dates. Based on the closing ONSM share price of $0.30 per share on December 31, 2013, we would have had no liability under the above arrangement and therefore we had recorded no accrual related to this matter as of that date. However, as of March 31, 2014, we determined that our share price had remained below $0.30 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, we recorded the approximately $74,000 present value of this obligation as a liability on our financial statements as of that date, which increased to approximately $81,000 as of June 30, 2014 as a result of the accretion of approximately $7,000 as interest expense for the three months then ended. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $107,500 would be required.

 

The fair market value at the time of issuance of the Working Capital Shares plus another 100,000 restricted common shares in connection with a finders agreement related to this financing, plus the cash deducted from the proceeds for related origination fees, was $258,260. $88,807 of this amount was reflected as a non-cash debt extinguishment loss (as well as a corresponding increase in additional paid-in capital for the shares) for the nine months ended June 30, 2014 (zero for the three months then ended), as discussed in more detail under the “Subordinated Notes”, Investor Notes” and “CCJ Note” sections below. The remainder of $169,453 was reflected as a discount against the Working Capital Notes (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the notes, resulting in a weighted average effective interest rate of approximately 33.2% per annum. This effective rate would increase in the event an early repayment was required, as discussed above. The aggregate unamortized portion of the debt discount recorded against the Working Capital Notes was $79,467 as of June 30, 2014.

 

 

50

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Subordinated Notes

 

Since April 30, 2012, we have received funding from various lenders, of which $250,000 and $316,667 was outstanding as of June 30, 2014 and September 30, 2013, respectively, in exchange for our issuance of unsecured subordinated promissory notes (“Subordinated Notes”), fully subordinated to the Line and the Rockridge Note or assignees or successors thereto. Details of the notes making up these totals are as follows:

 

On April 30, 2012 we received $100,000 for an unsecured subordinated note bearing interest at 15% per annum. Finders and origination fees were paid by the issuance of an aggregate of 20,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $11,800. This amount was reflected as a discount and was amortized as interest expense over the one year term through November 1, 2012. Including this discount, the effective interest rate of this note was approximately 29% per annum. On December 31, 2012 we issued an additional 35,000 common shares to the holder of this note in exchange for a reduction of the interest rate from 15% to 12% per annum, effective November 1, 2012, and a modification of the principal payment schedule to a single payment of $100,000 due on October 31, 2014. Prior to this modification, the principal was payable in equal monthly installments of $8,333 starting November 30, 2012, with the balance of $58,333 payable on April 30, 2013, although none of these payments were made. Interest for the first six months was paid on October 31, 2012, with subsequent interest payments due every three months thereafter through October 31, 2014. The $12,600 value of the additional shares issued in December 2012 were reflected as a discount against this note (as well as a corresponding increase in additional paid-in capital for the value of the shares on the date of issuance) and that amount, as well as the unamortized portion of the previously recorded discount, are being amortized as interest expense over the remaining term of the note, as modified, resulting in an effective interest rate of approximately 21% per annum.

 

Since we concluded that there was less than a 10% difference between the present value of the cash flows of this note after the November 1, 2012 modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, the modified terms were not considered substantially different and therefore accounting for this modification as an extinguishment of debt was not required.

 

On June 1, 2012 we received $100,000 for an unsecured subordinated note bearing interest at 12% per annum. The principal was payable in equal monthly installments of $8,333 starting January 1, 2013 plus a final payment of $58,333 on June 1, 2013. Interest for the first six months was paid on December 1, 2012 and was payable thereafter on a monthly basis. Finders and origination fees were paid with 40,000 restricted ONSM common shares and the fair market value at issuance of approximately $23,600 was reflected as a discount and amortized as interest expense over the one year term. Including this discount, the effective interest rate of this note, based on its originally contemplated term, was approximately 39% per annum. The outstanding balance of this note was $66,667 as of September 30, 2013.  On October 24, 2013, the outstanding principal balance of this note, as well as accrued but unpaid interest, in the aggregate amount of $71,182 was satisfied from the gross proceeds of a $170,000 note issued by us to the same lender as part of the Working Capital Notes discussed above. $28,031 of the balance due under this note is classified as non-current on our September 30, 2013 balance sheet based on the payment terms of the October 2013 financing.

 

51

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Subordinated Notes (continued)

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the June 1, 2012 note after its modification (by virtue of its inclusion in the Working Capital Note dated October 24, 2013) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2014 (zero for the three months then ended). This $26,693 debt extinguishment loss was calculated as the excess of the $97,875 acquisition cost of the new debt ($71,182 face value of the portion of the October 24, 2013 note replacing the June 1, 2012 note plus the $26,693 fair value of the corresponding pro-rata portion of the common shares plus cash fees and expenses issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $71,182.

 

During January 2013 we received an aggregate of $150,000 pursuant to our issuance of two unsecured subordinated notes, bearing interest at 20% per annum. The principal plus accrued interest was payable in a single balloon payment in July 2013. An aggregate of 120,000 restricted ONSM common shares with a fair market value at issuance of approximately $38,000 was issued to the lenders as an origination fee. This amount was reflected as a discount and amortized as interest expense over the six month term. In July 2013, accrued interest aggregating $15,000 was paid in cash and the maturity date of these notes was extended to January 2014. An aggregate of 120,000 restricted ONSM common shares with a fair market value at issuance of approximately $35,000 was issued to the lenders as an extension fee. This amount was reflected as a discount and was amortized as interest expense over the second six month term. In January 2014 the maturity date of these notes, as well as the due date of the aggregate of $15,000 earned but unpaid interest, was extended to October 2014. An aggregate of 240,000 restricted ONSM common shares with a fair market value at issuance of approximately $60,000 was issued to the lenders as an extension fee. This amount was reflected as a discount and is being amortized as interest expense over the third term of approximately nine and one half months. Including the discount, the effective interest rate of these notes was approximately 71% per annum for the first six months, approximately 67% per annum for the second six months and approximately 71% per annum for the third nine and one half months. The balance due under these notes, net of unamortized discount, is classified as non-current on our September 30, 2013 balance sheet based on the payment terms as modified in January 2014.

 

52

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Subordinated Notes (continued)

 

Since we concluded that there was less than a 10% difference between the present value of the cash flows of this note after the July 2013 modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, the modified terms were not considered substantially different and therefore accounting for this modification as an extinguishment of debt was not required. We also concluded that there was less than a 10% difference between the present value of the cash flows of this note after the January 2014 modification versus the present value of the cash flows under the payment terms in place one year earlier and thus accounting for that modification as an extinguishment of debt was not required. The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification.

 

The aggregate unamortized portion of the debt discount recorded against the Subordinated Notes was $25,363 and $27,148 as of June 30, 2014 and September 30, 2013, respectively.

 

Intella2 Investor Notes

 

On November 30, 2012 we issued unsecured promissory notes to five investors (the “Intella2 Investor Notes”), with an initial aggregate outstanding balance of $450,000 bearing interest at 12% per annum and which are fully subordinated to the Line and the Rockridge Note or any assignees or successors thereto. These notes were issued in exchange for $350,000 cash proceeds plus the satisfaction of the $100,000 outstanding principal balance due on a subordinated note issued by us on March 9, 2012. Note payments are interest only during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year. Furthermore, in connection with the issuance of the Fuse Note on March 19, 2013 (discussed in more detail above), we modified the terms on one of the Intella2 Investor Notes, held by Fuse and having a $200,000 outstanding principal balance, to allow conversion of the principal balance into restricted common shares at Fuse’s option using a rate of $0.50 per share.

 

53

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Intella2 Investor Notes (continued)

 

Although there was no difference between the present value of the cash flows of the November 30, 2012 Intella2 Investor Note held by Fuse after its March 19, 2013 modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), if a substantive conversion feature is added to an instrument, the modified terms are considered substantially different and extinguishment accounting is required. Since the ONSM closing price was greater than the $0.50 per share conversion price at times during the ninety days prior to granting such conversion feature (although the ONSM closing price was below $0.50 at the time the conversion feature was granted), we determined that it was at least reasonably possible that the conversion feature would be exercised and thus determined the conversion feature to be substantive. Accordingly, we recognized a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2013 (zero for the three months then ended). This $43,481 debt extinguishment loss was calculated as the excess of the $200,000 acquisition cost of the new debt over the net carrying amount of the extinguished debt immediately before the modification, which was $156,519.

 

In connection with the initial issuance of the Intella2 Investor Notes, we issued to the holders an aggregate of 180,000 restricted common shares (the “Intella2 Common Stock”), which we have agreed to buy back, under certain terms. If the fair market value of the Intella2 Common Stock is not equal to at least $0.40 per share on the final maturity date two (2) years after issuance, we will buy back, to the extent permitted by law, those shares of the originally issued Intella2 Common Stock from the investor at $0.40 per share. This only applies to the extent the Intella2 Common Stock is still held by the investor(s) at the applicable date and only if the investor gives us notice and delivers the shares within fifteen days after the final maturity date. As of June 30, 2013 we determined that our share price had remained below $0.40 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, we recorded the $48,000 present value of this obligation as a liability on our financial statements as of June 30, 2013 which increased to $52,000 as of September 30, 2013, as a result of the accretion of $4,000 as interest expense for the year then ended and increased again to $58,000 as of June 30, 2014 as a result of the accretion of $6,000 as interest expense for the nine months then ended. If the closing ONSM share price of $0.18 per share as of August 8, 2015 was used as a basis of calculation, a stock repurchase payment of $72,000 would be required.

 

We paid (i) financing fees in cash of $16,000 to a third-party agent, related to $200,000 of this financing, and (ii) a commission of 100,000 unrestricted common shares to another third-party agent, which is related to the entire $350,000 cash portion of the financing as well as to potential additional financing which may be raised under these terms. The value of the Intella2 Common Stock, plus the value of common stock issued and cash paid for related financing fees and commissions, was reflected as a $117,400 discount against the Intella2 Investor Notes (as well as a corresponding increase in additional paid-in capital for the shares) and that amount was partially amortized as interest expense over the term of the notes through March 31, 2013, resulting in an effective interest rate of approximately 26% per annum.

 

54

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Intella2 Investor Notes (continued)

 

The unamortized portion of this discount related to the Intella2 Investor Note held by Fuse was $43,481 as of March 31, 2013, prior to its write-off as the debt extinguishment loss recognized for the nine months ended June 30, 2013, as discussed above. As a result, the effective interest rate of the Intella2 Investor Note held by Fuse after March 31, 2013 is 12% per annum, with the effective interest rate for the other Intella2 Investor Notes remaining at approximately 26% per annum. After the write-off of a portion of the discount as debt extinguishment loss, the aggregate unamortized portion of the debt discount recorded against the Intella2 Investor Notes was $13,570 and $38,046 (none of which related to the portion of this debt classified as a convertible debenture) as of June 30, 2014 and September 30, 2013, respectively.

 

Effective April 1, 2014 the Intella2 Investor Note held by Fuse was amended to provide that the $200,000 principal balance would not be payable until the November 30, 2014 maturity date, although interest would continue to be payable on a monthly basis. In exchange for this amendment, we issued 20,000 common shares, having a fair market value of approximately $4,200, to Fuse, which we determined to be immaterial for recording as additional discount and subsequent periodic amortization and thus we expensed as interest for the nine and three months ended June 30, 2014. We also determined that the remaining unamortized discount as of June 30, 2014 was immaterial for purposes of evaluating this modification as to whether loan extinguishment accounting would be required.

 

During the third quarter of fiscal 2014, Intella2 Investor Notes held by two of the other four investors were amended to provide that the principal balances aggregating $90,000 would not be payable until the November 30, 2014 maturity date, although interest would continue to be payable on a monthly basis. In exchange for these amendments, we issued 9,000 common shares, having a fair market value of approximately $1,900, to the other investors, which we determined to be immaterial for recording as additional discount and subsequent periodic amortization and thus we expensed as interest for the nine and three months ended June 30, 2014. We also determined that the remaining unamortized discount as of June 30, 2014 was immaterial for purposes of evaluating these modifications as to whether loan extinguishment accounting would be required.

 

Investor Notes

 

On or about November 30, 2012 we received $175,000 pursuant to unsecured promissory notes issued to four investors and on January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (in aggregate, the “Investor Notes”), bearing interest at 12% per annum and which are fully subordinated to the Line and the Rockridge Note or any assignees or successors thereto. Note payments are interest only during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the twenty-fifth month. On November 4, 2013, the outstanding principal balance of the $25,000 note issued to CCJ, as well as accrued but unpaid interest, in the aggregate amount of $26,000 was satisfied from the gross proceeds of a $250,000 note issued by us to the same lender as part of the Working Capital Notes discussed above.

 

 

55

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Investor Notes (continued)

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows the $25,000 portion of the Investor Notes issued to CCJ after its modification (by virtue of its inclusion in the Working Capital Note dated November 4, 2013) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2014 (zero for the three months then ended). This $15,518 debt extinguishment loss was calculated as the excess of the $35,779 acquisition cost of the new debt ($26,021 face value of the portion of the November 4, 2013 note replacing the January 2, 2013 note plus the $9,758 fair value of the corresponding pro-rata portion of the common shares plus cash fees and expenses issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $20,261 (net of unamortized discount).

 

In connection with the above financing, we issued to the holders of the Investor Notes an aggregate of 240,000 restricted common shares (the “Investor Common Stock”), of which we have agreed to buy back up to 35,000 shares, under certain terms. If the fair market value of the Investor Common Stock is not equal to at least $0.80 per share on the final maturity date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 35,000 shares of the originally issued Investor Common Stock from the investor at $0.80 per share. The above only applies to the extent the Investor Common Stock is still held by the investor(s) at the applicable date and only if the investor gives us notice and delivers the shares within fifteen days after the final maturity date. As of November 30, 2012 we determined that our share price had remained below $0.80 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, we recorded the $16,000 present value of this obligation as a liability on our financial statements as of November 30, 2012 which increased to $21,000 as of September 30, 2013, as a result of the accretion of $5,000 as interest expense for the year then ended and increased again to $25,000 as of June 30, 2014 as a result of the accretion of $4,000 as interest expense for the nine months then ended. If the closing ONSM share price on August 8, 2014 of $0.18 per share was used as a basis of calculation, a stock repurchase payment of $28,000 would be required.

 

In addition to the above, in November 2013 we agreed with one holder of Investor Notes to reimburse them for the approximately $3,200 shortfall between the proceeds to them for their sale of 5,000 shares we issued them in connection with the issuance of the Investor Notes and the $0.80 per share that we had previously agreed to pay for those shares, to the extent permitted by law and subject to the other restrictions noted above. We recorded no accrual for this matter on our financial statements as of September 30, 2013, based on the immateriality of an approximately $2,700 liability, if calculated based on the September 30, 2013 ONSM closing price of $0.27 per share. However, we recognized the actual liability of approximately $3,200 as interest expense for the nine months ended June 30, 2014 (zero for the three months then ended).

 

56

 


 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 4: DEBT (Continued)

 

Notes and Leases Payable (continued)

 

Investor Notes (continued)

 

We paid a third-party agent financing fees of $14,000 plus 35,000 unrestricted common shares related to this financing. The value of the Investor Common Stock, plus the value of common stock issued and cash paid for related financing fees, was reflected as a $113,700 discount against the Investor Notes (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the notes, resulting in an effective interest rate of approximately 43% per annum. The aggregate unamortized portion of the debt discount recorded against the Investor Notes was $24,984 and $68,604 as of June 30, 2014 and September 30, 2013, respectively.

 

USAC Note

 

On February 15, 2013 we executed a letter agreement promissory note with the Universal Service Administrative Company (“USAC”) for $372,453, payable in monthly installments of $19,075 over twenty-two months starting March 15, 2013 through December 15, 2014 (the “USAC Note”). These payments include interest at 12.75% per annum. This letter agreement promissory note is related to our liability for Universal Service Fund (USF) contribution payments previously reflected as an accrued liability on our balance sheet and therefore resulted in the reclassification of a portion of that accrued liability to notes payable. USAC is a not-for-profit corporation designated by the Federal Communications Commission (“FCC”) as the administrator of the USF program. See notes 1 and 5.

 

CCJ Note

 

The CCJ Note dated December 31, 2012 had an initial principal amount of $145,779 was payable in 24 monthly principal and interest installments of $6,862 starting January 31, 2013 and which payment amount included interest at 12% per annum. On November 4, 2013, the outstanding principal balance of the CCJ Note, as well as accrued but unpaid interest, in the aggregate amount of $125,000 was satisfied from the gross proceeds of a $250,000 note issued by us to the same lender as part of the Working Capital Notes discussed above. $72,702 of the balance due under this note was classified as non-current on our September 30, 2013 balance sheet based on the payment terms of the November 2013 financing.

 

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the December 31, 2012 note after its modification (by virtue of its inclusion in the Working Capital Note dated November 4, 2013) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the nine months ended June 30, 2014 (zero for the three months then ended). This $46,596 debt extinguishment loss was calculated as the excess of the $170,852 acquisition cost of the new debt ($124,256 face value of the portion of the November 4, 2013 note replacing the December 31, 2012 note plus the $46,596 fair value of the corresponding pro-rata portion of the common shares plus cash fees and expenses issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $124,256.

 

57

 


 

 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

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), 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”. In addition, our Compensation Committee and Board have approved certain corrections and modifications to those agreements from time to time, which are reflected in the discussion below. The employment 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. 

 

After annual increases in prior years as set forth in the employment agreements, the contractual annual base salaries for the five Executives in aggregate are approximately $1.6 million, subject to a five percent (5%)  increase on September 27, 2014 and each year thereafter – a portion of these contractual salaries are presently not being paid to the Executives, as discussed below. 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.

 

Under the terms of the 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 (3) times the Executive’s base salary plus full benefits for a period of the lesser of (i) three (3) years from the date of termination or (ii) the date of termination until a date one (1) 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 (6) months, to the extent required by Internal Revenue Code Section 409A.

 

Under the terms of the employment agreements, we may terminate an Executive’s employment upon his death or disability or with or without cause. If 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.

 

59

 


 
 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Employment contracts and severance (continued)  

 

Effective October 1, 2009, in response to our operating cash requirements, the base salary amounts being paid to the Executives were adjusted to be 10% less than the contractual amounts. In addition, until certain actions as discussed below, the amounts representing the subsequent contractual annual increases to those base salary amounts were not paid. No related modifications of the compensation as called for under their related employment agreements was made, as it was expected that this compensation withheld from the Executives would eventually be paid, although the Executives did agree that they would accept payment in equity of such shortfalls to a certain extent and under certain terms. Accordingly, we are accruing these unpaid amounts as non-cash compensation expense, with the unpaid portion reflected as an accrued liability under the balance sheet caption “Amounts due to executives and officers”. This accrued liability has been reduced for the following actions:

 

1.       Based on approval by our Compensation Committee effective September 29, 2011, 41,073 restricted common Plan shares and four-year Plan options to purchase 266,074 common shares for $0.97 per share (greater than fair market value on the date of issuance) were issued to the Executives as partial consideration for this unpaid compensation. The common shares are restricted from trading unless Board approval is given. The options were never vested and they were subsequently replaced with Executive Incentive Shares as discussed below.

 

2.       Effective September 16, 2012, the base salary amounts being paid to the Executives were reinstated by an amount representing approximately 7.8% of the contractual base salary at that time. As of August 8, 2014, the base salary payments to the Executives are 18.6% less than the contractual base salaries, compared to the 10% reduction instituted in October 2009 and which reduction was initially company-wide but no longer affects a majority of our other employees. A second reinstatement to the Executives, representing approximately 4.5% of the contractual base salary at that time, was approved since January 1, 2013, although as of August 8, 2014, and in recognition of our cash requirements, the second reinstatement has not been implemented.

 

3.       In consideration of the waiver and satisfaction of any remaining unpaid salary due to the Executives through December 31, 2012 under their employment agreements, as well as the waiver and satisfaction of any remaining unpaid amounts due to certain of those Executives in connection with the acquisition of Acquired Onstream (see note 2), we (as authorized by our Board of Directors) and the Executives agreed, effective January 22, 2013, (i) to pay $100,000 ($20,000 per Executive) of the withheld compensation in cash and (ii) to issue 1,700,000 (340,000 per Executive) fully vested ONSM common shares, subject to certain trading restrictions (the “Executive Shares”).

 

60

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Employment contracts and severance (continued)  

 

As of August 8, 2014, the Executive Shares have not been issued, due to certain administrative and documentation requirements, nor has the $100,000 in cash been paid. However, since the Executive Shares were committed to be issued by the January 22, 2013 action of the Board, that issuance was reflected in our financial statements as of the date of such commitment. The number of Executive Shares was based on the average of the closing bid prices for the three trading days prior to the approval by our Board of Directors in their January 22, 2013 meeting, which was approximately $0.29 per share. However, the Executive Shares have been recorded on our financial statements as common stock committed for issue (at par value) and additional paid-in capital, based on their fair value at the time of the January 22, 2013 agreement, which was $578,000 ($0.34 per share), with the approximately $86,000 excess of that fair value over the amount of the previously recorded liability being satisfied by such issuance reflected as non-cash compensation expense for the nine months ended June 30, 2013 (zero for the three months then ended).

 

The Federal income tax withholding for the taxable value of the Executive Shares, as well as any employee Social Security or Medicare taxes, will be funded by the Executives at the time such shares are issued, from the $100,000 portion of pre December 31, 2012 compensation payable in cash as discussed above, or from remaining unpaid salary due to the Executives for periods after December 31, 2012. Our payment of that compensation and remittance of all or a part to the government in settlement of taxes will be recorded as a reduction of the accrued compensation liability at the time of such payment. Although we will incur a related expense for the matching employer portion of the Social Security and Medicare taxes, we have determined that such amount is immaterial for accrual and it will be expensed when paid.

 

To the extent there is any shortfall from the gross proceeds upon resale by the Executives of the Executive Shares versus twenty-nine cents ($0.29) per share, the shortfall will be reimbursed to the Executives by us in cash, or at our option, by the issuance of additional fully vested ONSM common shares (the “Additional Executive Shares”), with the Additional Executive Shares subject to reimbursement by us to the Executives of any shortfall from the gross proceeds upon resale as compared to the fair value used to determine the number of such Additional Executive Shares. All shortfall reimbursements shall be payable by us within ten (10) business days after presentation by reasonable supporting documentation of the shortfall to us by the Executives. As of September 30, 2013, we determined that our share price had remained below $0.29 per share for a sufficient period that it was appropriate to record a liability for this repurchase commitment. Therefore, based on the $0.27 closing ONSM share price as of September 30, 2013, we recorded this $34,000 obligation as a liability on our financial statements as of that date, which was reflected as non-cash compensation expense for the year then ended (zero for the nine and three months ended June 30, 2013). Although the closing ONSM share price increased to $0.30 as of December 31, 2013, and on that basis we would have no liability under this obligation, we determined that the increase in our share price was temporary and no adjustment was made to the previous accrual as of December 31, 2013 or for the three months then ended. However, based on the closing ONSM price of $0.20 per share as of June 30, 2014, we increased the $34,000 liability initially recorded by us by recognizing approximately $119,000 of non-cash compensation expense for the nine months ended June 30, 2014, which resulted in an approximately $153,000 liability on our financial statements as of that date.  If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, our obligation for this shortfall payment would be $187,000, or the equivalent in common shares.

 

61

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Employment contracts and severance (continued)

 

On February 20, 2013, we (as authorized by our Board of Directors) and the Executives agreed to certain changes in the Executives’ employment agreements, as follows: (i) cancellation of the previous compensation program allowing for cash compensation aggregating to 15% of the sales price of the Company payable to the Executives as well as other employees and certain directors, (ii) cancellation of all stock options held by the Executives, including the previous employment agreement provision that would have allowed for the conversion of those options into approximately 1.3 million paid-up common shares (plus compensation for the tax effect) under certain circumstances and (iii) implementation of an executive incentive compensation plan (the “Executive Incentive Plan”).

Compensation under the Executive Incentive Plan would be in the form of Fully Restricted (as defined below) ONSM common Plan shares (“Executive Incentive Shares”) and is based on the Company achieving certain financial objectives, as follows:

·         Increased revenues in each of fiscal years 2011 through 2015 (as compared to the respective prior year).

·          Positive operating cash flow (as defined in the Executive Incentive Plan) in each of fiscal years 2011 through 2015.

·         EBITDA, as adjusted, (as defined in the Executive Incentive Plan) for at least two quarters of each of fiscal years 2013 through 2015.

The objectives related to fiscal 2011 and fiscal 2012 were based on discussions between the Board and the Executives that had been going on for some time as part of the process of agreeing on the Executive Incentive Plan. In addition, as disclosed in our previous public filings, the Compensation Committee had already indicated their intent as of January 14, 2011 to issue options to purchase an aggregate of at least 450,000 underlying common shares to the Executives as a group, for which the issuance and vesting would have required no performance and which would have been convertible into paid-up shares (including tax effect) under certain circumstances. Accordingly, the Board determined that the objectives for fiscal 2011 and fiscal 2012 were a reasonable basis for the issuance of an aggregate of 950,000 Executive Incentive Shares to the Executives as a group for the accomplishment of those goals for that two-year period. In addition, we agreed to issue an aggregate of 1.3 million Executive Incentive Shares to the Executives (as a group) as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled.
 

The 2,250,000 Executive Incentive Shares that were earned as of the date the Executive Incentive Plan was established were issued in May 2013 and have been recorded on our financial statements based on their fair value at the time of the February 20, 2013 agreement, which was $1,237,500 ($0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation. The net amount of approximately $1,137,000 was reflected as non-cash compensation expense for the nine months ended June 30, 2013 (zero for the three months then ended).

 

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ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Employment contracts and severance (continued)

 

In September 2013, the Executives as a group were issued an aggregate of 250,000 Executive Incentive Shares for meeting one of the fiscal 2013 objectives - achieving positive EBITDA, as adjusted, for at least two quarters of fiscal 2013. Accordingly, those shares were recorded on our financial statements and reflected as non-cash compensation expense of $77,500 for the nine and three months ended June 30, 2013, based on their fair value of $0.31 per share as of August 9, 2013, the date it was conclusively determined that the objective had been met and the shares had been earned. Accomplishment of the other objectives for fiscal 2013 would have resulted in an aggregate of 375,000 Executive Incentive Shares issued to the Executives as a group, but it was determined that these shares were not earned.

 

Accomplishment of the objectives for fiscal 2014 and fiscal 2015 would result in an aggregate of 625,000 Executive Incentive Shares issued to the Executives as a group for each of those two years. A lesser amount of Executive Incentive Shares would be issuable for achievement for only one or two of the three objectives set for each year.

 

With respect to fiscal 2014, the Executives have earned an aggregate of 250,000 Executive Incentive Shares for meeting the objective of achieving positive EBITDA, as adjusted, for at least two quarters (the first and second fiscal quarters). Accordingly, those shares have been recorded on our financial statements and reflected as non-cash compensation expense of $52,500 for the nine months ended June 30, 2014 (zero for the three months then ended), based on their fair value of $0.21 per share as of May 20, 2014, the date it was conclusively determined that the objective had been met and the shares had been earned. Also with respect to fiscal 2014, we have determined that it is probable that the Executives will earn an additional aggregate of 250,000 Executive Incentive Shares for meeting the objective of achieving positive operating cash flow (as defined in the Executive Incentive Plan) for fiscal 2014. Accordingly, those shares have been recorded on our financial statements in the amount of $45,000, based on their fair value of $0.18 per share as of August 8, 2014, the date it was conclusively determined that it was probable the objective would be met and the shares would be earned. This amount will be reflected as non-cash compensation expense over the remaining term of service, which is $22,500 during the nine and three months ended June 30, 2014 and the balance during the three months ending September 30, 2014. As of June 30, 2014 the potential issuance of the shares related to the other 2014 objective has not been reflected on our financial statements, since based on the fiscal year 2014 financial results to date the issuance of these shares is not considered probable.

 

63

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Employment contracts and severance (continued)

 

The Executive Incentive Shares are being issued in accordance with the terms of the 2007 Equity Incentive Plan (the “Plan”) which our Board of Directors and a majority of our shareholders adopted on September 18, 2007 and they amended on March 25, 2010 and on June 13, 2011, and to the extent these and other issuances under the Plan do not exceed the number of authorized Plan shares – see note 8. The Executive Incentive Shares are subject to a complete restriction on the Executive’s ability to access or transact in any way such shares until the restriction is lifted. Upon a change of control, termination of the Executive’s employment or the imminently proposed and/or anticipated sale of the Company at a price of $1.00 per common share or more, all restrictions on the Executive Incentive Shares and any other common shares held by the Executives will be lifted. In the case of a sale, all restrictions will be lifted in time for those previously restricted shares to participate in all voting with respect to the proposed sale and will be eligible, at the Executive’s option, for inclusion as part of the shares sold in that transaction. Due to the restrictions on the Executive Incentive Shares, we have determined that the issuance thereof will not result in taxable compensation income to the Executives (or tax deductible compensation expense to the Company) until such restrictions have been lifted.

 

Upon a change of control, termination of the Executive’s employment or the imminently proposed and/or anticipated sale of the Company at a price of $1.00 per common share or more before September 30, 2015, the Executive Incentive Shares still potentially issuable for future fiscal years will be considered earned and will be issued to the Executives on an unrestricted basis. In the case of a sale, all such accelerated shares shall be issued in time for those previously unissued shares to participate in all voting with respect to the proposed sale and will be eligible, at the Executive’s option, for inclusion as part of the shares sold in that transaction. Notwithstanding the above, in the event that termination of the Executive’s employment is the result of the Executive’s voluntary resignation, and such voluntary resignation is not due to the Company’s breach of the Executive’s employment agreement or is not due to constructive termination as outlined in the Executive’s employment agreement, such restrictions will be promptly lifted, provided that no bona-fide and legally defensible objection to such issuance has been raised by written notice provided by a majority of the other four Executives to the terminating Executive, within ninety (90) days after such termination date.

 

Other compensation

 

On August 11, 2009 our Compensation Committee determined that in the event we were sold for a company sale price (as defined) that represented at least $6.00 per share (adjusted for recapitalization including but not limited to splits and reverse splits), cash compensation of two and one-half percent (2.5%) of the company sale price would be allocated equally between the then four outside Directors, as a supplement to provide appropriate compensation for ongoing services as a Director and as a termination fee, as well as one additional executive-level employee other than the Executives. In June 2010, one of the four outside Directors passed away (and was replaced in April 2011) and in January 2013 another one of the four outside Directors resigned (who is not expected to be replaced). In January 2013 the Board voted to terminate this compensation program, in conjunction with the termination of a similar compensation program for the Executives. Although the termination of the program for the Executives was in consideration of a new Executive Incentive Plan agreed on between the Company and the Executives, as of August 8, 2014 it has not yet been determined what the replacement compensation program will be, if any, for the outside Directors and the other executive-level employee in lieu of the terminated program.

 

64

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Lease commitments

 

As of June 30, 2014, we were obligated under operating leases for six office locations (one each in Pompano Beach, Florida, San Francisco, California, San Diego, California and Colorado Springs, Colorado and two in the New York City area), which call for monthly payments totaling approximately $61,000. The leases have expiration dates ranging from 2014 to 2018 (after considering our rights of termination) and in most cases provide for renewal options.

 

The three-year operating lease for our principal executive offices in Pompano Beach, Florida expired September 15, 2013. The monthly base rental is currently approximately $21,100 (including our share of property taxes, insurance and other operating expenses incurred under the lease but excluding operating expenses such as electricity paid by us directly). The lease provided for two percent (2%) annual increases, as well as one two-year renewal option, with a three percent (3%) rent increase in year one. We have notified the landlord of our exercise of the renewal option. Although the landlord has not yet confirmed that we have met the conditions for such renewal, we have included the lease payments for such renewal period in the table of future minimum lease payments as presented below.

 

The five-year operating lease for our office space in San Francisco which was set to expire on July 31, 2015, is being terminated and replaced by a new forty-nine month lease commencing September 1, 2014. The initial monthly base rental under the new lease, for a smaller space in the same building, is approximately $5,400 with annual increases of approximately 3.0%. We are also responsible for a pro-rata portion of any increase in the building real estate taxes and operating expenses, both as defined in the lease, as compared to calendar 2014.

 

The five-year operating lease for our Infinite Conferencing location in New Jersey expires October 31, 2018. The monthly base rental is approximately $17,700. The lease provides for one five-year renewal option, with a rent increase of up to 10% but not to exceed fair market value at the time of renewal. The lease is also cancellable by us in the event of the sale of Infinite Conferencing or Onstream Media Corporation any time after November 1, 2016, and six months after cancellation notice is given by us to landlord after such sale.

 

The five-year operating lease for our office space in New York City expires January 24, 2018.  The monthly base rental is approximately $8,100 with annual increases up to 2.8%. The lease provides one two-year renewal option at the greater of the fifth year rental or fair market value and also provides for early cancellation at any time after forty-two months, at our option, with notice of no more than nine months and no less than six months plus a cancellation payment of approximately $22,000.

 

The operating leases for our office space in San Diego, California and in Colorado Springs, Colorado call for aggregate monthly payments totaling approximately $3,600 and are on short-term leases with remaining maturities of less than one year.

 

65

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Lease commitments (continued)

 

The future minimum lease payments required under the non-cancelable operating leases are as follows:

 

Year Ending June 30:

 

 

2015

$

640,289

2016

 

445,124

2017

 

364,108

2018

 

282,972

2019

 

88,724

Total minimum lease payments

$

1,821,217

 

The capital leases included in Notes Payable (see note 4) were determined to be immaterial for inclusion in the above table.

 

In addition to the commitments listed above, we have commitments not included in the above table for leasing equipment space at co-location or other equipment housing facilities in South Florida, Georgia, New Jersey, Colorado, Texas, Iowa and Minnesota. An aggregate approximately $5,000 per month related to these facilities is classified by us as rental expense with an approximately $31,000 per month remaining balance of our payments to these facilities classified as cost of revenues – see discussion of bandwidth and co-location facilities purchase commitment discussion below. Total rental expense (including executory costs) for all operating leases was approximately $589,000 and $656,000 for the nine months ended June 30, 2014 and 2013, respectively, and approximately $201,000 and $199,000 for the three months ended June 30, 2014 and 2013, respectively.

 

Purchase commitments

 

We have entered into various agreements for our purchase of Internet, long distance and other connectivity as well as use of the co-location facilities discussed above, for an aggregate remaining minimum purchase commitment of approximately $1.7 million, approximately $1.5 million of that commitment related to the one year period ending June 2015 and the balance of such commitment related to the period from June 2015 through August 2017.

 

66

 


 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 5:  COMMITMENTS AND CONTINGENCIES (Continued)

 

Legal and regulatory proceedings

 

Our audio and video networking services are conducted primarily over telephone lines, which are heavily regulated by various Federal and other agencies. Although we believe that the responsibility for compliance with those regulations primarily falls on the local and long distance telephone service providers and not us, the Federal Communications Commission (FCC) issued an order in 2008 that requires conference calling companies to remit Universal Service Fund (USF) contribution payments on customer usage associated with audio conference calls. In addition, in 2011 the FCC announced its position that the 2008 order extended to audio bridging services provided using internet protocol (IP) technology and in April 2012 announced their intention to write additional rules and/or revised existing rules that may expand the business operations that are considered subject to USF contribution payments. While we believe that we have registered our operations appropriately with the FCC, including the filing of both quarterly and annual reports regarding the revenues derived from audio conference calling, and the remittance of USF contributions thereon, it is possible that our determination of the extent to which our operations are subject to USF could be challenged. However, we do not believe that the ultimate outcome of any such challenge would have a material adverse effect on our financial position or results of operations. See notes 1 and 4.

 

We are involved in legal and regulatory matters 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.

 

NOTE 6:  CAPITAL STOCK

 

Common Stock

 

During the nine months ended June 30, 2014, we issued 1,547,334 common shares for interest, financing fees and finders fees as follows: (i) 800,000 common shares related to the modification of Sigma Note 1 and to Sigma Note 2, which were valued at approximately $175,000 and are being recognized as interest expense over loan terms of ten and eight months, respectively, (ii) 458,334 common shares related to the Working Capital Notes, which were valued at approximately $128,000, recognized partially as part of debt extinguishment loss for the nine and three months ended June 30, 2014 with the remainder being recognized as interest expense over eighteen month loan terms, (iii) 240,000 common shares relate to the extension of certain Subordinated Notes, which were valued at approximately $60,000 and are being recognized as interest expense over loan terms of approximately nine and one half months and (iv) 49,000 common shares relate to the extension of certain Intella2 Investor Notes, which were valued at approximately $10,000 and were recognized as interest expense at the time of issuance. See note 4 for details.

 

 

67

 


 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 6:  CAPITAL STOCK (Continued)

 

Common Stock (continued)

 

During the nine months ended June 30, 2014 we issued 491,502 unregistered common shares for consulting and advisory services valued at approximately $97,000, which are being recognized as professional fees expense over various service periods of up to twelve months. None of these shares were issued to our directors or officers. Professional fee expenses arising from these and prior issuances of shares and options for financial consulting and advisory services were approximately $129,000 and $190,000 for the nine months ended June 30, 2014 and 2013, respectively. As a result of previously issued shares for financial consulting and advisory services, we have recorded approximately $27,000 in deferred equity compensation expense at June 30, 2014, to be amortized over the remaining periods of service of nine months. The deferred equity compensation expense is included in the balance sheet caption prepaid expenses.

 

During the nine months ended June 30, 2014 we recorded the issuance of 500,000 fully restricted common shares for executive compensation valued at approximately $98,000, which are being recognized as professional fees expense over various service periods of up to six months. Compensation expense arising from these and prior issuances of shares for compensation were approximately $417,000 and $1.6 million for the nine months ended June 30, 2014 and 2013, respectively. As a result of previously issued shares for compensation, we have recorded approximately $23,000 in deferred equity compensation expense at June 30, 2014, to be amortized over the remaining periods of service of three months. The deferred equity compensation expense is included in the balance sheet caption prepaid expenses. See note 4 for details.

 

In December 2012, as part of a transaction under which J&C Resources issued us a funding commitment letter, we agreed to reimburse CCJ in cash the shortfall, payable on December 31, 2014, as compared to minimum guaranteed net proceeds of $175,000, from their resale of 437,500 common shares CCJ received on December 31, 2012 upon their conversion of 17,500 shares of Series A-13 and after effecting our agreement as part of the same transaction to reduce the conversion rate on all Series A-13 shares from $1.72 per common share to $0.40 per common share. We recorded an estimated shortfall liability of $43,750 and amortized that amount to interest expense over the one-year term of the funding commitment ending December 31, 2013 (approximately $11,000 for the three months then ended). Based on the closing ONSM price of $0.30 per share on December 31, 2013, we determined that there was no material difference between the present value of this obligation and the accrued liability recorded by us. However, based on the closing ONSM price of $0.20 per share as of June 30, 2014, the gross proceeds would be approximately $88,000 and the shortfall would be approximately $87,000. Therefore, we increased the $43,750 liability initially recorded by us by recognizing approximately $32,000 of interest expense for the six months ended June 30, 2014  which resulted in an approximately $76,000 liability on our financial statements as of that date, representing the present value of this obligation. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, the gross proceeds would be approximately $79,000 and the shortfall would be approximately $96,000.

 

68

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 7:  SEGMENT INFORMATION

 

Our operations are comprised within two groups, Audio and Web Conferencing Services and Digital Media Services, determined in accordance with ASC 280-10-50-1 (“Segment Reporting – Overall – Disclosure”). The Audio and Web Conferencing Services Group is primarily comprised of our business activities selling telephone related services to business customers, such as conference calling, voicemail, text messaging and collaboration and consists of our Infinite, OCC and EDNet divisions. The primary operating activities of the Infinite division are in the New York City area and the primary operating activities of the OCC and EDNet divisions are in California. The Digital Media Services Group is primarily comprised of our business activities selling Internet related services to business customers, such as webcasting, date storage and data streaming and consists primarily of our Webcasting and DMSP divisions. The primary operating activities of the Webcasting division, as well as our corporate headquarters, are in Florida. The Webcasting division has a sales and support facility in New York City. The primary operating activities of the DMSP division are in Colorado. 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, 2014 and 2013 and total assets by segment as of June 30, 2014 and September 30, 2013.

 

 

 

For the nine months ended

June 30,

 

For the three months ended

June 30,

 

 

 

2014

 

2013

 

2014

 

2013

Segment revenue:

 

 

 

 

 

 

 

 

 

 

 

Audio and Web Conferencing Services

$

8,611,928

 

$

8,459,353

 

$

2,902,537

 

$

2,907,450

Digital Media Services

 

4,282,032

 

 

4,686,088

 

 

1,582,793

 

 

1,562,952

Total consolidated revenue

$

12,893,960

 

$

13,145,441

 

$

4,485,330

 

$

4,470,402

 

 

 

 

 

 

 

 

 

 

 

 

Segment operating income:

 

 

 

 

 

 

 

 

 

 

 

Audio and Web Conferencing Services

$

2,740,178

 

$

2,564,301

 

$

946,490

 

$

868,118

Digital Media Services

 

1,206,268

 

 

969,988

 

 

551,466

 

 

371,801

Total segment operating income

 

3,946,446

 

 

3,534,289

 

 

1,497,956

 

 

1,239,919

Depreciation and amortization

 

(662,667)

 

 

(1,008,193)

 

 

(227,456)

 

 

(303,512)

Corporate and unallocated shared expenses

 

(3,379,458)

 

 

(4,808,943)

 

 

(1,031,206)

 

 

(1,116,670)

Gain from litigation settlement

 

741,554

 

 

-

 

 

741,554

 

 

-

Other expense, net

 

(1,651,171)

 

 

(1,121,985)

 

 

(620,726)

 

 

(339,980)

Net (loss) income

$

(1,005,296)

 

$

(3,404,832)

 

$

360,122

 

$

(520,243)

 
 

 

June 30,

 2014

 

September 30,

2013

Assets:

 

 

 

 

 

Audio and Web Conferencing Services

$

10,608,302

 

$

10,827,959

Digital Media Services

 

2,734,099

 

 

2,638,457

Corporate and unallocated

 

873,668

 

 

460,994

Total assets

$

14,216,069

 

$

13,927,410

 

Depreciation and amortization, as well as corporate and unallocated shared expenses and other expense, net, and gain from litigation settlement are not utilized by our primary decision makers for making decisions with regard to resource allocation or performance evaluation of the segments.

 

69

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 8:  STOCK OPTIONS AND WARRANTS

 

As of June 30, 2014, we had issued options and warrants still outstanding to purchase up to 1,174,532 ONSM common shares, including 491,199 shares under Plan Options to employees, consultants and directors; 383,333 shares under Plan and Non-Plan Options to financial and other consultants; and 300,000 shares under warrants issued in connection with various financings and other transactions.

 

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. 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 by 2,500,000 to 4,500,000. Based on the issuance of 3,377,763 common shares under the Plan (including the 3,000,000 Executive Incentive Shares issued as discussed in note 5) through June 30, 2014, 491,199 outstanding employee, consultant and director Plan Options as of June 30, 2014 and 75,000 outstanding consultant Plan Options as of June 30, 2014, there are 556,038 shares available for additional issuances under the Plan.

 

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, vesting over two years and having an exercise price of $1.23 per share, fair market value on the date of the grant. 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. In January 2013, the Compensation Committee and the Executives agreed on an Executive Incentive Plan which included provisions that were in lieu of issuing 450,000 of the additional authorized options – see note 5. As of June 30, 2014, 142,500 of the additional authorized option issuances relate to terminated directors, employees and consultants. The Compensation Committee is evaluating what action would be appropriate for it to take with respect to the remaining 391,200 additional authorized options.

 

Detail of employee, consultant, and director Plan Option activity under the Plan for the nine months ended June 30, 2014 is as follows:

 

 

Number of

Shares

 

Weighted

Average

 Exercise

 Price

 

 

 

 

 

Balance, beginning of period

538,499

 

$

1.85

Granted during the period

-

 

$

-

Expired or forfeited during the period

(47,300)

 

$

1.11

Balance, end of the period

491,199

 

$

1.92

Exercisable at end of the period

491,199

 

$

1.92

 

70

 


 
 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

 

The outstanding Plan Options for the purchase of 491,199 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 7 months and are further described below.

 

 

 

 

Total

number of

underlying

common shares

 

Vested

portion of

underlying

common shares

 

 

 

 

 

 

 

 

Exercise price

per share

 

Expiration

date

Grant date

Description

 

 

 

May 2008

Consultant

16,667

 

16,667

 

$6.00

 

Jan 2015

May 2009

Consultant

33,333

 

33,333

 

$3.00

 

Jan 2015

Aug 2009

Employee (non-Executive)

10,014

 

10,014

 

$9.42

 

Aug 2014

Dec 2009

Employee (non-Executive)

14,986

 

14,986

 

$9.42

 

Dec 2014

Jan 2011

Directors

50,000

 

50,000

 

$1.23

 

Jan 2015

Jan 2011

Employees (non-Executive)

316,199

 

316,199

 

$1.23

 

Jan 2015

Jan 2011

Consultant

25,000

 

25,000

 

$1.23

 

Jan 2015

Jun 2011

Director

25,000

 

25,000

 

$1.00

 

Jun 2015

 

 

Total common shares underlying

Plan Options as of June 30, 2014

491,199

 

491,199

 

 

 

 

 

As of June 30, 2014, there were outstanding and fully vested Plan and Non-Plan Options issued to financial and other consultants for the purchase of 383,333 common shares, as follows:

 

 
 

 

Number of

common shares

 

Exercise price

per share

 

 

 

Expiration

Date

Issuance period

 

 

Type

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

November 2011

30,000

 

$0.92

 

Plan

 

Nov 2016

March 2012

25,000

 

$0.65

 

Plan

 

March  2015

July 2012

20,000

 

$6.00

 

Plan

 

July 2016

Year ended September 30, 2012

75,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

March 2011

300,000

 

$1.50

 

Non-Plan

 

March 2015

Year ended September 30, 2011

300,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

September 2009

8,333

 

$3.00

 

Non-Plan

 

Sept 2014

Year ended September 30, 2009

8,333

 

 

 

 

 

 

 

Total common shares underlying consultant

options as of June 30, 2014

383,333

 

 

 

 

 

 

                                                                                             

71

 


 

 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

 

As of June 30, 2014, there were outstanding vested warrants, issued in connection with various financings, to purchase an aggregate of 300,000 shares of common stock, as follows:

 

 

 

 

 

Exercise

price

per share

 

 

 

Number of

common shares

 

 

Expiration

Date

Description of transaction

 

 

 

 

 

 

 

 

LPC stock purchase – February 2012

 

 

 

 

 

(“New LPC Warrant 2”)

50,000

 

$0.38

 

February  2017

LPC Purchase Agreement – September 2010

 

 

 

 

 

(“New LPC Warrant 1”)

250,000

 

$0.38

 

March 2016

Total common shares underlying warrants as of June 30, 2014

300,000

 

 

 

 

 

On September 17, 2010, we entered into a purchase agreement (the “LPC Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to purchase, and did purchase, a certain number of our common and preferred shares during the term of the LPC Purchase Agreement, which term expired on September 17, 2013. In connection with the LPC Purchase Agreement, we also issued LPC a warrant (“LPC Warrant 1”). Due to the price-based anti-dilution protection provisions of  LPC Warrant 1 (also known as “down round” provisions) and in accordance with ASC Topic 815, “Contracts in Entity’s Own Equity”, we were required to recognize LPC Warrant 1 as a liability at its fair value on each previous reporting date. Effective October 25, 2012, LPC Warrant 1 was cancelled and replaced with New LPC Warrant 1, with 250,000 underlying common shares exercisable at $0.38 per share, with such amounts only adjustable in accordance with standard anti-dilution provisions – the price-based anti-dilution provisions that were in LPC Warrant 1 are not included in New LPC Warrant 1. Accordingly, since accounting for LPC Warrant 1 or New LPC Warrant 1 under ASC Topic 815 was no longer applicable, we performed a valuation of LPC Warrant 1 as of October 25, 2012 in order to make the appropriate adjustments. Based on this valuation of $53,894, as compared to the $81,374 carrying value of LPC Warrant 1 on our consolidated balance sheet as of September 30, 2012, the $27,480 decrease in the fair value of this liability from September 30, 2012 to October 25, 2012 was reflected as other income in our consolidated statement of operations for the nine months ended June 30, 2013 (zero for the three months then ended) and the remaining $53,894 was reclassified from liability to additional paid-in capital.

 

On February 15, 2012, in exchange for $140,000 cash proceeds, we issued LPC 200,000 unregistered common shares and a five-year warrant to purchase 100,000 unregistered common shares at an exercise price of $1.00 per share (“LPC Warrant 2”). This transaction was unrelated to the LPC Purchase Agreement. Effective October 25, 2012, LPC Warrant 2 was cancelled and replaced with New LPC Warrant 2, which was issued with 50,000 underlying common shares exercisable at $0.38 per share, with such amounts only adjustable in accordance with standard anti-dilution provisions.

 

72

 


 

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

JUNE 30, 2014

 

 

NOTE 8:  STOCK OPTIONS AND WARRANTS (Continued)

 

New LPC Warrant 1 and New LPC Warrant 2 contain certain cashless exercise rights, as did the predecessor warrants. The number of shares of ONSM common stock that can be issued upon the exercise of New LPC Warrant 1 or New LPC Warrant 2 is limited to the extent necessary to ensure that following the exercise the total number of shares of ONSM common stock beneficially owned by the holder does not exceed 4.99% 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%.

 

The exercise prices of New LPC Warrant 1 and New LPC Warrant 2 are subject to adjustment for various factors, including in the event of stock splits, stock dividends, pro rata distributions of equity securities, evidences of indebtedness, rights or warrants to purchase common stock or cash or any other asset or mergers or consolidations. Such adjustment of the exercise price would in most cases result in a corresponding adjustment in the number of shares underlying the warrant.

 

 

NOTE 9:  SUBSEQUENT EVENTS

 

The following notes to the consolidated financial statements contain disclosure as noted with respect to transactions occurring after June 30, 2014:

 

  • Note 1 (impact of certain cost reductions for periods after June 30, 2014; impact of certain debt and other obligations coming due after June 30, 2014)

 

  • Note 2 (Intella2 litigation settlement in July 2014; patent application activity in July, 2014; impact of change in ONSM common share price through August 8, 2014)

 

  • Note 3 (Software placed in service in July 2014)

 

  • Note 4 (status of negotiations for renewal of the Line for periods after June 30, 2014; August 2014 termination of Sigma Put Right; impact of change in ONSM common share price through August 8, 2014)

 

  • Note 5 (status of issuance of Executive Shares and related payment of cash compensation through August 8, 2014; issuance of Executive Incentive Shares after June 30, 2014; status of lease renewal negotiations in Florida after June 30, 2014; new San Francisco office lease effective September 1, 2014; impact of change in ONSM common share price through August 8, 2014)

 

  • Note 6 (impact of change in ONSM common share price through August 8, 2014)

  

 

During July 2014 we issued 235,000 unregistered common shares for investor relations and financial consulting services valued at approximately $42,000, which will be recognized as professional fees expense over a service period of twelve months.

 

73




ITEM 2.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION


The following discussion should be read together with the information contained in the Consolidated Financial Statements and related Notes included in the quarterly report.


Overview


We are 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.  We had approximately 86 full time employees as of August 8, 2014, with operations organized in two main operating groups:


·

Audio and Web Conferencing Services Group

·

Digital Media Services Group


Our Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division, our Onstream Conferencing Corporation (“OCC”) division and our EDNet division. Our Infinite division, which operates primarily from the New York City area, and our OCC division, which operates primarily from San Diego, California, provide “reservationless” and operator-assisted audio and web conferencing services. Our 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.


Our Digital Media Services Group consists primarily of our Webcasting division and our DMSP (“Digital Media Services Platform”) division. The DMSP division includes the related UGC (“User Generated Content”) and Smart Encoding divisions. Our Webcasting division, which operates primarily from Pompano Beach, Florida and has a sales and support 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.  As of October 1, 2013, the Webcasting division became responsible for sales of the MarketPlace365 service. Our 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. Our UGC division, which also operates as Auction Video 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. Our 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.


For segment information related to the revenue and operating income of these groups, see Note 7 to the Consolidated Financial Statements.


Recent Developments


During October and November 2013 we obtained aggregate net financing proceeds of approximately $246,000 from the issuance of partially secured promissory notes to three investors (the “Working Capital Notes”), with an initial aggregate outstanding balance of $620,000 bearing interest at 15% per annum. Working Capital Note payments are interest only during the first six months (in two quarterly payments), approximately 50% of the principal in equal monthly payments plus interest during the next eleven months and the remaining 50% of the principal balance due eighteen months after the Working Capital Note issuance date. The proceeds of the Working Capital Notes were used to repay $223,812 outstanding principal and interest due on notes previously issued by us. In addition, $125,000 in origination fees and $25,000 for a Funding Commitment Letter were deducted from the proceeds of the Working Capital Notes. In connection with the above financing, we issued, or committed to issue, to the holders of Working Capital Notes or in connection with a related finders agreement, an aggregate of 458,334 restricted common shares.


74



On February 6, 2014, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”), agreeing to provide us, within twenty (20) days after our notice on or before December 31, 2014, aggregate cash funding of up to $800,000. 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, 2015 and (b) 7.5 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.


During fiscal 2013, we entered into a March 21, 2013 financing transaction with Sigma Opportunity Fund II, LLC (“Sigma”), which was amended on June 14, 2013, under which aggregate gross proceeds of $945,000 were received by us (“Sigma Note 1”). On February 28, 2014, the terms of Sigma Note 1 were amended so that principal and interest payments otherwise due on Sigma Note 1, starting with the December 31, 2013 payment and ending with the September 30, 2014 payment, were eliminated and replaced with monthly principal and interest payments on the last day of October and November 2014 plus a final principal and interest payment on the December 18, 2014 maturity date of Sigma Note 1, such payments aggregating $1,022,314. Sigma has the right to convert up to $395,000 of the outstanding balance of Sigma Note 1 into our common shares at a price of $1.00 per share.


On February 28, 2014 we borrowed $500,000 from Sigma (from which were deducted certain fees and we repaid certain debt) pursuant to a senior secured note (“Sigma Note 2”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Rockridge Capital Holdings LLC (“Rockridge”) and Thermo Credit LLC. The $500,000 principal, plus $59,447 interest (based on 17% per annum compounding monthly), is due on October 31, 2014. Sigma shall have the right to convert the Sigma Note 2 (including the accrued interest thereon), in its entirety or partially, and at its option, into our common shares at a price of $1.00 per share.


In connection with the Sigma Note 2, we issued 560,000 restricted common shares to Sigma as well as reimbursed $11,354 of Sigma’s legal and other expenses related to this financing. We also issued 240,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and paid them $267,857 in advisory fees in connection with a February 28, 2014 Advisory Services Agreement.


Upon our receipt of funds in excess of $2.0 million as a result of the sale of any portion of our business, however structured, including, without limitation, sale of assets, subsidiaries or business units, and/or (ii) the issuance of additional equity, debt or convertible debt capital, and/or (iii) our consolidation or merger with or into another entity, all outstanding principal and interest with respect to Sigma Note 1 and/or Sigma Note 2 will be due.


See Liquidity and Capital Resources for further details with respect to the financing transactions highlighted in this Recent Developments section.


 75



Since November 2013, we have been involved in litigation with Intella2 and its owner, Paul Cohen, in connection with the Intella2 acquisition. On July 29, 2014, the parties entered into a settlement agreement and on August 4, 2014, the lawsuit was dismissed with prejudice by the court. Under the terms of the settlement agreement, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014, and we also agreed to pay him $20,000 ($10,000 per month in July and August) with respect to such activity before July 1, 2014. We also agreed to transfer certain computer equipment already owned by us and used to support the free conferencing business, with an estimated net book value of $20,000, to Mr. Cohen. No further purchase price or other amounts will be payable by us under the agreements entered into at the time of the November 30, 2012 acquisition. Based on the litigation settlement, we reduced the approximately $782,000 estimated liability for the unpaid portion of the purchase price to an estimated liability of $40,000, which resulted in our recognition of other income of approximately $742,000 for the nine and three months ended June 30, 2014.


Revenue Recognition


Revenues from recurring service are recognized when (i) persuasive evidence of an arrangement exists between us and the customer, (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.

 

Our Audio and Web Conferencing Services Group recognizes revenue from audio and web conferencing as well as customer usage of digital telephone connections.
 

The Infinite and OCC divisions generally charge for audio conferencing and web conferencing services on a per-minute usage rate, although webconferencing services are also available for 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 primarily generates revenue from customer usage of digital telephone connections controlled by them. EDNet purchases digital phone lines from telephone companies 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 usage of those services.
 

Our Digital Media Services Group recognizes revenues from the acquisition, editing, transcoding, indexing, storage and distribution of its customers’ digital media, as well as from live and on-demand internet webcasting and internet distribution of travel information.

 

The Webcasting division charges for live and on-demand webcasting at the time an event is accessible for streaming over the Internet. Charges to customers by the DMSP division are generally based on a monthly subscription fee, as well as charges for hosting, storage and professional services. Fees charged to customers for customized applications or set-up are recognized as revenue at the time the application or set-up is completed. Charges to customers by the Smart Encoding and UGC divisions are generally based on the activity or volumes of such media, expressed in megabytes or similar terms, and are recognized at the time the service is performed. This division also provides hosting, storage and streaming services for digital media, which are provided via the DMSP.

 

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.


We add to our customer billings for certain services an amount to recover USF contributions which we have determined that we will be obligated to pay to the FCC, related to those particular services. This additional billing to our customers is not reflected as revenue by us, but rather is recorded as a liability on our books, which liability is relieved upon our remittance of USF contributions as they are billed to us by USAC, an administrative and collection agency of the FCC.


76



Results of Operations


Our consolidated net loss for the nine months ended June 30, 2014 was approximately $1.0 million ($0.04 loss per share) as compared to a net loss of approximately $3.4 million ($0.20 loss per share) for the corresponding period of the prior fiscal year, a decrease in our net loss of approximately $2.4 million (70.5%). The decreased net loss was primarily due to an approximately $1.7 million, or 21.9%, decrease in compensation, including compensation paid with equity, as compared to the corresponding period of the prior fiscal year.


Our consolidated net income for the three months ended June 30, 2014 was approximately $360,000 ($0.02 per share) as compared to a net loss of approximately $520,000 ($0.03 loss per share) for the corresponding period of the prior fiscal year, an improvement of approximately $880,000. The improvement was primarily due to an approximately $742,000 gain from litigation settlement, for which there was no comparable transaction in the corresponding period of the prior fiscal year.


77


 

Nine months ended June 30, 2014 compared to the nine months ended June 30, 2013 - The following table shows, for the periods indicated, the percentage of revenue represented by items on our consolidated statements of operations.


 

Nine months ended June 30,

 

2014

 

2013

Revenue:

 

 

 

 

 

    Audio and web conferencing

         55.4

%

 

         52.1

%

    Webcasting

      27.0

 

 

       29.4

 

    Network usage

      11.2

 

 

      11.6

 

    DMSP and hosting

    5.5

 

 

    5.5

 

    Other

        0.9

 

 

        1.4

 

Total revenue

    100.0

%

 

    100.0

%

 

 

 

 

 

 

Costs of revenue:

 

 

 

 

 

    Audio and web conferencing

         15.1

 

 

        14.5

%

    Webcasting

        7.1

 

 

       8.2

 

    DMSP and hosting

    0.9

 

 

   0.8

 

    Network usage

        4.8

 

 

       5.7

 

    Other

        0.2

 

 

       0.3

 

Total costs of revenue

     28.1

%

 

    29.5

%

 

 

 

 

 

 

Gross margin

     71.9

%

 

   70.5

%

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

    Compensation (excluding equity)

      42.7

%

 

      45.9

%

    Compensation (paid with equity)

    3.3

 

 

   11.8

 

    Professional fees

        8.0

 

 

        8.0

 

    Other general and administrative

      13.5

 

 

      14.5

 

    Depreciation and amortization

        5.1

 

 

        7.7

 

Total operating expenses

        72.6

%

 

        87.9

%

   

 

 

 

 

 

Loss from operations

         (0.7)

%

 

       (17.4)

%

 

 

 

 

 

 

Other expense, net:

 

 

 

 

 

    Interest expense

    (11.9)

%

 

      (7.4)

%

    Debt extinguishment loss

   (1.0)

 

 

   (1.1)

 

    Gain from adjustment of derivative liability to fair value

-

 

 

0.2

 

    Gain from litigation settlement

             5.7

 

 

         -

 

    Other income (expense), net

             0.1 

 

 

       (0.2)

 

Total other expense, net

          (7.1)

%

 

        (8.5)

%

 

 

 

 

 

 

Net loss

         (7.8)

%

 

       (25.9)

%


78


 

The following table is presented to illustrate our discussion and analysis of our results of operations.  This table should be read in conjunction with the consolidated financial statements and the notes thereto.

 

For the nine months ended

 June 30,

 


Increase (Decrease)

 

2014

 

2013

 

Amount

 

Percent

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

$

12,893,960

 

$

13,145,441

 

$

(251,481)

 

 (1.9)

%

Total costs of revenue

 

3,627,860

 

 

      3,884,197

 

 

(256,337)

 

 (6.6)

 

Gross margin

 

9,266,100

 

 

9,261,244

 

 

4,856

 

 0.1

%

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative expenses

 

8,699,112

 

 

10,535,898

 

 

(1,836,786)

 

 (17.4)

%

Depreciation and amortization

 

662,667

 

 

      1,008,193

 

 

(345,526)

 

 (34.3)

 

Total operating expenses

 

9,361,779

 

 

    11,544,091

 

 

(2,182,312)

 

 (18.9)

%

 

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(95,679)

 

 

(2,282,847)

 

 

(2,187,168)

 

 (95.8)

%

 

 

 

 

 

 

 

 

 

 

 

 

Other expense, net

 

 (909,617)

 

 

    (1,121,985)

 

 

(   212,368)

 

 (18.9)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

$

(1,005,296)

 

$

(3,404,832)

 

$

(2,399,536)

 

 (70.5)

%


Revenues and Gross Margin


Consolidated operating revenue was approximately $12.9 million for the nine months ended June 30, 2014, a decrease of approximately $251,000 (1.9%) from the corresponding period of the prior fiscal year, due to decreased revenues of the Digital Media Services Group, partially offset by increased revenues of the Audio and Web Conferencing Services Group.


Digital Media Services Group revenues were approximately $4.3 million for the nine months ended June 30, 2014, a decrease of approximately $404,000 (8.6%) from the corresponding period of the prior fiscal year, primarily due to a decrease in webcasting division revenues.


Webcasting division revenues decreased by approximately $379,000 (9.8%) for the nine months ended June 30, 2014 as compared to the corresponding period of the prior fiscal year. We produced approximately 3,000 webcasts during the nine months ended June 30, 2014, which was approximately 800 less than the number of webcasts produced in the corresponding period of the prior fiscal year. The impact on revenue arising from the decreased number of events was partially offset by an increase in the average revenue per webcast event to $1,255 for the nine months ended June 30, 2014, which represented an increase of $182, or 17.0%, from the corresponding period of the prior fiscal year. The number of webcasts reported, as well as the resulting calculation of the average revenue per webcast event, does not include any webcast events attributed with $100 or less revenue, based on our determination that excluding such low-priced or even no-charge events increases the usefulness of this statistic. The average revenue per webcast also includes revenue billed by the webcasting division to its customers but purchased by the webcasting division from another Onstream division and thus included in that other division’s reported revenues.


 79


 

 

We believe that our webcasting division revenues will continue to be favorably impacted during the remainder of fiscal 2014 and into fiscal 2015 by the comprehensive update to our Visual Webcaster webcasting platform (VW4), which we released in January 2013 and have been updating with new features since then. We also expect to see increased sales as a result of our Virtual Conference Center which is a multiple event conference venue with integrated webcasting (and based on our MP365 technology) as well as from iEncode, a service that allows our customers to self-encode their live professional video and attach the streams to the Visual Webcaster system in the cloud. iEncode allows them to take advantage of using their internal staff and facilities while still utilizing all of the Visual Webcaster features. Also in development is another “do it yourself” large audience webcasting product that can be run from the customer’s desktop and will be available on a fixed cost monthly subscription basis that can be purchased on-line.


Audio and Web Conferencing Services Group revenues were approximately $8.6 million for the nine months ended June 30, 2014, an increase of approximately $153,000 (1.8%) from the corresponding period of the prior fiscal year. This increase arose primarily from the revenues of the Infinite division of approximately $6.4 million for the nine months ended June 30, 2014, which represented an increase of approximately $266,000 (4.3%) as compared to the corresponding period of the prior fiscal year. This was in turn due to a 10.9% increase in the number of minutes billed which was approximately 109.1 million for the nine months ended June 30, 2014, as compared to approximately 98.3 million minutes for the corresponding period of the prior fiscal year.  This increase in the number of minutes billed was partially offset by a decrease in average revenue per minute, which was approximately 6.0 cents for the nine months ended June 30, 2014, as compared to approximately 6.4 cents for the corresponding period of the prior fiscal year. The average revenue per minute statistic includes auxiliary services and fees that are not billed to the customer on a per minute basis. The average revenue per minute also includes revenue billed by Infinite to its customers but purchased by Infinite from another Onstream division and thus included in that other division’s reported revenues. Although the decrease in average revenue per minute reflects our reactions to competitive pressures on the pricing side, we have been able to reduce our costs for the same reason.


We believe that Infinite’s alliances with existing and new third party conferencing providers, anticipated internal software development and other sales and marketing initiatives, should continue to favorably impact Infinite division revenues during the remainder of fiscal 2014 and into fiscal 2015.


The revenues of our OCC division, which is included in the Audio and Web Conferencing Services Group, were approximately $761,000 for the nine months ended June 30, 2014, which represented an increase of approximately $27,000 (3.7%) as compared to the corresponding period of the prior fiscal year. The OCC division is being managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The OCC division acquired Intella2 Inc., a San Diego-based communications company (“Intella2”) on November 30, 2012. Accordingly, nine months of Intella2 revenues were recognized during the nine months ended June 30, 2014 versus just seven months of Intella2 revenues during the corresponding period of the prior fiscal year. The Intella2 acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail.


The OCC division revenues included approximately $153,000 of free conferencing business revenues for the nine months ended June 30, 2014, as compared to approximately $155,000 for the corresponding period of the prior fiscal year. Since November 2013, we have been involved in litigation with Intella2 and its owner, Paul Cohen, in connection with the Intella2 acquisition. On July 29, 2014, the parties entered into a settlement agreement and on August 4, 2014, the lawsuit was dismissed with prejudice by the court. Under the terms of the settlement agreement, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014.


80



Although it appears that our consolidated revenues for fiscal 2014 will not exceed our consolidated revenues for fiscal 2013, we expect, primarily because of our expectations with respect to our recent and anticipated introductions of several new or enhanced products, to achieve revenue growth in the fourth quarter of fiscal 2014 as well as fiscal 2015, as compared to corresponding prior year periods, although this cannot be assured.


Consolidated gross margin was approximately $9.3 million for the nine months ended June 30, 2014, an increase of approximately $5,000 (0.1%) from the corresponding period of the prior fiscal year. However, our consolidated gross margin percentage was 71.9% for the nine months ended June 30, 2014, versus 70.5% for the corresponding period of the prior fiscal year. This increase in percentage was primarily due to reductions in audio and web conferencing cost of sales, webcasting cost of sales (proportionally greater than the reduction in revenues) and network usage cost of sales (proportionally greater than the reduction in revenues).


Effective June 2014, we renegotiated a supplier contract representing approximately $252,000 in annualized savings, which we expect will cumulatively reduce our cost of sales by approximately $63,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our cost of sales by approximately $168,000 in aggregate for the first eight months of fiscal 2015 as compared to the corresponding prior year period.


Primarily because of the anticipated cost savings noted above, we expect our consolidated fiscal 2014 gross margin will exceed our consolidated fiscal 2013 gross margin, although this cannot be assured. Primarily because of these anticipated cost savings as well as our expectations for revenue growth arising from our recent and anticipated introductions of several new or enhanced products, we expect our consolidated fiscal 2015 gross margin will exceed our consolidated fiscal 2014 gross margin, although this cannot be assured.


Operating Expenses


Consolidated operating expenses were approximately $9.4 million for the nine months ended June 30, 2014, a decrease of approximately $2.2 million (18.9%) from the corresponding period of the prior fiscal year, primarily due to an approximately $1.7 million, or 21.9%, decrease in total compensation. This decrease in total compensation was comprised of an approximately $1.1 million, or 73.1%, decrease in compensation paid with equity, and an approximately $525,000, or 8.7%, decrease in compensation other than amounts paid with equity, both as compared to the corresponding period of the prior fiscal year.


In February 2013, we (as authorized by our Board of Directors) established an Executive Incentive Plan, under which the five Executives could receive fully restricted (as defined in the Executive Incentive Plan) common shares (“Executive Incentive Shares”), issued based on the Company achieving certain financial objectives (as defined in the Executive Incentive Plan). In February 2013, the initial issuance authorized under the Executive Incentive Plan was an aggregate of 2,250,000 Executive Incentive Shares, which were issued in connection with meeting certain financial objectives related to fiscal 2011 and fiscal 2012 as well as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives had been cancelled. These 2,250,000 Executive Incentive Shares were recorded on our financial statements based on their fair value at the time of the February 2013 authorization, which was $1,237,500 (based on $0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation. The net amount of approximately $1,137,000 was reflected on our financial statements as non-cash compensation expense for the nine months ended June 30, 2013, which was approximately $1.1 million greater than the approximately $75,000 (based on $0.18 to $0.21 per share) related to Executive Incentive Shares recorded during on our financial statements as non-cash compensation expense for the nine months ended June 30, 2014, in connection with meeting certain identified financial objectives related to fiscal 2014.

 

81

 

 

During the period from June 2013 through January 2014 we made certain headcount reductions representing approximately $1.1 million in annualized savings, which accounted for an approximately $512,000 reduction in cash compensation expense for the nine months ended June 30, 2014, as compared to the corresponding prior year period. We expect these headcount reductions will also reduce our compensation expenditures by approximately $199,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our compensation expenditures by approximately $159,000 in aggregate for the first seven months of fiscal 2015 as compared to the corresponding prior year period.


Excluding the impact, if any, arising from any goodwill impairment charges, as well as increased general and administrative expenses related to any increased revenues, we expect our consolidated operating expenses for the remainder of fiscal year 2014 as well as fiscal 2015 to be less than the corresponding prior year amounts, although this cannot be assured.


Other Expense


Other expense of approximately $910,000 for the nine months ended June 30, 2014 represented an approximately $212,000 (18.9%) decrease as compared to the corresponding period of the prior fiscal year. This decrease was primarily due to an approximately $742,000 gain from litigation settlement, for which there was no comparable transaction in the corresponding period of the prior fiscal year, partially offset by an approximately $555,000, or 56.9%, increase in interest expense for the nine months ended June 30, 2014, as compared to the corresponding period of the prior fiscal year.


On November 26, 2013, Intella2 and its owner Paul Cohen filed a civil lawsuit in Florida naming Onstream Media Corporation, Onstream Conferencing Corporation and Infinite Conferencing as defendants. The action alleged breach of contract with respect to payment of certain components of the purchase price for the Intella2 acquisition and related commissions and sought money damages as well as declaratory relief declaring Mr. Cohen’s related non-compete agreement with us unenforceable. On December 31, 2013 we filed our response to this lawsuit, which contained various objections to the lawsuit allegations as well as a number of counterclaims. On July 29, 2014, the parties entered into a settlement agreement and on August 4, 2014, the lawsuit was dismissed with prejudice by the court. Under the terms of the settlement agreement, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014, and we also agreed to pay him $20,000 ($10,000 per month in July and August) with respect to such activity before July 1, 2014. We also agreed to transfer certain computer equipment already owned by us and used to support the free conferencing business, with an estimated net book value of $20,000, to Mr. Cohen. No further purchase price or other amounts will be payable by us under the agreements entered into at the time of the November 30, 2012 acquisition, including the Asset Purchase Agreement, the Total Free Conferencing Business Revenue Share Agreement and the Master Agent and Non-Compete Agreement. Under the terms of the settlement agreement, Mr. Cohen’s non-compete agreement was cancelled and replaced by mutual agreements as to non-disparagement and non-solicitation.


Prior to adjustment for the litigation settlement, the unpaid portion of the purchase price reflected as an accrued liability on our financial statements through June 30, 2014 was approximately $782,000. This represented the remaining unpaid portion of the purchase price of approximately $705,000, as determined as of the time of the initial purchase, plus accretion of approximately $74,000 reflected as interest expense on our statement of operations for the year ended September 30, 2013 and accretion of approximately $53,000 reflected as interest expense on our statement of operations for the nine months ended June 30, 2014 and less approximately $50,000 of payments made to Intella2 after closing through June 30, 2014, which were considered to be payment of the accretion (i.e., interest) instead of the purchase price (i.e., principal).


82


 

Authoritative accounting guidance allows one year from the acquisition date for us to make adjustments to the purchase price, in the event that such adjustments are based on facts and circumstances that existed as of the acquisition date that, if known, would have resulted in such adjusted assets and liabilities as of that date. However, changes resulting from facts and circumstances arising after the acquisition date, or after the one year timeframe noted above, would be recognized in our results of operations. Based on the litigation settlement, which was reached more than one year after the acquisition date and was based on facts and circumstances arising after the acquisition date, we reduced the approximately $782,000 estimated liability for the unpaid portion of the purchase price to an estimated liability of $40,000, classified as current, which resulted in our recognition of other income of approximately $742,000 for the nine months ended June 30, 2014.


The approximately $555,000 increase in interest expense was primarily attributable to (i) an approximately $329,000 increase for the aggregate of cash and non-cash interest expense recognized for Sigma Note 1 (which was initially funded in March 2013 and funded additionally in June 2013), which was approximately $430,000 for the nine months ended June 30, 2014 and approximately $101,000 for the corresponding period of the prior fiscal year and (ii) approximately $169,000 for the aggregate of cash and non-cash interest expense recognized during the nine months ended June 30, 2014 for Sigma Note 2 (which was funded in February 2014) and for which we recognized no interest expense during the corresponding period of the prior fiscal year.


 

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Three months ended June 30, 2014 compared to the three months ended June 30, 2013 - The following table shows, for the periods indicated, the percentage of revenue represented by items on our consolidated statements of operations.


 

Three months ended June 30,

 

2014

 

2013

Revenue:

 

 

 

 

 

    Audio and web conferencing

         54.4

%

 

         53.0

%

    Webcasting

      29.3

 

 

       28.4

 

    Network usage

      10.2

 

 

      11.7

 

    DMSP and hosting

    5.3

 

 

    5.4

 

    Other

        0.8

 

 

        1.5

 

Total revenue

    100.0

%

 

    100.0

%

 

 

 

 

 

 

Costs of revenue:

 

 

 

 

 

    Audio and web conferencing

        14.4

%

 

        14.8

%

    Webcasting

      6.9

 

 

       7.1

 

    DMSP and hosting

   1.0

 

 

   0.8

 

    Network usage

       4.4

 

 

       4.9

 

    Other

       0.1

 

 

       0.3

 

Total costs of revenue

     26.8

%

 

    27.9

%

 

 

 

 

 

 

Gross margin

     73.2

%

 

    72.1

%

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

    Compensation (excluding equity)

      39.8

%

 

      46.4

%

    Compensation (paid with equity)

    2.5

 

 

        3.0

 

    Professional fees

        7.4

 

 

        5.8

 

    Other general and administrative

      13.1

 

 

      14.1

 

    Depreciation and amortization

        5.1

 

 

        6.8

 

Total operating expenses

       67.9

%

 

        76.1

%

   

 

 

 

 

 

Income (loss) from operations

          5.3

%

 

         (4.0)

%

 

 

 

 

 

 

Other income (expense), net:

 

 

 

 

 

    Interest expense

    (14.0)

%

 

      (7.6)

%

    Gain from litigation settlement

          16.5

 

 

               -   

 

    Other income (expense), net

            0.2

 

 

   -   

 

Total other income (expense), net

        2.7

%

 

        (7.6)

%

 

 

 

 

 

 

Net income (loss)

        8.0

%

 

       (11.6)

%


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The following table is presented to illustrate our discussion and analysis of our results of operations.  This table should be read in conjunction with the consolidated financial statements and the notes thereto.


 

For the three months ended

 June 30,

 


Increase (Decrease)

 

2014

 

2013

 

Amount

 

Percent

 

 

 

 

 

 

 

 

 

 

 

 

Total revenue

$

4,485,330

 

$

4,470,402

 

$

14,928

 

0.3

%

Total costs of revenue

 

1,203,614

 

 

1,248,482

 

 

 (44,868)

 

 (3.6)

 

Gross margin

 

3,281,716

 

 

3,221,920

 

 

59,796

 

1.9

%

 

 

 

 

 

 

 

 

 

 

 

 

General and administrative expenses

 

2,814,966

 

 

3,098,671

 

 

(283,705)

 

 (9.2)

%

Depreciation and amortization

 

227,456

 

 

303,512

 

 

 (76,056)

 

 (25.1)

 

Total operating expenses

 

3,042,422

 

 

3,402,183

 

 

 (359,761)

 

 (10.6)

%

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

239,294

 

 

(180,263)

 

 

419,557

 

        232.7

%

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense), net

 

120,828

 

 

 (339,980)

 

 

460,808

 

135.5

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income (loss)

$

360,122

 

$

 (520,243)

 

$

880,365

 

169.2

%



Revenues and Gross Margin


Consolidated operating revenue was approximately $4.5 million for the three months ended June 30, 2014, an increase of approximately $15,000 (0.3%) from the corresponding period of the prior fiscal year.

 

Digital Media Services Group revenues were approximately $1.6 million for the three months ended June 30, 2014, an increase of approximately $20,000 (1.3%) from the corresponding period of the prior fiscal year, primarily due to an increase in webcasting division revenues.


Webcasting division revenues increased by approximately $48,000 (3.8%) for the three months ended June 30, 2014 as compared to the corresponding period of the prior fiscal year. We produced approximately 1,000 webcasts during the three months ended June 30, 2014, which was approximately 300 less than the number of webcasts produced in the corresponding period of the prior fiscal year. The impact on revenue arising from the decreased number of events was offset by an increase in the average revenue per webcast event to $1,368 for the three months ended June 30, 2014, which represented an increase of $343, or 33.4%, from the corresponding period of the prior fiscal year. The number of webcasts reported, as well as the resulting calculation of the average revenue per webcast event, does not include any webcast events attributed with $100 or less revenue, based on our determination that excluding such low-priced or even no-charge events increases the usefulness of this statistic. The average revenue per webcast also includes revenue billed by the webcasting division to its customers but purchased by the webcasting division from another Onstream division and thus included in that other division’s reported revenues.


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Audio and Web Conferencing Services Group revenues were approximately $2.9 million for the three months ended June 30, 2014, a decrease of approximately $5,000 (0.2%) from the corresponding period of the prior fiscal year. The revenues of the Infinite division of approximately $2.2 million for the three months ended June 30, 2014 represented an increase of approximately $142,000 (6.9%) as compared to the corresponding period of the prior fiscal year. This was in turn due to an 8.6% increase in the number of minutes billed which was approximately 37.6 million for the three months ended June 30, 2014, as compared to approximately 34.6 million minutes for the corresponding period of the prior fiscal year.  The average revenue per minute was approximately 6.1 cents for the three months ended June 30, 2014, as well as for the corresponding period of the prior fiscal year. The average revenue per minute statistic includes auxiliary services and fees that are not billed to the customer on a per minute basis. The average revenue per minute also includes revenue billed by Infinite to its customers but purchased by Infinite from another Onstream division and thus included in that other division’s reported revenues. Although the decrease in average revenue per minute reflects our reactions to competitive pressures on the pricing side, we have been able to reduce our costs for the same reason.


The revenues of our OCC division, which is included in the Audio and Web Conferencing Services Group, were approximately $233,000 for the three months ended June 30, 2014, which represented a decrease of approximately $73,000 (23.8%) as compared to the corresponding period of the prior fiscal year. The total revenues from those operations included approximately $44,000 of free conferencing business revenues for the three months ended June 30, 2014, as compared to approximately $61,000 for the corresponding period of the prior fiscal year. As discussed above, as part of a July 29, 2014 settlement of litigation with Intella2 and its owner, Paul Cohen, in connection with the Intella2 acquisition, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014.


Consolidated gross margin was approximately $3.3 million for the three months ended June 30, 2014, an increase of approximately $60,000 (1.9%) from the corresponding period of the prior fiscal year. In addition, our consolidated gross margin percentage was 73.2% for the three months ended June 30, 2014, versus 72.1% for the corresponding period of the prior fiscal year. This increase in percentage was primarily due to reductions in audio and web conferencing cost of sales and webcasting cost of sales (proportionally greater than the reduction in revenues).


Operating Expenses


Consolidated operating expenses were approximately $3.0 million for the three months ended June 30, 2014, a decrease of approximately $360,000 (10.6%) from the corresponding period of the prior fiscal year, primarily due to an approximately $288,000, or 13.9%, decrease in compensation other than amounts paid with equity, as compared to the corresponding period of the prior fiscal year. During the period from June 2013 through January 2014 we made certain headcount reductions representing approximately $1.1 million in annualized savings, which accounted for an approximately $219,000 reduction in cash compensation expense for the three months ended June 30, 2014, as compared to the corresponding prior year period.


Other Income


Other income of approximately $121,000 for the three months ended June 30, 2014 represented an approximately $461,000 increase in income as compared to the approximately $340,000 of other expense for the corresponding period of the prior fiscal year. This increase was primarily due to an approximately $742,000 gain from litigation settlement, for which there was no comparable transaction in the corresponding period of the prior fiscal year, partially offset by an approximately $230,000, or 85.2%, increase in interest expense for the three months ended June 30, 2014, as compared to the corresponding period of the prior fiscal year.


As discussed above, based on the conditions of a July 29, 2014 settlement of litigation with Intella2 and its owner, Paul Cohen, in connection with the Intella2 acquisition, we reduced the approximately $782,000 estimated liability for the unpaid portion of the purchase price to an estimated liability of $40,000, classified as current, which resulted in our recognition of other income of approximately $742,000 for the three months ended June 30, 2014.

 

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The approximately $230,000 increase in interest expense was primarily attributable to (i) an approximately $78,000 increase for the aggregate of cash and non-cash interest expense recognized for Sigma Note 1 (which was initially funded in March 2013 and funded additionally in June 2013), which was approximately $179,000 for the three months ended June 30, 2014 and approximately $101,000 for the corresponding period of the prior fiscal year and (ii) approximately $139,000 for the aggregate of cash and non-cash interest expense recognized during the three months ended June 30, 2014 for Sigma Note 2 (which was funded in February 2014) and for which we recognized no interest expense during the corresponding period of the prior fiscal year.


Liquidity and Capital Resources


For the year ended September 30, 2013, we had a net loss of approximately $7.2 million, although cash provided by operating activities for that period was approximately $504,000. For the nine months ended June 30, 2014, we had a net loss of approximately $1.0 million, although cash provided by operating activities for that period was approximately $499,000. Although we had cash of approximately $600,000 at June 30, 2014, we had a working capital deficit of approximately $6.2 million at that date.


In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender”) under which we may presently borrow up to an aggregate of $2.0 million for working capital, collateralized by our accounts receivable and certain other related assets. Borrowings under the Line are subject to certain formulas with respect to the amount and aging of the underlying receivables. The outstanding balance (approximately $1.7 million as of June 30, 2014 and as of August 8, 2014) bears interest at 12.0% per annum, adjustable based on changes in prime, plus a weekly monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit.


Although the Line expired on December 27, 2013, we and the Lender have been actively working together to complete the documentation for the renewal of that Line and on January 13, 2014 we received a letter from the Lender confirming that they will be renewing the Line through December 31, 2015, with terms materially equivalent to the just expired Line. Those terms include a commitment fee, which is calculated as one percent (1%) per year of the maximum allowable borrowing amount and paid in annual installments. However, pending the formal renewal of the Line, we agreed in August 2014 to pay a commitment fee calculated on a pro-rata basis for eight months payable August 31, 2014 and a pro-rata monthly commitment fee thereafter.


The outstanding principal is due on demand in the event a payment default is uncured one (1) day after written notice. The outstanding principal balance due under the Line may be repaid by us at any time, and the term 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.


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”). The Covenant requires that the sum of (i) our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense and (ii) contributions to capital (less cash distributions and/or cash dividends paid during such period) and proceeds from subordinated unsecured debt, be equal to or greater than the sum of cash payments for interest and debt principal payments. We have complied with this Covenant for all applicable quarters through June 30, 2014.


The terms of the Line require that all funds remitted by our customers in payment of receivables be deposited directly to a bank account owned by the Lender. Once those deposited funds become available, the Lender is then required to immediately remit them to our bank account, provided that we are not in default under the Line and to the extent those funds exceed any past due principal, interest or other payments due under the Line, which the Lender may offset before remitting the balance.


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On March 21, 2013 (the “Sigma Closing”) we closed a transaction with Sigma Opportunity Fund II, LLC (“Sigma”), under which we would receive up to $800,000 pursuant to a senior secured note (“Sigma Note 1”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Thermo Credit and Rockridge. Sigma remitted $600,000 (net of certain fees and expenses discussed below) to us at the Sigma Closing, and the funding of the remaining $200,000 (“Contingent Financing”) was subject to us meeting certain revenue and operating cash flow targets for either the three months ended June 30, 2013 or the six months ended September 30, 2013, as well as making all scheduled principal and interest payments on our indebtedness to Sigma and our other lenders.

 

On June 14, 2013, Sigma Note 1 was amended to provide that we would receive immediate additional funding of $345,000, which would be in lieu of the $200,000 Contingent Financing. Furthermore, this $345,000 would be subject to the same terms as the Contingent Financing, in that it would be repayable as a balloon payment due on December 18, 2014 and prior to repayment, along with the previous balloon payment of $50,000 for a total balloon payment of $395,000, would be convertible into restricted common shares, at Sigma’s option, using a conversion rate of $1.00 per share.  After the amendment the total gross proceeds received under Sigma Note 1 was $945,000. Interest, computed at 17% per annum on the outstanding principal balance, was payable in monthly installments commencing April 30, 2013 and principal was payable in monthly installments commencing June 30, 2013. The required payments were made through November 30, 2013.

 

On February 28, 2014, the terms of Sigma Note 1 were amended so that principal and interest payments otherwise due on Sigma Note 1, starting with the December 31, 2013 payment and ending with the September 30, 2014 payment, were eliminated and replaced with monthly principal and interest payments on the last day of October and November 2014 plus a final principal and interest payment on the December 18, 2014 maturity date of Sigma Note 1. As of February 28, 2014, the outstanding principal balance under Sigma Note 1 was approximately $895,000 (including accrued interest made a part of that balance) and all other terms of the Sigma Note remain in effect. Interest at 17% per annum will continue to accrue on the outstanding principal balance (including the portion representing these eliminated principal and interest payments), compounding monthly and added to the respective note principal amount until paid. After giving effect to the February 28, 2014 modification, the payments due under Sigma Note 1 are as follows:


October 31, 2014

$50,000 principal plus $13,991 interest

November 30, 2014

$50,000 principal plus $13,282 interest

December 18, 2014

$887,599 principal  (including previously accrued interest made part of principal) plus $7,441 interest


Sigma Note 1 may be prepaid by us at any time, provided, however, that if Sigma Note 1 is prepaid during the twelve months immediately following the Sigma Closing, we shall pay an additional 90 days of interest on the then outstanding principal as of such prepayment date. If following the Sigma Closing we receive proceeds from the sale of a business unit and/or in connection with the issuance of additional equity, debt or convertible debt capital in the amounts listed in the table below, calculated on an aggregate basis subsequent to the Sigma Closing (“Aggregate Capital Raise”), we are required to immediately repay to Sigma the indicated amount (“Early Repayment Amount”), applied first toward repayment of interest and then toward principal.

 

Aggregate Capital Raise

Early Repayment Amount

$500,000 to $1,000,000

Lesser of outstanding principal plus interest or 25% of Capital Raise

$1,000,001 to $2,000,000

Lesser of outstanding principal plus interest or 50% of Capital Raise (reduced by any amounts previously repaid as a result of a Capital Raise transaction)

$2,000,001 or Higher

All outstanding principal plus Interest must be paid


 88


 

The Aggregate Capital Raise excludes (i) advances received by us against accounts receivable from Thermo Credit pursuant to the Line, or any successor agreement entered into on materially the same terms, (ii) up to $330,000 of additional subordinated financing obtained by us on materially the same as certain previously-agreed terms and (iii) the additional amounts received in June 2013 from Sigma.


In connection with the initial March 2013 financing, we issued 300,000 restricted common shares to Sigma and agreed to reimburse up to $30,000 of Sigma’s legal and other expenses related to this financing, $27,500 of which was paid by us at the Sigma Closing. We also issued 60,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and agreed to pay them a $75,000 advisory fee, in connection with an Advisory Services Agreement we entered into with Sigma Capital effective March 18, 2013. $55,000 of the cash fee was paid by us at the Sigma Closing and the remaining $20,000 was paid over the next four months.  We also paid finders and other fees to other third parties in connection with this transaction, which totaled 60,000 restricted common shares and $12,000 cash. In connection with the June 2013 amendment, we issued 325,000 restricted common shares to Sigma and made payments aggregating $45,000 to Sigma and Sigma Capital, representing an administrative fee plus reimbursement of Sigma’s other cost and expenses related to this financing. We also issued 125,000 restricted common shares to Sigma Capital.


Including the value of the common stock issued plus the amount of cash paid for related financing fees and expenses results in an effective interest rate of approximately 56% per annum (which was 60% per annum for the period prior to the June 2013 amendment). Effective February 28, 2014, a portion of the value of the common shares issued and the fees paid in connection with Sigma Note 2, aggregating $124,655, was allocated to Sigma Note 1 and that amount is being amortized as interest over the remaining term of Sigma Note 1. When combined with the amortization of the remaining unamortized discount arising from the initial March 2013 financing and the June 2013 amendment, the resulting effective interest rate as of February 28, 2014 is approximately 66% per annum, which would increase in the event an Early Repayment Amount was required, as discussed above.


For so long as Sigma Note 1 is outstanding, if at any time after the Sigma Closing we issue additional shares of common stock (other than as a result of common stock equivalents already issued prior to the Issuance Date) or common stock equivalents in an amount which exceeds, in the aggregate, 25% of our fully diluted shares (as defined) as of the Sigma Closing, whether through one or multiple issuances, then provided the proceeds of such issuance are not being used to pay all outstanding amounts owed under Sigma Note 1, we shall issue to Sigma and Sigma Capital, respectively, such number of shares of common stock as is necessary for Sigma and Sigma Capital to maintain the same beneficial ownership percentage of our capital stock, on a fully diluted basis, after the additional shares issuance as they had immediately before the additional shares issuance.  If, at the time of any additional share issuance, Sigma has not converted all or a portion of the amount of Sigma Note 1 eligible for conversion to common shares, we shall reserve for future issuance to Sigma upon any subsequent conversion, and shall issue to Sigma upon any subsequent conversion, such number of shares of common stock as to which Sigma would have been entitled hereunder had Sigma converted the unconverted amount immediately prior to the additional shares issuance. Notwithstanding the above, this provision shall only apply to beneficial ownership resulting from transactions related to Sigma Note 1 or the March 18, 2013 Advisory Services Agreement and shall not apply to our issuance of common stock or common stock equivalents in connection with our acquisition of another entity or the material portion of the assets of another entity, which transaction results in operating cash flow in excess of any related debt service.


We completed another transaction with Sigma on February 28, 2014, under which we borrowed $500,000 (from which were deducted certain fees and we repaid certain debt as discussed below) pursuant to a senior secured note (“Sigma Note 2”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Rockridge and Thermo Credit LLC. The $500,000 principal, plus $59,447 interest (based on 17% per annum compounding monthly), is due on October 31, 2014. Sigma shall have the right to convert Sigma Note 2 (including the accrued interest thereon), in its entirety or partially, and at its option, into our common shares at a price of $1.00 per share.


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In connection with the February 28, 2014 closing and funding of Sigma Note 2, we issued 350,000 restricted common shares to Sigma as well as reimbursed $11,354 of Sigma’s legal and other expenses related to this financing. In connection with a February 28, 2014 Advisory Services Agreement, we also issued 150,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and paid them a $167,857 advisory fee, of which $107,857 was withheld from the gross proceeds of Sigma Note 2 at the time of the February 28, 2014 funding to us and the $60,000 balance was paid in installments of $15,000 per month commencing April 1, 2014.  In accordance with the terms of the Sigma Note 2 financing, if by June 30, 2014 we had not signed a definitive agreement calling for receipt of funds in excess of $2.0 million as a result of the sale of all or a part of our operations or assets, we would be obligated to issue Sigma and Sigma Capital, in aggregate, another 300,000 restricted common shares plus pay Sigma Capital an additional cash fee of $100,000. Since those conditions were not met, on June 30, 2014 we recorded the issuance of those additional shares as well as a liability for the additional cash fee, which we paid in July 2014. The value of the common stock issued, plus the amount of cash paid for related financing fees and expenses, was reflected as a $124,655 discount against Sigma Note 1 and a $329,556 discount against Sigma Note 2 (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 115% per annum. This effective rate would increase in the event an early repayment was required, as discussed above.

 

Per the terms of the Sigma Note 2 financing, and prior to the termination as discussed below, Sigma and Sigma Capital had the joint right as of December 18, 2014 and for one year thereafter, to require us to purchase up to 1 million of our common shares held by them, at $0.25 per share (the “Sigma Put Right”). Our obligation under the Sigma Put Right was collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Thermo Credit and Rockridge. We issued Sigma and Sigma Capital an aggregate of 500,000 ONSM common shares on February 28, 2014, which resulted in total holdings by them at that date of 950,000 ONSM common shares, which they still held as of June 30, 2014. In addition, we have recorded the issuance of an additional 300,000 ONSM common shares to them as of June 30, 2014. Accordingly, our financial statements reflect an approximately $214,000 liability as of June 30, 2014, representing the present value of our potential $250,000 liability as of that date for the repurchase of 1 million common shares.

 

Effective August 13, 2014, Sigma and Sigma Capital agreed that the Sigma Put Right was terminated and as a result the related liability discussed above will be reversed by us, effective for our balance sheet as of September 30, 2014. In connection with such termination, we agreed that the right previously granted to us in connection with the Sigma Note 2 financing and extending through December 18, 2015, to purchase any and all of our common shares that were issued to Sigma and still held by them at the higher of (i) a 20% discount to the 15 trading day volume-weighted average share price (“VWAP”) or (ii) $0.25 per share, would also be terminated.  We also agreed to pay the expenses of Sigma and Sigma Capital, which we estimate will be $2,000, in connection with their private sale of the 1,250,000 ONSM common shares held by them.


Upon our receipt of funds in excess of $2.0 million as a result of the sale of any portion of our business, however structured, including, without limitation, sale of assets, subsidiaries or business units, and/or (ii) the issuance of additional equity, debt or convertible debt capital, and/or (iii) our consolidation or merger with or into another entity, all outstanding principal and interest with respect to Sigma Note 1 and/or Sigma Note 2 will be due.


The terms of the Sigma Note 2 required that we use at least $107,000 of the related proceeds to pay principal on our outstanding note (the “Rockridge Note”) due to Rockridge Capital Holdings, LLC (“Rockridge”), an entity controlled by one of our largest shareholders,.  Accordingly, on February 28, 2014 we made a principal payment of $119,615 (plus accrued interest), in exchange for Rockridge’s agreement that we would only be obligated to pay interest on a monthly basis until our repayment of the remaining outstanding principal of $400,000 on October 14, 2014. We also agreed to pay the outstanding principal plus any accrued interest upon our receipt of proceeds in excess of $5 million related to the sale of any of our business units or subsidiaries.


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In connection with the issuance of Sigma Note 2, an agreement was executed between Sigma and Rockridge, which included Rockridge’s agreement (along with our agreement) that Sigma has the right, but not the obligation, to repay the Rockridge Note at face value at any point after October 14, 2014, and always in case of a default on Sigma Note 1, Sigma Note 2 or the Rockridge Note. Such repayment amount would be added to the principal of Sigma Note 1, would accrue interest at 17% per annum and such amount plus accrued interest would be payable by us on December 18, 2014. In the event of such repayment by Sigma, Sigma would receive fees in cash and shares calculated on a pro-rata basis comparable to the terms of Sigma Note 2, based on the amount repaid to Rockridge and the amount of time the repaid debt would be unpaid by us after such repayment. For example, if $400,000 were repaid to Rockridge by Sigma on October 14, 2014, we would owe Sigma a fee of approximately $30,000 cash plus approximately 106,000 common shares.


The Rockridge Note is secured 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.


Upon notice from Rockridge at any time and from time to time prior to the Maturity Date, all or part of the outstanding principal amount of the Rockridge Note may be converted into a number of restricted shares of ONSM common stock. These 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 ONSM common stock for the twenty (20) days of trading on the OTCQB (or such other exchange or market on which ONSM common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share.  


The Note and Stock Purchase Agreement with Rockridge calls for our issuance of an origination fee, upon not less than sixty-one (61) days written notice to us, of 591,667 restricted shares of our common stock (the “Shares”). The value of those Shares is subject to a limited guaranty of no more than an additional payment by us of $75,000 which will be effective in the event the Shares are sold for an average share price less than the minimum of $1.20 per share (the “Shortfall Payment”). The $71,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, the required Shortfall Payment would be $75,000.


Including the fair market value of the Shares at the time they were recorded on our books, plus legal fees paid by us, the effective interest rate of the Rockridge Note was approximately 44.3% per annum, until a September 2009 amendment, when it was reduced to approximately 28.0% per annum, a December 2012 amendment, when it was increased to approximately 29.1% per annum, and the accrual of the Shortfall Payment, which increased it to approximately 31.1% per annum. Effective February 28, 2014, as a result of the inclusion of the remaining unamortized discount in a debt extinguishment loss, the effective rate was reduced to approximately 12% per annum. These rates do not give effect to any difference between the sum of the value of the Shares at the time of issuance plus the Shortfall Payment, as compared to the recorded value of the Shares on our books, nor do they give effect to the variance between the conversion price versus market prices that might be applicable if any portion of the principal is satisfied with common shares issued upon conversion instead of cash.


As of June 30, 2014, we were obligated for $200,000 under an unsecured subordinated note issued on March 19, 2013 to Fuse Capital LLC (“Fuse”) (the “Fuse Note”). The Fuse Note, which is convertible into restricted common shares at Fuse’s option using a rate of $0.50 per share, is payable on March 19, 2015, with interest at 12% per annum payable on a monthly basis.


 

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In connection with the original issuance of the Fuse Note, we issued Fuse 80,000 restricted common shares (the “Fuse Common Stock”), which we agreed to buy back under the following terms: If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 40,000 shares of the originally issued Fuse Common Stock from Fuse at $0.40 per share. If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 80,000 shares of the originally issued Fuse Common Stock, less the amount of any shares already bought back at the one year point, from Fuse at $0.40 per share. The above only applies to the extent the Fuse Common Stock is still held by Fuse at the applicable dates. The $26,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $32,000 would be required.


In connection with the original issuance of the Fuse Note, we also issued 40,000 restricted common shares to another third party for finder and other fees. Including the value of the Fuse Common Stock plus the value of the common stock issued for related financing fees (but excluding a portion of this amount written off as a debt extinguishment loss as a result of the modification, by virtue of its inclusion in the Fuse Note, of a predecessor note) results in an effective interest rate of approximately 19% per annum.


During October and November 2013 we obtained aggregate net financing proceeds of approximately $246,000 from the issuance of partially secured promissory notes to three investors (the “Working Capital Notes”), with an initial aggregate outstanding balance of $620,000 bearing interest at 15% per annum. The proceeds of the Working Capital Notes were used to repay (i) $126,000 outstanding principal and interest due on the CCJ Note issued by us on December 31, 2012, (ii) $71,812 outstanding principal and interest due on a Subordinated Note issued by us on June 1, 2012 and (iii) $26,000 outstanding principal and interest due on an Investor Note issued by us on January 2, 2013. In addition, $125,000 in origination fees and $25,000 for a Funding Commitment Letter (discussed below) were deducted from the proceeds of the Working Capital Notes.

Working Capital Note payments are interest only during the first six months (in two quarterly payments), approximately 50% of the principal in equal monthly payments plus interest during the next eleven months and the remaining 50% of the principal balance due eighteen months after the Working Capital Note issuance date. In the event that we receive funds in excess of $5 million as a result of a single transaction for the sale of all or a part of our operations or assets, the Working Capital Notes are payable in full within ten (10) days of our receipt of such funds, along with any interest due at that time.

The Working Capital Notes are expressly subordinated to the following notes issued by us and outstanding at the time of the issuance of the Working Capital Notes: Thermo Credit LLC, Rockridge Capital Holdings LLC, Sigma Opportunity Fund II, LLC, USAC, and certain capital leases (HP Financial and Tamco), or any assignees or successors thereto, subject to a cumulative maximum outstanding balance of $3.9 million. The Working Capital Notes are secured by a limited claim to our assets, pari passu with up to $775,000 of total indebtedness and related obligations raised and incurred by us during the first quarter of fiscal 2014, subject to all prior liens of the foregoing entities and limited to the extent such a lien is allowable by the terms of the loan documents executed between us and the foregoing entities.

In connection with the above financing, we issued to the holders of Working Capital Notes an aggregate of 358,334 restricted common shares (the “Working Capital Shares”), which we have agreed to buy back, to the extent permitted by law, from the holder for $0.30 per share on the maturity dates of the Working Capital Notes, if the fair market value is less than that on that date. The above only applies to the extent the Working Capital Shares are still held by the noteholder on the applicable date and the buyback obligation only applies if the noteholder gives us notice and delivers the shares within fifteen days after the applicable maturity dates. The $81,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $107,500 would be required.


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The fair market value at the time of issuance of the Working Capital Shares, plus 100,000 finders agreement shares we also issued, plus the cash deducted from the proceeds for related origination fees, was $258,260. $88,807 of this amount was reflected as a non-cash debt extinguishment loss. The remainder of $169,453 was reflected as a discount against the Working Capital Notes (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the notes, resulting in a weighted average effective interest rate of approximately 33.2% per annum. This effective rate would increase in the event an early repayment was required, as discussed above.

As of June 30, 2014, we were obligated for $250,000 under unsecured subordinated notes issued to various lenders from April 2012 through January 2013, which are fully subordinated to the Line and the Rockridge Note. These notes bear cash interest at rates ranging from 12% to 20% per annum and, after allowing for modifications made in January 2014 to the terms of certain of these notes, are due in October 2014. Including the value of common shares issued to the various lenders in connection with these notes results in effective interest rates ranging from approximately 21% to 71% per annum.

As of June 30, 2014, we were obligated for $625,000 outstanding principal on unsecured subordinated notes issued in November 2012 to various lenders, which are fully subordinated to the Line and the Rockridge Note. These notes bear cash interest at 12% per annum. Note payments are interest only during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year. During the third quarter of fiscal 2014, three of these notes representing an aggregate of $290,000 principal were amended to provide that the principal balance would not be payable until the November 30, 2014 maturity date, although interest would continue to be payable on a monthly basis.


One of the above notes, held by Fuse and having a $200,000 outstanding principal balance, is convertible into restricted common shares at Fuse’s option using a rate of $0.50 per share. Including the value of common shares issued to the various lenders in connection with these notes results in effective interest rates ranging from approximately 26% to 43% per annum, except that the effective interest rate of the note held by Fuse is 12% per annum, after the write-off of a portion of the value of these common shares as a debt extinguishment loss, arising from the March 2013 modification of the note held by Fuse to add the conversion feature.


In connection with the initial issuance of the above notes, we issued to the holders of the certain of those notes having an initial outstanding balance of $450,000 an aggregate of 180,000 restricted common shares, which we have agreed to buy back, under certain terms. If the fair market value of the stock is not equal to at least $0.40 per share on the final maturity date two (2) years after issuance, we will buy back, to the extent permitted by law, those shares of the originally issued common stock from the investor at $0.40 per share. This only applies to the extent the stock is still held by the investor(s) at the applicable date and only if the investor gives us notice and delivers the shares within fifteen days after the final maturity date. The $58,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share as of August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $72,000 would be required.


In connection with the initial issuance of the above notes, we issued to the holders of certain of those notes having an initial outstanding balance of $200,000 an aggregate of 240,000 restricted common shares, of which we have agreed to buy back up to 35,000 shares, under certain terms. If the fair market value of the stock is not equal to at least $0.80 per share on the final maturity date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 35,000 shares of the originally issued stock from the investor at $0.80 per share. The above only applies to the extent the stock is still held by the investor(s) at the applicable date and only if the investor gives us notice and delivers the shares within fifteen days after the final maturity date. The $25,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share as of August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $28,000 would be required.

 

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On June 30, 2014 we were obligated for $110,510 under a letter agreement promissory note with the Universal Service Administrative Company (“USAC”), payable in monthly installments of $19,075 through December 15, 2014 (the “USAC Note”). These payments include interest at 12.75% per annum. This letter agreement promissory note is related to our liability for Universal Service Fund (USF) contribution payments previously reflected as an accrued liability on our balance sheet and therefore resulted in the reclassification of a portion of that accrued liability to notes payable. USAC is a not-for-profit corporation designated by the Federal Communications Commission (“FCC”) as the administrator of the USF program.


Although they were repaid on March 21, 2013, the terms of the Equipment Notes still provided that on the maturity dates (as established in the December 12, 2012 modification), the Recognized Value of the shares issued as part of such repayment would be calculated as the sum of the following two items – (i) the gross proceeds to the Investors from the sales of the 583,334 shares issued per the December 12, 2012 modification plus (ii) the value of those shares issued and still held by the Noteholders and not sold, using the average ONSM closing bid price per share for the ten (10) trading days prior to the applicable maturity date. If the Recognized Value exceeded the Credited Value, then we would receive 50% (fifty percent) of such excess, although the amount received by us shall not exceed $175,000. If the Credited Value exceeded the Recognized Value, then we would be obligated to pay such excess to the Noteholders. With respect to Equipment Notes held by one of the three Noteholders, the Credited Value exceeded the Recognized Value for 166,667 common shares by approximately $16,000 as of the respective November 15, 2013 maturity date. We recorded no accrual for this matter on our financial statements as of September 30, 2013, based on the immateriality of a $5,000 liability, if calculated based on the September 30, 2013 ONSM closing price of $0.27 per share. However, we recognized the actual liability of approximately $16,000 as of June 30, 2014 and as interest expense for the nine months then ended (zero for the three months then ended).


In connection with financing obtained by us in October and November 2013 from the other two Noteholders (see “Working Capital Notes” above), the above terms with respect to settlement of differences between the Credited Value and the Recognized Value were replaced with our agreement to buy back, to the extent permitted by law, the 416,667 common shares issued to those Noteholders, if the fair market value of the shares are not equal to at least $0.30 per share on the maturity dates of the October and November 2013 financing, which are April 24 and May 4, 2015, respectively. The above only applies to the extent the shares are still held by the Noteholders on the applicable date and the buyback obligation only applies if the Noteholders give us notice within fifteen days after the applicable maturity dates of the October and November 2013 financing. The $96,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share as of August 8, 2014 was used as a basis of calculation, a stock repurchase payment of $125,000 would be required.


Furthermore, we have agreed that in the event we receive funds in excess of $5 million as a result of a single transaction for the sale of all or a part of our operations or assets, that those funds will be available to satisfy the above buyback obligation, such availability subject only to prior satisfaction of any claims held by Thermo Credit LLC, Rockridge Capital Holdings LLC, Sigma Opportunity Fund II, LLC, USAC, and certain capital leases (HP Financial and Tamco), or any assignees or successors thereto and pari passu with up to $775,000 of total indebtedness and related obligations raised and incurred by us during the first quarter of fiscal 2014. In addition, we agreed that to the extent the number of outstanding shares of our common stock exceeds 22 million shares, then we will issue the Noteholders additional shares of common stock equal to seventy-six hundredths percent (0.76%, or 0.0076) of the excess over 22 million, times the percentage of the original 416,667 common shares still held by the Noteholders on the six and twelve month anniversary dates of the October and November 2013 financing, as well as the eighteen month maturity date. For clarity, additional issuances based on any particular increase in the number of our outstanding shares over the stated limit will only be made once and so additional issuances on the second and third dates will be limited and related to increases since the first and second dates, respectively.


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In December 2012, as part of a transaction under which J&C Resources issued us a funding commitment letter, we agreed to reimburse CCJ in cash the shortfall, payable on December 31, 2014, as compared to minimum guaranteed net proceeds of $175,000, from their resale of 437,500 common shares CCJ received on December 31, 2012 upon their conversion of 17,500 shares of Series A-13 and after effecting our agreement as part of the same transaction to reduce the conversion rate on all Series A-13 shares from $1.72 per common share to $0.40 per common share. We recorded an estimated shortfall liability of $43,750 and amortized that amount to interest expense over the one-year term of the funding commitment ending December 31, 2013 (approximately $11,000 for the three months then ended). Based on the closing ONSM price of $0.30 per share on December 31, 2013, we determined that there was no material difference between the present value of this obligation and the accrued liability recorded by us. However, based on the closing ONSM price of $0.20 per share as of June 30, 2014, the gross proceeds would be approximately $88,000 and the shortfall would be approximately $87,000. Therefore, we increased the $43,750 liability initially recorded by us by recognizing approximately $32,000 of interest expense for the six months ended June 30, 2014  which resulted in an approximately $76,000 liability on our financial statements as of that date, representing the present value of this obligation. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, the gross proceeds would be approximately $79,000 and the shortfall would be approximately $96,000.


After annual increases in prior years as set forth in the employment agreements, the contractual annual base salaries for the five Executives in aggregate are approximately $1.6 million, subject to a five percent (5%)  increase on September 27, 2014 and each year thereafter – a portion of these contractual salaries are presently not being paid to the Executives and we are accruing these unpaid amounts as non-cash compensation expense, with the unpaid portion reflected as an accrued liability under the balance sheet caption “Amounts due to executives and officers”. Effective October 1, 2009, in response to our operating cash requirements, the base salary amounts being paid to the Executives were adjusted to be 10% less than the contractual amounts. In addition, until certain actions as discussed below, the amounts representing the subsequent contractual annual increases to those base salary amounts were not paid.  Effective September 16, 2012, the base salary amounts being paid to the Executives were reinstated by an amount representing approximately 7.8% of the contractual base salary at that time. As of August 8, 2014, the base salary payments to the Executives are 18.6% less than the contractual base salaries, compared to the 10% reduction instituted in October 2009 and which reduction was initially company-wide but no longer affects a majority of our other employees. A second reinstatement to the Executives, representing approximately 4.5% of the contractual base salary at that time, was approved since January 1, 2013, although as of August 8, 2014, and in recognition of our cash requirements, the second reinstatement has not been implemented. Under the terms of the 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 (3) times the Executive’s base salary plus full benefits for a period of the lesser of (i) three (3) years from the date of termination or (ii) the date of termination until a date one (1) year after the end of the initial employment contract term.


In consideration of the waiver and satisfaction of any remaining unpaid salary due to the Executives through December 31, 2012 under their employment agreements, as well as the waiver and satisfaction of any remaining unpaid amounts due to certain of those Executives in connection with the acquisition of Acquired Onstream, we (as authorized by our Board of Directors) and the Executives agreed, effective January 22, 2013, (i) to pay $100,000 ($20,000 per Executive) of the withheld compensation in cash and (ii) to issue 1,700,000 (340,000 per Executive) fully vested ONSM common shares, subject to certain trading restrictions (the “Executive Shares”).


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As of August 8, 2014, the Executive Shares have not been issued, due to certain administrative and documentation requirements, nor has the $100,000 in cash been paid. However, since the Executive Shares were committed to be issued by the January 22, 2013 action of the Board, that issuance was reflected in our financial statements as of the date of such commitment.


To the extent there is any shortfall from the gross proceeds upon resale by the Executives of the Executive Shares as compared to twenty-nine cents ($0.29) per share, the shortfall will be reimbursed to the Executives by us in cash, or at our option, by the issuance of additional fully vested ONSM common shares (the “Additional Executive Shares”), with the Additional Executive Shares subject to reimbursement by us to the Executives of any shortfall from the gross proceeds upon resale as compared to the fair value used to determine the number of such Additional Executive Shares. All shortfall reimbursements shall be payable by us within ten (10) business days after presentation by reasonable supporting documentation of the shortfall to us by the Executives. The $153,000 present value of this obligation is recorded as a liability on our financial statements as of June 30, 2014. If the closing ONSM share price of $0.18 per share on August 8, 2014 was used as a basis of calculation, our obligation for this shortfall payment would be $187,000, or the equivalent in common shares.


On February 20, 2013, we (as authorized by our Board of Directors) and the Executives agreed to certain changes in the Executives’ employment agreements, which among other things included the implementation of an executive incentive compensation plan (the “Executive Incentive Plan”). Compensation under the Executive Incentive Plan would be in the form of Fully Restricted (as defined below) ONSM common Plan shares (“Executive Incentive Shares”) and is based on the Company achieving certain financial objectives as follows for each of the fiscal years 2014 and 2015:

·

Increased revenues (as compared to the respective prior year).

·

Positive operating cash flow (as defined in the Executive Incentive Plan).

·

EBITDA, as adjusted, (as defined in the Executive Incentive Plan) for at least two quarters.


Accomplishment of the objectives for fiscal 2014 and fiscal 2015 would result in an aggregate of 625,000 Executive Incentive Shares issued to the Executives as a group for each of those two years. A lesser amount of Executive Incentive Shares would be issuable for achievement for only one or two of the three objectives set for each year. With respect to fiscal 2014, the Executives have earned an aggregate of 250,000 Executive Incentive Shares for meeting the objective of achieving positive EBITDA, as adjusted, for at least two quarters (the first and second fiscal quarters). Accordingly, those shares have been recorded on our financial statements and reflected as non-cash compensation expense of $52,500 for the nine and three months ended June 30, 2014, based on their fair value of $0.21 per share as of May 20, 2014, the date it was conclusively determined that the objective had been met and the shares had been earned. Also with respect to fiscal 2014, we have determined that it is probable that the Executives will earn an additional aggregate of 250,000 Executive Incentive Shares for meeting the objective of achieving positive operating cash flow (as defined in the Executive Incentive Plan) for fiscal 2014. Accordingly, those shares have been recorded on our financial statements in the amount of $45,000, based on their fair value of $0.18 per share as of August 8, 2014, the date it was conclusively determined that it was probable the objective would be met and the shares would be earned. This amount will be reflected as non-cash compensation expense over the remaining term of service, which is $22,500 during the nine and three months ended June 30, 2014 and the balance during the three months ending September 30, 2014. As of June 30, 2014 the potential issuance of the shares related to the other 2014 objective has not been reflected on our financial statements, since based on the fiscal year 2014 financial results to date the issuance of these shares is not considered probable.


The Executive Incentive Shares are subject to a complete restriction on the Executive’s ability to access or transact in any way such shares until the restriction is lifted. Upon a change of control, termination of the Executive’s employment or the imminently proposed and/or anticipated sale of the Company at a price of $1.00 per common share or more, all restrictions on the Executive Incentive Shares and any other common shares held by the Executives will be lifted. In the case of a sale, all restrictions will be lifted in time for those previously restricted shares to participate in all voting with respect to the proposed sale and will be eligible, at the Executive’s option, for inclusion as part of the shares sold in that transaction. Due to the restrictions on the Executive Incentive Shares, we have determined that the issuance thereof will not result in taxable compensation income to the Executives (or tax deductible compensation expense to the Company) until such restrictions have been lifted.


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As of June 30, 2014, we were obligated under operating leases for six office locations (one each in Pompano Beach, Florida, San Francisco, California, San Diego, California and Colorado Springs, Colorado and two in the New York City area), which call for monthly payments totaling approximately $61,000. The leases have expiration dates ranging from 2014 to 2018 (after considering our rights of termination) and in most cases provide for renewal options. The future minimum lease payments required under the non-cancelable operating leases total approximately $1.8 million through June 30, 2019, of which approximately $640,000 relates to the year ending June 30, 2015.


We have entered into various agreements for our purchase of Internet, long distance and other connectivity as well as use of the co-location facilities discussed above, for an aggregate remaining minimum purchase commitment of approximately $1.6 million, approximately $1.5 million of that commitment related to the one year period ending June 2015 and the balance of such commitment related to the period from June 2015 through August 2017.


Projected capital expenditures for the year ending June 30, 2015 total approximately $800,000, which includes software and hardware upgrades to the webcasting platform (including VW4 and iEncode), the DMSP and the audio and web conferencing infrastructure. Some of these projected capital expenditures may be financed, deferred past the twelve month period or cancelled entirely, depending on our other cash flow considerations.

 

During the period from June 2013 through January 2014 we made certain headcount reductions representing approximately $1.1 million in annualized savings, which we expect will reduce our compensation expenditures by approximately $199,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our compensation expenditures by approximately $159,000 in aggregate for the first seven months of fiscal 2015 as compared to the corresponding prior year period. Effective June 2014, we also renegotiated a supplier contract representing approximately $252,000 in annualized savings, which we expect will cumulatively reduce our cost of sales by approximately $63,000 for the remaining three months of fiscal 2014 as compared to the corresponding prior year period and which we expect will reduce our cost of sales by approximately $168,000 in aggregate for the first eight months of fiscal 2015 as compared to the corresponding prior year period.

 

On February 6, 2014, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”), agreeing to provide us, within twenty (20) days after our notice on or before December 31, 2014, aggregate cash funding of up to $800,000. Mr. Charles Johnston, a former ONSM director, 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. 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, 2015 and (b) 7.5 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 funds in excess of $5.0 million as a result of a single transaction for the sale of all or a part of its operations or assets, this Funding Letter will be terminated.


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We have incurred losses since our inception, and have an accumulated deficit of approximately $139.8 million as of June 30, 2014. Our operations have been financed primarily through the issuance of equity and debt, including convertible debt and debt combined with the issuance of equity. During the nine months ended June 30, 2014, our revenues were not sufficient to fund our total cash expenditures (operating, capital and debt service) and as a result we obtained additional funding from the Working Capital Notes and Sigma Note 2 and we also restructured the payment terms of Sigma Note 1 and certain other notes, as discussed above. However, primarily because of our expectations with respect to our recent and anticipated introductions of several new or enhanced products, we expect to achieve revenue growth in the fourth quarter of fiscal 2014 as well as fiscal 2015, as compared to corresponding prior year periods. However, in the event we are unable to achieve the necessary revenue increases to fund our total cash expenditures, we believe that identified decreases in our current level of expenditures that we have already planned to implement or could implement (in addition to the already implemented cost savings discussed above and including a significant reduction in our software development costs and capital equipment purchases) and the raising of additional capital in the form of debt and/or equity and/or the sales of assets or operations would be sufficient to fund our operations through June 30, 2015. 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. The Executives have agreed to defer a portion of their compensation in the past, to the extent we needed that cash to meet other operating expenses and, in the event of extremely critical or urgent requirements in the future, are expected to continue to do so.


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 and/or that we will be able to borrow further funds other than under the Line or the Funding Letter and/or that we will be able to sell assets or operations and/or that we will be able to 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.


Cash required to fund our continued operations will be affected by numerous known and unknown risks and uncertainties including, but not limited to, our ability to successfully market and sell our products and services, the degree to which competitive products and services are introduced to the market, our ability to control and/or reduce expenses, our need to invest in new equipment and/or technology, and our ability to service and/or refinance our existing debt and accounts payable. We cannot assure that our revenues will continue at their present levels, nor can we assure that they will not decrease.


To the extent our cash flow from sales is insufficient to completely fund operating expenses, financing costs (including principal repayments) and capital expenditures, as well as any acceleration of our repayments of accounts payable and/or accrued liabilities, we will continue depleting our cash and other financial resources. Other than working capital which may become available to us from further borrowing or sales of equity or assets or operations (including but not limited to proceeds from the Line or the Funding Letter, as discussed above), we do not presently have any additional sources of working capital other than cash on hand and cash, if any, generated from operations. As a result of the uncertainty as to our available working capital over the upcoming months, we may be required to delay or cancel certain of the projected capital expenditures, some of the planned marketing expenditures, or other planned expenses. In addition, it is possible that we will need to seek additional capital through equity and/or debt financing or through other activities.  If we raise additional capital through the issuance of debt, this will result in increased interest expense. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our company held by existing shareholders will be reduced and those shareholders may experience significant dilution.


The resolution of debt and other obligations becoming due within the twelve months ended June 30, 2015 (the end of the one year time frame on which our liquidity analysis and conclusions above were based), and in particular those becoming due during October through December 2014, represents a future unknown contingency.


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Our cash balance increased by approximately $343,000 during the nine months ended June 30, 2014. This was the result of approximately $499,000 provided by operating activities and approximately $270,000 provided by financing activities, partially offset by approximately $426,000 used in investing activities.


Cash provided by operating activities of approximately $499,000 for the nine months ended June 30, 2014, represents an approximately $115,000 increase in cash provided as compared to approximately $383,000 cash provided by operating activities for the corresponding period of the prior fiscal year. The approximately $499,000 cash provided by operating activities for the nine months ended June 30, 2014 reflects (i) our net loss of approximately $1.0 million, reduced by approximately $2.1 million of non-cash expenses included in that loss, offset by a non-cash gain on litigation settlement of approximately $742,000 and resulting in net cash provided by operating activities before changes in current assets and liabilities other than cash of approximately $376,000 and (ii) an approximately $123,000 net decrease in non-cash working capital items. The primary non-cash expenses included in our loss for the nine months ended June 30, 2014 were approximately $723,000 of amortization of discount on notes payable and convertible debentures, approximately $663,000 of depreciation and amortization and approximately $417,000 of compensation expenses paid with common shares and other equity. The approximately $123,000 net decrease in non-cash working capital items for the nine months ended June 30, 2014 is primarily due to an approximately $411,000 increase in accounts payable, accrued liabilities and amounts due to directors and officers, partially offset by an approximately $171,000 increase in accounts receivable and an approximately $81,000 increase in prepaid expenses. The approximately $123,000 net decrease in non-cash working capital items was approximately $377,000 less than the net decrease in non-cash working capital items of approximately $500,000 for the corresponding period of the prior fiscal year. The primary sources of cash inflows from operations are from receivables collected from sales to customers.  


Cash used in investing activities was approximately $426,000 for the nine months ended June 30, 2014 as compared to approximately $1.4 million cash used in investing activities for the corresponding period of the prior fiscal year. Current period investing activities related to the acquisition of property and equipment, including capitalized software development costs. Prior period investing activities related primarily to the November 30, 2012 Intella2 acquisition as well as the acquisition of property and equipment, including capitalized software development costs.


Cash provided by financing activities was approximately $270,000 for the nine months ended June 30, 2014 as compared to approximately $1.0 million cash provided by financing activities for the corresponding period of the prior fiscal year. Current year period financing activities, as well as those in the comparable prior year period, primarily related to proceeds from notes payable, partially offset by repayments of notes and leases payable. Most of the cash provided by financing activities for the nine months ended June 30, 2013, excluding accounts receivable based borrowing and repayment activity under the Line, was associated specifically or generally with the November 30, 2012 Intella2 acquisition.


Critical Accounting Policies and Estimates


Our consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”) and our significant accounting policies are described in Note 1 to those statements.  The preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying footnotes.  Our assumptions are based on historical experiences and changes in the business environment.  However, actual results may differ from estimates under different conditions, sometimes materially.  Critical accounting policies and estimates are defined as those that are most important to the management’s most subjective judgments. Our most critical accounting policies and estimates are described below.


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Goodwill and Other Intangible Assets:


Our prior acquisitions of several businesses, including Infinite Conferencing, Intella2, EDNet and Acquired Onstream, have resulted in significant increases in goodwill and other intangible assets. Goodwill and other unamortized intangible assets, which include acquired customer lists, were approximately $8.9 million at June 30, 2014, representing approximately 63% of our total assets and approximately 187% of the book value of shareholder equity. In addition, property and equipment as of June 30, 2014 includes approximately $1.4 million (net of depreciation) primarily related to the capitalized development costs of the DMSP and Webcasting/iEncode platforms, representing approximately 10% of our total assets and approximately 29% of the book value of shareholder equity.


In accordance with GAAP, we periodically test these assets for potential impairment.  As part of our testing, we rely on both historical operating performance as well as anticipated future operating performance of the entities that have generated these intangibles.  Factors that could indicate potential impairment include a significant change in projected operating results and cash flow, a new technology developed and other external market factors that may affect our customer base.  We will continue to monitor our intangible assets and our overall business environment. If there is a material adverse and ongoing change in our business operations (or if an adverse change initially considered temporary is determined to be ongoing), the value of our intangible assets could decrease significantly. In the event that it is determined that we will be unable to successfully market or sell any of our services, an impairment charge to our statement of operations could result. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition and results of operations.


In accordance with ASC Topic 350, Intangibles – Goodwill and Other, which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, goodwill must be tested for impairment on a periodic basis, at a level of reporting referred to as a reporting unit. Although other intangible assets are being amortized to expense over their estimated useful lives, the unamortized balances are still subject to review and adjustment for impairment. There is a two-step process for impairment testing of goodwill 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.


The provisions of ASC 350-20-35-3 in certain cases would allow us to forego the two-step impairment testing process based on certain qualitative evaluation.  However, based on our assessment as of September 30, 2013 of relevant events and circumstances as listed in ASC 350-20-35-3C, we determined that we were not eligible to employ qualitative evaluation to forego the two-step impairment testing process with respect to our reporting units as of September 30, 2013, as it was not more likely than not that impairment loss had not occurred. These relevant events and circumstances included certain macroeconomic conditions, including access to capital and the ongoing decrease in the ONSM share price.


The material portion of our goodwill and other intangible assets are contained in the EDNet reporting unit, the Acquired Onstream/DMSP reporting unit and the audio and web conferencing reporting unit, which includes the Infinite Conferencing and the OCC/Intella2 divisions. Our reporting units were identified based on the requirements of ASC 350-20-35-33 through 350-20-35-46. According to ASC 350-20-35-34, a component of an operating segment is a reporting unit if that component represents a business for which discrete financial information is available and segment management regularly reviews the operating results of that component. This is the case for the EDNet division, the Acquired Onstream/DMSP division, the Infinite Conferencing division and the OCC/Intella2 division. However, ASC 350-20-35-35 provides that two or more components of an operating segment shall be aggregated and deemed a single reporting unit if the components have similar economic characteristics. This is the case for the Infinite Conferencing division and the OCC/Intella2 division, since they are both in the business of audio and web conferencing sold primarily to business customers. Although EDNet is in the same operating segment as the Infinite Conferencing division and the OCC/Intella2 division, it is not considered to be part of the audio and web conferencing reporting unit since EDNet offers a specialized telephone service to the entertainment industry (movies, television, advertising) that also uses a specific type of phone line (ISDN) that is different from the standard telephone lines used by the Infinite Conferencing division and the OCC/Intella2 division.


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As part of the two-step process discussed above, our management performed discounted cash flow (“DCF”) analyses to determine whether the goodwill of our reporting units was potentially impaired and the amount of such impairment. Our management determined the rates and assumptions, including the discount rates and the probability of future revenues and costs, used by it to perform these analyses and also considered macroeconomic and other conditions such as: our credit rating, stock price and access to capital; a decline in market-dependent multiples in absolute terms; telecommunications industry growth projections; internet industry growth projections; entertainment industry growth projections (re EDNet customer base); our historical sales trends and our technological accomplishments compared to our peer group.

We analyzed our corporate payroll and other costs to determine their relevance to the reporting units, and to the extent relevant, we allocated such costs when preparing the projections used by us in the above analyses. We determined that approximately 72% of our corporate costs (excluding non-cash expenses) were allocable to our reporting units, including those without goodwill or other intangible assets. The non-allocable corporate costs related to various public company related requirements and expenses as well as the costs of evaluating new business opportunities and products outside the existing divisions.


Based on these evaluations, we determined that it was more likely than not that the fair values of the EDNet and Acquired Onstream reporting units were more than their respective carrying amounts as of September 30, 2013 since the carrying value of the each of those reporting units (after reduction for interest-bearing debt) was less than or not material different than the result of the respective DCF analysis. However, we were unable to arrive at the same conclusion as a result of our evaluation of the audio and web conferencing reporting unit, since the carrying value exceeded the results of the DCF analysis (after reduction for interest-bearing debt) for that reporting unit.


Accordingly, we performed further calculations in order to determine the amount of the impairment of the goodwill of the audio and web conferencing reporting unit and determined that the carrying value of the audio and web conferencing reporting unit exceeded the results of the DCF analysis (after reductions for interest bearing debt and for an allocation of that amount to recognize an increase in the recorded value of the audio and web conferencing reporting unit customer lists to an updated fair value) for that reporting unit by approximately $2.2 million. Accordingly, this difference was the amount by which the goodwill of the audio and web conferencing reporting unit was impaired as of September 30, 2013, and a $2.2 million adjustment was made to reduce the carrying value of the audio and web conferencing reporting unit’s goodwill as of that date. This adjustment was further allocated to our Infinite division. The increase in the recorded value of the audio and web conferencing reporting unit customer lists to an updated fair value as discussed above was not reflected on our books, since in accordance with GAAP that calculation is solely for purposes of determining impairment of goodwill and is not for the purpose of adjusting the carrying value of other intangible assets.


In order to address whether any further consideration of ONSM’s share price was needed with respect to impairment testing, we performed an analysis to compare our book value (after the impairment adjustment for the audio and web conferencing reporting unit discussed above) to our market capitalization as of September 30, 2013, including adjustments for (i) paid-for but not issued common shares, such as the Rockridge Shares and the Executive Shares and (ii) an appropriate control premium. Based on this analysis, we concluded that there were no conditions with respect to our market capitalization as of September 30, 2013 which would require further evaluation with respect to the carrying values of our reporting units.   


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An annual impairment review of our goodwill and other acquisition-related intangible assets will be performed as part of preparing our September 30, 2014 financial statements. Until that time, we are reviewing certain factors to determine whether a triggering event has occurred that would require an interim impairment review. Those factors include, but are not limited to, 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 and the market price of our common stock. Since the July 2014 litigation settlement discussed above resulted in the discontinuance of a significant portion of the business acquired by us from Intella2, we considered that to be a “triggering event” that would require us to make an interim review of the carrying value of the goodwill of the audio and web conferencing reporting unit (which includes the Intella2 goodwill) as of June 30, 2014. Accordingly, we updated five-year projections that were used in the DCF analysis prepared for the review of the goodwill of the audio and web conferencing reporting unit as of September 30, 2013, taking into account the impact of the litigation settlement as well as other changes since those projections were initially prepared. Based on our determination that the updated projections resulted in anticipated cash flow materially equal to or greater than the initial projections, we concluded that no further evaluation or adjustment with respect to the carrying value of the goodwill of the audio and web conferencing reporting unit was necessary as of June 30, 2014.


Although the closing ONSM share price declined from $0.27 per share at September 30, 2013 to $0.20 per share as of June 30, 2014, the comparison of our book value to our market capitalization as of June 30, 2014, including adjustments for (i) paid-for but not issued common shares, such as the Rockridge Shares (see note 4) and the Executive Shares (see note 5) and (ii) an appropriate control premium, supported our conclusion that there were no conditions with respect to our market capitalization as of June 30, 2014 which would require further evaluation with respect to the carrying values of our reporting units. The closing ONSM share price was $0.18 per share on August 8, 2014.


EDNet’s operations are heavily dependent on the use of ISDN phone lines (“ISDN”), which are only available from a limited number of suppliers. The two telecommunication companies which are the primary suppliers of ISDN to EDNet have made recent public indications of intentions to restrict, or even eventually eliminate, their provision of ISDN. Such actions could have a significant adverse impact on our future evaluations of the carrying value of EDNet goodwill, especially if alternative ISDN suppliers cannot be identified or if an alternative such as Internet based technology is not available or economically feasible as a basis to continue the EDNet operations. However, these two companies have not announced definitive timetables for taking any extensive actions with regard to restricting ISDN and therefore we have not assumed any such actions would take place within the timeframe of our discounted cash flow analyses used by us for these evaluations to date.


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ITEM 4T.

 CONTROLS AND PROCEDURES


Management’s report on disclosure controls and procedures:


Our management, with the participation of our Chief Executive Officer and our Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2014. The term “disclosure controls and procedures,” as defined in Rules 13a – 15(e) and 15d – 15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act, is recorded, processed, summarized, and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer concluded that, as of June 30, 2014, our disclosure controls and procedures were not effective at the reasonable assurance level.


Management’s report on internal control over financial reporting:


Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15 promulgated under the 1934 Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated Framework (“COSO”). Based on our evaluation under the COSO framework, management has concluded that, as of June 30, 2014, our internal control over financial reporting was not effective at the reasonable assurance level.

Our internal control system is designated to provide reasonable assurance to our management and Board of Directors regarding the preparation and fair presentation of published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Our management has worked, and continues to work, to strengthen our internal control over financial reporting. We are committed to ensuring that such controls are operating effectively. Since identifying the material weakness in our internal control over financial reporting, we are working to enhance the design and operation of our controls by improving our controls and documentation related to our accounting policies and practices to identify, document and periodically assess whether all key judgments, conventions and estimates used conform to U.S. GAAP.

Changes in Internal Control over Financial Reporting:


Except as noted above, there were no changes in our internal control over financial reporting during the most recent fiscal quarter ended June 30, 2014  that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.


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PART II - OTHER INFORMATION


Item 1. Legal Proceedings


On November 26, 2013, Intella2 and its owner Paul Cohen filed a civil lawsuit in Florida naming Onstream Media Corporation, Onstream Conferencing Corporation and Infinite Conferencing as defendants. The action alleged breach of contract with respect to payment of certain components of the purchase price for the Intella2 acquisition and related commissions and sought money damages as well as declaratory relief declaring Mr. Cohen’s related non-compete agreement with us unenforceable. On December 31, 2013 we filed our response to this lawsuit, which contained various objections to the lawsuit allegations as well as a number of counterclaims. On July 29, 2014, the parties entered into a settlement agreement and on August 4, 2014, the lawsuit was dismissed with prejudice by the court. Under the terms of the settlement agreement, we agreed to transfer all free conferencing customers and all associated revenues and expenses to Mr. Cohen, effective July 1, 2014, and we also agreed to pay him $20,000 ($10,000 per month in July and August) with respect to such activity before July 1, 2014. We also agreed to transfer certain computer equipment already owned by us and used to support the free conferencing business, with an estimated net book value of $20,000, to Mr. Cohen. No further purchase price or other amounts will be payable by us under the agreements entered into at the time of the November 30, 2012 acquisition, including the Asset Purchase Agreement, the Total Free Conferencing Business Revenue Share Agreement and the Master Agent and Non-Compete Agreement. Under the terms of the settlement agreement, Mr. Cohen’s non-compete agreement was cancelled and replaced by mutual agreements as to non-disparagement and non-solicitation. Based on the litigation settlement, as of June 30, 2014 we reduced the previously estimated liability recorded on our books for the unpaid portion of the purchase price to an estimated settlement liability of $40,000. We believe that the amounts ultimately payable by us in accordance with this settlement will not be materially greater than this estimate.


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 future financial position or results of operations.


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


As of May 20, 2014 it was conclusively determined that our five senior executives (the “Executives”) were entitled to an aggregate of 250,000 fully restricted common shares, related to achievement of one of the financial objectives for fiscal 2014, as outlined in an Executive Incentive Plan authorized by our Board of Directors on February 20, 2013. These 250,000 shares, which had a fair market value of $52,500 on the date they were determined to be earned, were issued to the Executives in June 2014.


During July 2014 we issued 300,000 unregistered common shares, valued at $60,000 in connection with a transaction with Sigma on February 28, 2014, under which we borrowed $500,000 pursuant to a senior secured note (“Sigma Note 2”) issued to Sigma and collateralized by all of our assets, subordinated only to security interests already held in connection with outstanding financings with Rockridge and Thermo Credit LLC. In accordance with the terms of the Sigma Note 2 financing, if by June 30, 2014 we had not signed a definitive agreement calling for receipt of funds in excess of $2.0 million as a result of the sale of all or a part of our operations or assets, we would be obligated to issue Sigma and Sigma Capital, in aggregate, another 300,000 restricted common shares plus pay Sigma Capital an additional cash fee of $100,000. Those conditions were not met as of June 30, 2014.


During July 2014 we issued 235,000 unregistered common shares for investor relations and financial consulting services valued at approximately $42,000, which will be recognized as professional fees expense over a service period of twelve months.


All of the above securities were offered and sold without such offers and sales being registered under the Securities Act of 1933, as amended (together with the rules and regulations of the Securities and Exchange Commission (the "SEC") promulgated thereunder, the "Securities Act"), in reliance on exemptions therefrom as provided by Section 4(a)(2) and Regulation D of the Securities Act of 1933, for securities issued in private transactions. The recipients were either accredited or otherwise sophisticated investors and the certificates evidencing the shares that were issued contained a legend restricting their transferability absent registration under the Securities Act of 1933 or the availability of an applicable exemption therefrom. The purchasers had access to business and financial information concerning our company. Each purchaser represented that he or she was acquiring the shares for investment purposes only, and not with a view towards distribution or resale except in compliance with applicable securities laws.


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Item 3. Defaults upon Senior Securities


None.



Item 4. Mine Safety Disclosures


None.



Item 5. Other Information


None.



Item 6. Exhibits


31.1 - Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer

31.2 - Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer

32.1 - Section 906 Certification of Chief Executive Officer

32.2 - Section 906 Certification of Chief Financial Officer

101 - Interactive data files pursuant to Rule 405 of Regulation S-T, as follows:

101.INS - XBRL Instance Document

101.SCH - XBRL Taxonomy Extension Schema Document

101.CAL - XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF - XBRL Taxonomy Extension Definition Linkbase Document

101.LAB - XBRL Taxonomy Extension Label Linkbase Document

101.PRE  - XBRL Taxonomy Extension Presentation Linkbase Document


SIGNATURES


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




                                          Onstream Media Corporation,

                                          a Florida corporation


Date: August 19, 2014


                                          /s/ Randy S. Selman

                                          ------------------------------

                                          Randy S. Selman,

                                          President and Chief Executive Officer


                                          /s/ Robert E. Tomlinson

                                          ------------------------------

                                          Robert E. Tomlinson

                                          Chief Financial Officer

                                          And Principal Accounting Officer



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