UNITED
      STATES


SECURITIES
      AND EXCHANGE COMMISSION


Washington,
      D.C. 20549





Form
      10-KSB





(Mark
      One)





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





For
      the
      fiscal year ended September 30, 2006





[
                ]
            TRANSITION
                REPORT UNDER 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


(Name
      of
      small business issuer in its charter)





Florida
            
            65-0420146(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)







1291
                SW 29 AvenuePompano
                Beach, Florida
            
            33069(Address
                of principal executive offices)
            
            (Zip
                Code)








Issuer's
      telephone number 954-917-6655





Securities
      registered under Section 12(b) of the Exchange Act:





Title
                of each class
            Name
                of each exchange on which registeredNone
            not
                applicable(Title
                of each class)





Securities
      registered under Section 12(g) of the Exchange Act:





common
      stock


(Title
      of
      class)








Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15(d) of the Exchange Act [
      ]





Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 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 [ ]





Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B is not contained in this form, and no disclosure will be
      contained, to the best of the registrant's knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-KSB
      or any amendment to this Form 10-KSB. [ ]





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





State
      issuer's revenues for its most recent fiscal year. $ 8,419,451 for the 12 months
      ended September 30, 2006.





State
      the
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates computed by reference to the price at which the common equity
      was
      sold, or the average bid and asked prices of such common equity, as of a
      specified date within the past 60 days. The aggregate market value of the common
      equity held by non-affiliates computed at the closing price of the registrant’s
      common stock on January 10, 2007 is approximately $64.8 million.





State
      the
      number of shares outstanding of each of the issuer's class of common equity,
      as
      of the latest practicable date. As of January 10, 2007, 24,181,795 shares of
      common stock are issued and outstanding.





DOCUMENTS
      INCORPORATED BY REFERENCE





If
      the
      following documents are incorporated by reference, briefly describe them and
      identify the part of the Form 10-KSB (e.g., Part I, Part II, etc.) into which
      the document is incorporated: (1) any annual report to security holders; (2)
      any
      proxy or information statement; and (3) any prospectus filed pursuant to Rule
      424(b) of the Securities Act of 1933 ("Securities Act"). Not
      Applicable.





Transitional
      Small Business Disclosure Form (check one): Yes __  No X











CERTAIN
      CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION





Certain
      statements in this annual report on Form 10-KSB contain or may contain
      forward-looking statements that are subject to known and unknown risks,
      uncertainties and other factors which may cause actual results, performance
      or
      achievements to be materially different from any future results, performance
      or
      achievements expressed or implied by such forward-looking statements. These
      forward-looking statements were based on various factors and were derived
      utilizing numerous assumptions and other factors that could cause our actual
      results to differ materially from those in the forward-looking statements.
      These
      risks, uncertainties and other factors include, but are not limited to, our
      ability to implement our strategic initiatives (including our ability to
      successfully complete, produce, market and/or sell the DMSP and/or our ability
      to eliminate cash flow deficits by increasing our sales), economic, political
      and market conditions and fluctuations, government and industry regulation,
      interest rate risk, U.S. and global competition, and other factors affecting
      the
      Company's operations and the fluctuation of the Company's common stock price,
      and other factors discussed elsewhere in this report and in other documents
      filed by the Company 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 September 30, 2006. Readers should carefully review
      this
      Form 10-KSB in its entirety, including but not limited to our financial
      statements and the notes thereto and the risks described in "Item 1.
      Business—Risk Factors." Except for our ongoing obligations to disclose material
      information under the Federal securities laws, we undertake no obligation to
      release publicly any revisions to any forward-looking statements, to report
      events or to report the occurrence of unanticipated events. Actual results
      could
      differ materially from the forward-looking statements. In light of these risks
      and uncertainties, there can be no assurance that the forward-looking
      information contained in this report will, in fact, occur. For any
      forward-looking statements contained in any document, we claim the protection
      of
      the safe harbor for forward-looking statements contained in the Private
      Securities Litigation Reform Act of 1995.





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














**PART
      I**








**ITEM
      1.**   **DESCRIPTION
      OF BUSINESS**





**Our
      Business, Products and Services**





We
      are an
      online service provider of live and on-demand digital media communications
      and
      applications, including webcasting, webconferencing, digital asset management
      and web publishing services. Our objective is to provide these services via
      a
      fully robust, comprehensive platform technology, the Digital Media Services
      Platform (“DMSP”), that virtually any company, government agency or other
      enterprise having a need to manage rich media content will be able to utilize
      in
      an affordable and highly secure environment.





Our
      operations are organized in two main operating groups:





·
            Digital
                Asset Management Group





·
            Webcasting
                Group





Products
      and services provided by each of the groups are:





***Digital
      Asset Management Group***





Our
      Digital Asset Management Group, which operates primarily from facilities in
      San
      Francisco, California, provides digital asset management and audio and video
      networking services that represented approximately 55.0% and 54.9% of our
      revenues for the years ended September 30, 2006 and 2005, respectively. These
      revenues are comprised primarily of network access and usage fees, the sale
      and
      rental of communication equipment, and fees for encoding, storage, search and
      retrieval and distribution of digital assets.





Digital
      asset management is a set of coordinated technologies and processes that allow
      the quick and efficient storage, retrieval, and reuse of the digital files
      that
      are essential to most businesses. These digital files include photos, videos,
      audio files, flash animations, engineering specs, architectural plans, web
      pages, and many other pieces of business collateral. Digital asset management
      provides the business rules and processes needed to acquire, store, index,
      secure, search, export and transform these assets and their descriptive
      information ***.*** ****





**** In
      addition, the Digital Asset Management Group services include providing
      connectivity within the entertainment and advertising industries through a
      private wide-area network managed by it, which encompasses production and
      post-production companies, advertisers, producers, directors, and talent. The
      network enables high-speed exchange of high quality audio, compressed video
      and
      multimedia data communications, utilizing long distance carriers, regional
      phone
      companies, satellite operators, and major Internet service providers. The global
      network has approximately 500 active access locations in cities throughout
      the
      United States, Canada, Mexico, Europe, and the Pacific Rim.





In
      December 2004 we completed our acquisition of the remaining approximately 74%
      of
      Acquired Onstream not previously owned by us (the “Onstream Merger”). Acquired
      Onstream was a development stage company founded in 2001 with the business
      objective of developing a feature rich digital asset management service and
      offering the service on a subscription basis over the Internet. This product,
      the Digital Media Services Platform (“DMSP”), will 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.





1


The
      DMSP
      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) and is actually comprised of four separate products - encoding,
      storage, search and retrieval and distribution. A limited version of the DMSP,
      with three of the four products accessible, was first placed in service with
      third-party customers in November 2005. The fourth product was made available
      to
      our DMSP customers as of October 2006.





In
      February 2004 we acquired certain assets from Virage, Inc. The assets acquired
      included the assignment of customer contracts for the performance of digital
      asset management services as well as assistance in the integration of those
      activities into our operations. Also in February 2004, Acquired Onstream entered
      into a license agreement whereby it licensed certain software from Virage,
      Inc.
      This software is being integrated into the DMSP.





In
      May
      2004 Acquired Onstream entered into a license agreement with Nine Systems,
      a
      software vendor of Internet protocol-based billing and provisioning solutions.
      Under this agreement, we, as Acquired Onstream’s successor, licensed on a
      perpetual basis the Nine Systems billing and provisioning software including
      systems integration support.





In
      December 2004 North Plains, a software developer of digital asset management
      repositories and work flow engines, entered into an agreement with us, as
      Acquired Onstream’s successor, to provide its software for use in the DMSP.





***Webcasting
      Group***





The
      Webcasting Group provides corporate-oriented, web-based media services including
      live audio and video webcasting and on-demand audio and video streaming and
      represented approximately 45.0% and 45.1% of our revenues for the years ended
      September 30, 2006 and 2005, respectively. These revenues are comprised
      primarily of production and distribution fees.





Our
      Webcasting Group, which operates primarily from facilities in Pompano Beach,
      Florida and a sales office in New York City, provides online webcasting
      services, a cost effective means for corporations to broadcast conference calls
      live, making them available to the investing public, the media and to anyone
      worldwide with Internet access. We market the webcasting services through a
      direct sales force and through channel partners, also known as resellers. Each
      webcast can be heard and/or viewed live, and then archived for replay for an
      additional fee with an option for accessing the archived material through a
      company's own web site. These webcasts primarily communicate corporate earnings
      and other financial information; product launches and other marketing
      information; training, emergency or other information directed to employees;
      and
      corporate or other special events.




Our
      Webcasting Group also includes our travel production and distribution
      operations. These operations primarily include the production, storage and
      Internet streaming of two to four minute multi-media videos for clients such
      as
      hotel, resort, golf facility, travel destination and time-shares. In May 2005
      we
      agreed to sell our travel production and distribution operations and the related
      assets. However, in September 2005 the buyer filed a legal action against us
      alleging that we did not deliver these assets as agreed and seeking return
      of
      the $50,000 deposit plus reimbursement of due diligence expenses alleged to
      be
      approximately $354,000 plus attorney fees and interest. On December 4, 2005,
      we
      filed a response objecting to all claims by the buyer, which we believe are
      without merit. As of January 10, 2007 both we and the buyer are continuing
      to
      conduct our respective discovery and a trial date has been set for March 2007.
      The Company believes that the ultimate resolution of this legal action will
      not
      have a material impact on its financial condition or results of operations
      and,
      pending such resolution, the Company continues these travel production and
      distribution operations.




2




**Sales
      and Marketing**





We
      use a
      variety of marketing methods, including our internal sales force and channel
      partners, also known as resellers, to market our products and services. One
      key
      element of our marketing strategy has been to enter into distribution agreements
      with recognized leaders in each of the markets for our products and services.
      By
      offering our products and services in conjunction with the distributors’
products, we believe these distribution agreements enable us to take advantage
      of the particular distributors' existing marketing programs, sales forces and
      business relationships. Contracts with these distributors generally range from
      one to two years.





We
      have
      expanded our marketing efforts during the past year through the use of public
      relations and telemarketing firms. We intend to continue these actions during
      the coming year, as well as the introduction of targeted television and radio
      advertising, as well as direct mail. See Item 6 - Liquidity and Capital
      Resources.





For
      the
      years ended September 30, 2006 and 2005, we provided webcasting services to
      one
      significant customer, Thomson/CCBN, under a contract that can be terminated
      upon
      a 30-day notification. Revenues from sales to this customer were approximately
      $331,000, or approximately 4%, and approximately $1.4 million, or approximately
      17%, of total consolidated revenue for the years ended September 30, 2006 and
      2005, respectively. These revenues represented approximately 9% and 38% of
      Webcasting Group revenues for the same periods.





For
      the
      years ended September 30, 2006
      and 2005
      the
      Company provided digital asset management services to another significant
      customer, America Online, Inc., under a contract that can be terminated upon
      a
      30-day notification. Revenues from sales to this customer were approximately
      $911,000, or approximately 11%, and approximately $1.2 million, or approximately
      15%, of total consolidated revenue for the years ended September 30, 2006 and
      2005, respectively. These revenues represented approximately 20% and 26% of
      Digital Asset Management Group revenues for the same periods.





Other
      than these agreements, no other agreement with a customer has represented more
      than 10% of our revenues during these periods. See Risk Factors
      below.





**Competition**





We
      operate in highly competitive and rapidly changing business segments. We expect
      our competition to intensify. We compete with:


-    other
          web
          sites, Internet portals and Internet broadcasters to acquire and provide
          content
          to attract users;


-    video
          and
          audio conferencing companies and Internet business service
          broadcasters;


-    online
          services, other web site operators and advertising networks;





-    traditional
      media, such as television, radio and print; and





-    end-user
      software products.





Our
      webcasting products and services fall into two competitive areas: live or
      archived financial and fair-disclosure related conferences, and all other live
      or archived webcast productions for the corporate, financial, educational and
      government segments. In the financial conferences area, we compete with Akamai,
      ON24, IVT, WILink, Talkpoint, Wall Street Transcripts, Netbriefings, PTEK
      Holdings, Shareholder.com, Thomson Financial Group, Media Link Worldwide and
      others that offer live webcasts
      of quarterly earnings conference calls. For other webcast production, we compete
      with other smaller geographically local entities. Our production services,
      however, have been in demand by some of our competitors, and from time to time
      we have provided services to these companies. The nature of the streaming media
      sector of the Internet market is highly interdependent while being
      competitive.





3


During
      fiscal 2006, our Webcasting Group experienced a revenue increase of
      approximately 3.0%, or approximately 4.3% before considering a decline in travel
      production and distribution revenues. Although the competitive pressures that
      reduced the number of audio-only webcasts in fiscal 2004 continued in fiscal
      2005 and 2006, this declining trend was offset during fiscal 2005 and 2006
      by
      sales growth from higher priced video webcasts.





Competition
      for the audio and video networking services provided by the EDNet division
      of
      our Digital Asset Management Group is based upon the ability to provide systems
      compatibility and proprietary off-the-shelf codecs. Due to the difficulty and
      expense of developing and maintaining private digital networks, bridging
      services, engineering availability and service quality, we believe that the
      number of audio networking competitors are, and will remain small. Our primary
      video networking competitors are video appliance dealers that source video
      transport hardware. This group's advantage is one that provides a total solution
      including system design, broadband sourcing, and custom software connectivity
      applications that include a comprehensive digital path for television commercial
      transport.  However,
      companies that compete in some portion of the audio and video networking
      services market targeted by us include Telestream, Globix, Acceris, Media Link, Savvis, Digital Generation (DG)
      Systems, Globecast, MediaNet, SohoNet, Pathfire, Source Elements and Ascent
      Media.





While
      there is competition for the provision of digital asset management services
      by
      our Digital Asset Management Group, this is a relatively new product with few
      established providers. We believe that our approach of partnering with
      established providers such as SAIC, Autonomy/Virage Application Services and
      North Plains reduces the competition in this area. We also believe that our
      ability to offer integrated webcasting, networking and other services as part
      of
“full service” digital asset management limits direct competition. However,
      companies that compete in some portion of the digital asset management market
      targeted by us include MerlinOne, ClearStory
      Systems, Equant,
      Getty Images, Quebecor, American Color, Ascent Media, Wam!Net, Interchange
      Digital and Publicis.




**Government
      Regulation**





Although
      there are currently few laws and regulations directly applicable to the
      Internet, it is likely that new laws and regulations will be adopted in the
      United States and elsewhere covering issues such as broadcast license fees,
      copyrights, privacy, pricing, sales taxes and characteristics and quality of
      Internet services. It is possible that governments will enact legislation that
      may be applicable to us in areas such as content, network security, encryption
      and the use of key escrow, data and privacy protection, electronic
      authentication or "digital" signatures, illegal and harmful content, access
      charges and retransmission activities. Moreover, the applicability to the
      Internet of existing laws governing issues such as property ownership, content,
      taxation, defamation and personal privacy is uncertain. The majority of such
      laws were adopted before the widespread use and commercialization of the
      Internet and, as a result, do not contemplate or address the unique issues
      of
      the Internet and related technologies. Any such export or import restrictions,
      new legislation or regulation or governmental enforcement of existing
      regulations may limit the growth of the Internet, increase our cost of doing
      business or increase our legal exposure, which could have a material adverse
      effect on our business, financial condition and results of
      operations.





4


By
      distributing content over the Internet, we face potential liability for claims
      based on the nature and content of the materials that we distribute, including
      claims for defamation, negligence or copyright, patent or trademark
      infringement, which claims have been brought, and sometimes successfully
      litigated, against Internet companies. To protect our company from such claims,
      we maintain general liability insurance (including umbrella coverage) of
      approximately $3.0 million. The general liability insurance may not cover all
      potential claims of this type or may not be adequate to indemnify us for any
      liability to which we may be exposed. Any liability not covered by insurance
      or
      in excess of insurance coverage could have a material adverse effect on our
      business, results of operations and financial condition.





Our
      audio
      and video networking services are conducted primarily over telephone lines,
      which are heavily regulated by the various Federal and other agencies. However,
      we believe that the responsibility for compliance with those regulations
      primarily falls on the local and long distance telephone service providers
      and
      not the Company.





**Intellectual
      Property**





Our
      success depends in part on our ability to protect our intellectual property.
      To
      protect our proprietary rights, we rely generally on copyright, trademark and
      trade secret laws, confidentiality agreements with employees and third parties,
      and agreements with consultants, vendors and customers, although we have not
      signed such agreements in every case. Despite such protections, a third party
      could, without authorization, copy or otherwise obtain and use our content.
      We
      can give no assurance that our agreements with employees, consultants and others
      who participate in development activities will not be breached, or that we
      will
      have adequate remedies for any breach, or that our trade secrets will not
      otherwise become known or independently developed by competitors.





We
      may
      pursue the registration of certain of our trademarks and service marks in the
      United States, although we have not secured registration of all our marks.
      In
      addition, the laws of some foreign countries do not protect our proprietary
      rights to the same extent as do the laws of the United States, and effective
      copyright, trademark and trade secret protection may not be available in such
      jurisdictions. In general, there can be no assurance that our efforts to protect
      our intellectual property rights through copyright, trademark and trade secret
      laws will be effective to prevent misappropriation of our content. Our failure
      or inability to protect our proprietary rights could materially adversely affect
      our business, financial condition and results of operations.





**Employees**





At
      December 31, 2006 we had 64 full time employees, of whom 30 were design,
      production and technical personnel, 12 were sales and marketing personnel and
      22
      were general, administrative and executive management personnel. None of the
      employees are covered by a collective bargaining agreement and our management
      considers relations with our employees to be good.





**General**





We
      were
      formed under the laws of the State of Florida in May 1993. **** Our
      executive offices are located at 1291 SW 29th Avenue, Pompano Beach, Florida
      33069. Our telephone number at that location is (954) 917-6655.


5


**RISK
      FACTORS**





Before
      you invest in our securities, you should be aware that there are various risks.
      Additional risks and uncertainties not presently known to us or that we
      currently believe to be immaterial may also adversely affect our business.
      You
      should consider carefully these risk factors, together with all of the other
      information included in or incorporated by reference into this prospectus before
      you decide to purchase our securities. If any of the following risks and
      uncertainties develop into actual events, our business, financial condition
      or
      results of operations could be materially adversely affected.





***We
      have an accumulated deficit and we anticipate continuing losses that will
      eventually result in significant liquidity and cash flow problems absent a
      material increase in our revenues.***





We
      have
      incurred losses since our inception, and have an accumulated deficit of
      approximately $77.9 million as of September 30, 2006. For the year ended
      September 30, 2006, we had a net loss of approximately $6.5 million and cash
      used in operations was approximately $1.5 million. We had approximately $223,000
      of cash as of September 30, 2006, although we received significant additional
      cash after that date from debt and equity transactions, as discussed in
      Liquidity and Capital Resources.





We
      have
      projected capital expenditures for the next twelve months of approximately
      $900,000, which includes ongoing upgrades to both our Digital Services Media
      Platform (“DMSP”) as well as our webcasting software and hardware
      infrastructure. We also anticipate additional operating expenses in the coming
      year related to the continued expansion of our marketing programs, although
      we
      cannot guarantee that this continued expansion will be implemented or that
      our
      marketing efforts will be successful. Although we may experience increases
      in
      our operating expenses during the next year arising from our program for
      compliance with Section 404 of the Sarbanes-Oxley Act of 2002, we may be able
      to
      defer these expenses based on the status of regulatory changes in this
      area.





We
      cannot
      assure that our revenues will continue to increase, nor can we assure that
      they
      will not decrease. The DMSP was first placed in service with third-party
      customers in November 2005, but related revenues to date have been minimal
      and
      we cannot assure what the future sales activity will be. As long as our cash
      flow from operations remains insufficient to completely fund operations, we
      will
      continue depleting our cash and other financial resources. As a result of the
      uncertainty as to the ability of our operations to generate working capital,
      we
      may be required to delay or cancel certain of the projected capital
      expenditures, some of the planned marketing expenditures, or other planned
      expenses, which could adversely affect our ability to expand our business and
      operations during fiscal 2007.





Our
      operations have historically been financed primarily through the issuance of
      equity and debt. Our future working capital requirements depend primarily on
      the
      rate at which we can decrease our use of cash to fund operations, which is
      in
      turn dependent on an increase in our revenues. Cash used for operations will
      be
      affected by numerous known and unknown risks and uncertainties including, but
      not limited to, our ability to successfully sell the DMSP, market our other
      existing products and services, the degree to which competitive products and
      services are introduced to the market, and our ability to control overhead
      expenses as we grow. We are constantly evaluating our cash needs and existing
      burn rate, in order to make appropriate adjustments in operating expenses.
      If
      our current burn rate continues or increases, we will need to eventually raise
      additional working capital, which we cannot assure will be successfully
      raised. ****** 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. No assurances can be given that we will be
      successful in obtaining additional capital, or that such capital will be
      available on terms acceptable to us. If we are unable to raise additional
      working capital if and when needed, we may be required to curtail some of our
      operations.





6


***Our
      primary assets serve as collateral under outstanding convertible notes. If
      we
      were to default on these agreements, the holders could foreclose on our assets.***





In
      December 2004 through April 2005, we sold $6.525 million principal amount of
      8%
      senior secured convertible notes. Following the conversion to common shares
      by
      several of these note holders, the current remaining outstanding principal
      balance is approximately $630,000. In March 2006, we sold $2.3 million principal
      amount of 8% subordinated secured convertible notes, of which approximately
      $750,000 is still currently outstanding. The notes are collateralized by a
      blanket security interest in our assets and a pledge of the stock of our
      subsidiaries. If we should default under the payment of interest when due,
      the
      funding of redemptions as required, or other provisions of the notes, the
      holders could seek to foreclose on our primary assets. If the holders were
      successful, we would be unable to conduct our business as it is presently
      conducted and our ability to generate revenues and fund our ongoing operations
      would be materially adversely affected.





***We
      are dependent on short-term contracts. If these contracts are terminated, our
      results of operations would be materially adversely affected.***





We
      are
      dependent upon contracts with our clients, including America Online, Inc.
      Revenues from sales to America Online, Inc. were approximately $911,000, or
      11%,
      and $1.2 million, or 15%, of our consolidated revenue for the years ended
      September 30, 2006 and 2005, respectively. These revenues represented
      approximately 20% and 26% of the Digital Asset Management Group's revenues
      for
      the same periods. This contract can be terminated upon a 30-day notification.
      Because of the significant nature of the revenues from this contract to our
      consolidated results of operations, its termination could have a material
      adverse effect on our financial condition and results of operations.





***We
      may be unable to successfully market or sell the Digital Media Services Platform
      (“DMSP”).***





Our
      December 2004 purchase of Acquired Onstream included approximately $2.7 million
      capitalized by Acquired Onstream prior to that date for licensed software and
      development work by SAIC, Virage and other third parties related to the
      partially completed Digital Media Services Platform (“DMSP”). Subsequent to the
      acquisition, we have spent approximately $1.4 million to complete the platform
      in a commercially viable form, including computer equipment used in its
      development and initial operation. Although we believe there is a market for
      the
      DMSP and as of November 2005 have placed a limited version of it in service
      with
      some third-party customers, there have only been limited sales for the DMSP
      to
      date and we do not know when, if ever, that we will generate any significant
      revenues from this product. In addition there is no assurance that we will
      be
      able to sell the DMSP on a profitable basis. Our inability to successfully
      market and/or sell the DMSP could have a material adverse effect on our
      financial condition and results of operations.





Unamortized
      goodwill from the Onstream Merger was approximately $8.4 million at September
      30, 2006 and property and equipment as of September 30, 2006 included
      approximately $3.2 million (net of depreciation) related to the
      DMSP.





7


***A
      substantial portion of our assets are comprised of goodwill and other intangible
      assets, which may be subject to future impairment and result in financial
      statement write-offs.***





Our
      prior
      acquisitions of several businesses, including the Onstream Merger, have resulted
      in significant increases in goodwill and other intangible assets. Unamortized
      goodwill and other intangible assets, which includes acquired customer lists,
      were approximately $9.9 million at September 30, 2006, representing
      approximately 58% of our total assets and 118% of the book value of shareholder
      equity. In addition, property and equipment as of September 30, 2006 includes
      approximately $3.2 million (net of depreciation) related to the
      DMSP.





If
      there
      is a material change in our business operations, the value of the intangible
      assets we have acquired could decrease significantly. On an ongoing basis,
      we
      will evaluate, partially based on discounted expected future cash flows, whether
      the carrying value of such intangible assets may no longer be recoverable,
      in
      which case an additional charge to earnings may be necessary. 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.





***We
      may continue to experience volatility in our stock price, which has recently
      been below $1.00 per share (although the closing price was $2.88 on January
      10,
      2007)*** **.**





Historically,
      there has been volatility in the market price for our common stock. Our
      quarterly operating results, changes in general conditions in the economy,
      the
      financial markets or the marketing industry, or other developments affecting
      us
      or our competitors, could cause the market price of our common stock to
      fluctuate substantially. We expect to experience significant fluctuations in
      our
      future quarterly operating results due to a variety of factors. Factors that
      may
      adversely affect our quarterly operating results include:





-
            the
                announcement or introduction of new services and products by us and
                our
                competitors;  -
            our ability to upgrade and develop our systems in
              a
              timely and effective manner;





-
            our
                ability to retain existing clients and attract new clients at a steady
                rate, and maintain client satisfaction;





-
            the
                level of use of the Internet and online services and the rate of
                market
                acceptance of the Internet and other online services for transacting
                business;  -
            technical difficulties, system downtime, or Internet
              brownouts;





-
            the
                amount and timing of operating costs and capital expenditures relating
                to
                expansion of our business and operations;  -
            government regulation; and  -
            general economic conditions and economic conditions
              specific to the Internet.


As
      a
      result of these factors, in one or more future quarters, our operating results
      may fall below the expectations of securities analysts and investors. In this
      event, the market price of our common stock would likely be materially adversely
      affected. In addition, the stock market in general and the market prices for
      Internet-related companies in particular, have experienced extreme volatility
      that often has been unrelated to the operating performance of those companies.
      These broad market and industry fluctuations may adversely affect the price
      of
      our common stock, regardless of our operating performance.





8


The
      Company received a letter from NASDAQ dated August 2, 2006 indicating that
      the
      Company had 180 calendar days, or until January 29, 2007, to regain compliance
      with Marketplace Rule 4310(c)(4), which is necessary in order to be eligible
      for
      continued listing on the NASDAQ Capital Market. The letter from NASDAQ indicated
      that the Company’s non-compliance with that rule was as a result of the bid
      price of its common stock closing below $1.00 per share for the preceding thirty
      consecutive business days.  The
      Company received a letter from NASDAQ dated December 4, 2006, stating that
      the
      Company had regained compliance with NASDAQ Marketplace Rule 4310(c)(4) as
      of
      that date, by having met the $1.00 per share or greater minimum closing bid
      price requirement for a minimum of 10 consecutive business days. T he
      closing ONSM share price was $2.88 per share on January 10, 2007.




In
      the
      event our common stock is not listed or quoted, or is suspended from trading
      on
      an eligible market for a period of 20 or more trading days (which need not
      be
      consecutive), the purchasers of the 8%
      Senior
      Convertible Debentures and the 8% Subordinated Convertible
      Debentures may
      require us to redeem (i) any such notes still outstanding for 115% of the face
      value (or 115% of the market value of the underlying shares for the previous
      five days, if greater) plus (ii) any shares obtained from the conversion of
      those notes and still held, for 115% of the market value for the previous five
      days. In addition to the above, the 8% Convertible Debentures and the Additional
      8% Convertible Debentures provide cash penalties of 1% of the original purchase
      price per month, for each month that the common stock underlying those
      securities and the related warrants is not listed on the NASDAQ Capital
      Market.




***If
      the selling security holders listed in our recent registration statements all
      elect to sell their shares of our common stock at the same time, the market
      price of our shares may decrease.***





It
      is
      possible that the selling security holders listed in our recent registration
      statements on Form S-3 (declared effective in June 2005 and July 2006) will
      offer all of the shares for sale. Further, because it is possible that a
      significant number of shares could be sold at the same time hereunder, the
      sales, or the possibility thereof, may have a depressive effect on the market
      price of our common stock.





***The
      exercise of options and warrants, or the conversion of (i) shares of our Series
      A-10 Convertible Preferred Stock (ii) our 8% senior secured convertible notes
      or
      (iii) our 8% subordinated secured convertible notes, will be dilutive to our
      existing common shareholders.***





As
      of
      September 30, 2006 there were outstanding options and warrants to purchase
      a
      total of 15,212,431 shares of our common stock, with an average exercise price
      of $1.60 per share and approximately 76% exercisable between $0.71 and $1.65
      per
      share. During December 2006 and January 2007 to date, we received approximately
      $3.1 million from the exercise of previously issued warrants and options,
      resulting in our issuance of 2,076,479 registered common shares. These warrants
      and options had exercise prices ranging from $1.00 to $2.00 per
      share.





In
      addition, as of September 30, 2006 there were 430,983 shares of our Series
      A-10
      Convertible Preferred Stock outstanding, which are convertible at $1.00 per
      share into 4,309,830 shares of our common stock, as well as $3,000,000 principal
      amount 8% senior secured convertible notes and $2,225,000 principal amount
      8%
      subordinated secured convertible notes which are in aggregate convertible
      at $1.00 per share into 5,225,000 shares of our common stock.





9


During
      November and December 2006 and January 2007 to date, we issued an aggregate
      of
      4,812,982 registered common shares as a result of conversions by several
      investors of 8% Senior and Subordinated Convertible Debentures and Series A-10
      Preferred, as follows:





(i)
            2,404,887
                ONSM common shares for the conversion of $2,369,855 of 8% Senior
                Convertible Debentures, plus accrued
                interest,





(ii)
            1,500,405
                ONSM common shares for the conversion of $1,475,000 of 8% Subordinated
                Convertible Debentures, plus accrued
                interest,





(iii)
            907,690
                ONSM common shares for the conversion of 90,769 shares of Series
                A-10
                Preferred, including accrued
                dividends.




The
      closing ONSM share price was $2.88 per share on
      January 10, 2007.




***We
      have issued debt and preferred shares containing significant discounts which
      will adversely, and possibly unpredictably, affect interest and dividend expense
      in future years.***





We
      are
      required to record the fair value of warrants issued in conjunction with the
      Financing Transactions, plus the potential value arising from a beneficial
      conversion feature included in the terms of the financing, as a discount to
      the
      stated financing amount. The unamortized portions of these discounts which
      were
      reflected on our balance sheet at September 30, 2006 were approximately $1.4
      million for the Series A-10 Convertible Preferred, approximately $1.4 million
      for the 8% senior secured convertible notes, and approximately $930,000 for
      the
      8% subordinated secured convertible notes. These non-cash amounts will be
      amortized to dividend and interest expense over the remainder of the original
      four year financing terms, although any unamortized portion will be immediately
      expensed at the time of a conversion or redemption occurring before the end
      of
      those terms. Accordingly, conversions of approximately $3.8 million of our
      debentures occurring after September 30, 2006 will result in the write-off
      to
      expense of approximately $1.5 million unamortized debt discount during the
      three
      months ending December 31, 2006 and another approximately $100,000 during the
      three months ending March 31, 2007.





***We
      may be exposed to potential risks relating to our internal controls over
      financial reporting and our ability to have those controls attested to by our
      independent auditors.***





As
      directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and
      Exchange Commission adopted rules requiring public companies to include a report
      of management on the company's internal controls over financial reporting in
      their annual reports, including Form 10-KSB. In addition, the independent
      registered public accounting firm auditing a company's financial statements
      must
      also attest to and report on management's assessment of the effectiveness of
      the
      company's internal controls over financial reporting as well as the operating
      effectiveness of the company's internal controls. We were not subject to these
      requirements for the fiscal year ended September 30, 2006 and do not expect
      to
      be subject to them for the fiscal year ended September 30, 2007. We are
      evaluating our internal control systems in order to allow our management to
      report on our internal controls, as a required part of our Annual Report on
      Form
      10-KSB beginning with our report for the fiscal year ended September 30, 2008.
      Our independent registered public accounting firm will be required to attest
      to
      management’s report on our internal controls, as a required part of our Annual
      Report on Form 10-KSB beginning with our report for the fiscal year ended
      September 30, 2008.





While
      we
      expect to eventually expend significant resources in developing the necessary
      documentation and testing procedures required by Section 404 of the
      Sarbanes-Oxley Act of 2002, there is a risk that we will not comply with all
      of
      the requirements imposed thereby. At present, there is no precedent available
      with which to measure compliance adequacy. Accordingly, there can be no positive
      assurance that we will receive a positive attestation from our independent
      auditors.





10


In
      the
      event we identify significant deficiencies or material weaknesses in our
      internal controls that we cannot remediate in a timely manner or we are unable
      to receive a positive attestation from our independent auditors with respect
      to
      our internal controls, investors and others may lose confidence in the
      reliability of our financial statements and our ability to obtain equity or
      debt
      financing could suffer.





In
      addition to the above, in the event that our independent registered public
      accounting firm is unable to rely on our internal controls in connection with
      their audit of our financial statements, and in the further event that they
      are
      unable to devise alternative procedures in order to satisfy themselves as to
      the
      material accuracy of our financial statements and related disclosures, it is
      possible that we would receive a qualified or adverse audit opinion on those
      financial statements. In that event, the quotation of our common stock on the
      Nasdaq Capital Market could be adversely affected. In addition, investors
      and others may lose confidence in the reliability of our financial statements
      and our ability to obtain equity or debt financing could suffer.





***Provisions
      of our articles of incorporation and bylaws may delay or prevent a take-over,
      which may not be in the best interests of our shareholders.***





Provisions
      of our articles of incorporation and bylaws may be deemed to have anti-takeover
      effects, which include when and by whom special meetings of our shareholders
      may
      be called, and may delay, defer or prevent a takeover attempt. In addition,
      certain provisions of the Florida Business Corporation Act also may be deemed
      to
      have certain anti-takeover effects which include that control of shares acquired
      in excess of certain specified thresholds will not possess any voting rights
      unless these voting rights are approved by a majority of a corporation's
      disinterested shareholders.





In
      addition, our articles of incorporation authorize the issuance of up to
      5,000,000 shares of preferred stock with such rights and preferences as may
      be
      determined from time to time by our board of directors, of which 430,983 shares
      of our Series A-10 Convertible Preferred Stock were issued and outstanding
      at
      September 30, 2006. Our board of directors may, without shareholder approval,
      issue preferred stock with dividends, liquidation, conversion, voting or other
      rights that could adversely affect the voting power or other rights of the
      holders of our common stock.





**ITEM
      2.**   **DESCRIPTION
      OF PROPERTY**





We
      lease
      a 25,000 square foot facility at 1291 SW 29 th Street
      in Pompano Beach, Florida, which serves as our corporate headquarters and houses
      the majority of our webcasting production, marketing and distribution
      activities. Our lease ends in September 2007 and provides for a five-year
      renewal option. The monthly base rental is approximately $17,600 (including
      our
      share of property taxes and common area expenses) with annual three percent
      (3%)
      increases.





We
      also
      maintain business offices located at 440 Ninth Avenue, New York City, New York.
      This office, including available common areas, is approximately 2,000 square
      feet and serves as a sales office and as a backup to Florida for webcasting
      operations. We lease this space from an unaffiliated third party under a lease
      expiring on December 31, 2007 for a monthly rental of approximately
      $6,200.





In
      May
      2004, we entered into a five-year operating lease for office space at 200
      Vallejo Street in San Francisco. This is an approximately 8,500 square foot
      facility that operates as administrative headquarters for Digital Asset
      Management Group, including EDNet, and houses the centralized network hub for
      electronically bridging affiliate studios. In addition, the facility operates
      as
      a backup to Florida for webcasting operations. The lease provides for one
      five-year renewal option at 95% of fair market value. The monthly base rental
      is
      approximately $16,300 (including month-to-month parking) with annual increases
      up to five percent (5%).




11




**ITEM
      3.**   **LEGAL
      PROCEEDINGS**





On
      May
      18, 2005 we agreed to sell our travel video library, as well as all
      rights associated with that library, including the customer contracts and
      the related websites, for $455,000. We received a $50,000 non-refundable
      deposit at the time of the initial agreement, with the remaining balance due
      upon closing, originally anticipated to be no later than September
      2005. As part of the sale, the buyer also agreed to pay us $15,000 per
      month for a three-year period, in exchange for hosting and streaming services
      for the travel video library and similar content obtained elsewhere by the
      buyer. On September 23, 2005 the buyer filed a legal action against us in the
      District Court, 193 rd Judicial
      District, Dallas County, Texas, alleging that we did not deliver the assets
      as
      agreed and seeking return of the $50,000 deposit plus reimbursement of due
      diligence expenses alleged to be approximately $354,000 plus attorney fees
      and
      interest. On December 4, 2005, we filed a response objecting to all claims
      by
      the buyer, which we believe are without merit. As of January 10, 2007, both
      we
      and the buyer are continuing to conduct our respective discovery and a trial
      date has been set for March 13, 2007. We have not refunded the deposit, which
      is
      included in deferred revenue as of September 30, 2006. We do not believe that
      the ultimate resolution of this matter will have a material impact on our
      financial condition or results of operations. Pending closing of this
      transaction, we had the right to continue, and have continued, our travel
      production and distribution operations.





**ITEM
      4.**   **SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS**





On
      September 12, 2006 we held our 2006 annual meeting of shareholders, at which
      all
      matters submitted to a vote of the company's shareholders as described in the
      proxy statement filed with the SEC on August 1, 2006 were approved. 12,256,587
      shares were present, all by valid proxy. At the 2006 Annual Meeting, our
      shareholders took the following actions:





**Election
      of Directors** - Our
      shareholders elected Randy S. Selman, Clifford Friedland, Alan M. Saperstein,
      Benjamin Swirsky, Robert J. Wussler, Charles C. Johnston and Carl Silva to
      serve
      as directors until the next annual meeting of shareholders or until their
      successors are elected and qualified. The number of votes cast for each of
      these
      individuals are set forth below:





Shares
                For
            Shares
                Against
            Share
                AbstentionsRandy
                S. Selman
            12,120,391
            47,408
            88,788Clifford
                Friedland
            12,167,315
            484
            88,788Alan
                M. Saperstein
            12,166,439
            1,360
            88,788Benjamin
                Swirsky
            12,166,704
            1,095
            88,788Robert
                J. Wussler
            12,167,054
            745
            88,788Charles
                C. Johnston
            12,167,054
            745
            88,788Carl
                Silva
            12,166,673
            1,126
            88,788








**Ratification
      of Accountants** - Our shareholders ratified the appointment of Goldstein Lewin & Co.,
      Certified Public Accountants, as our independent accountants. The vote totals
      were 12,155,803 shares for, 75,359 shares against and 25,425 share
      abstentions.





12


**PART
      II**


**ITEM
          5.****MARKET
          FOR COMMON EQUITY AND RELATED STOCKHOLDER
          MATTERS**





Our
      common stock is quoted on the Nasdaq Capital Market. From July 1997 until
      January 5, 2005 our common stock traded under the symbol "VDAT." On January
      5,
      2005 following the change of our corporate name to Onstream Media Corporation
      our trading symbol was changed to "ONSM."





The
      following table sets forth the high and low closing sale prices for our common
      stock as reported on the Nasdaq Stock Market and for the period from October
      1,
      2004 through December 31, 2006. These prices do not include retail mark-ups,
      markdowns or commissions, and may not necessarily represent actual transactions.






**
            High
            
            Low
            ****
            **
            **
            **
            **
            **FISCAL
                YEAR 2005:First
                Quarter
            
            $
            1.79
            
            $
            1.06Second
                Quarter
            
            $
            2.33
            
            $
            1.35Third
                Quarter
            
            $
            1.70
            
            $
            1.07Fourth
                Quarter
            
            $
            1.16
            
            $
            0.95
            ****
            **
            **
            **
            **
            **
            **
            **FISCAL
                YEAR 2006:First
                Quarter
            
            $
            1.17
            
            $
            0.65Second
                Quarter
            
            $
            1.15
            
            $
            0.85Third
                Quarter
            
            $
            1.30
            
            $
            0.78Fourth
                Quarter
            
            $
            0.95
            
            $
            0.56FISCAL
                YEAR 2007:First
                Quarter
            
            $
            3.15
            
            $
            0.46








On
      January 10, 2007, the last reported sale price of the common stock on the Nasdaq
      Capital Market was $2.88 per share. As of January 10, 2007 there were
      approximately 567 shareholders of record of the common stock.





**Dividend
      Policy**





We
      have
      never declared or paid any cash dividends on our common stock. We currently
      expect to retain future earnings, if any, to finance the growth and development
      of our business. The approval of the holders of a majority of the outstanding
      principal face amount of the 8% Convertible Debentures and the Additional 8%
      Convertible Debentures, and the giving of notice to the holders of the 8%
      Subordinated Convertible Debentures twenty days in advance of record date,
      is
      required prior to the payment of any dividend on our common stock. Dividends
      related to the Series A-10 Convertible Preferred are cumulative and must be
      fully paid by us prior to the payment of any dividend on our common
      stock.





13





**Recent
      Sales of Unregistered Securities**





During
      the period from August 9, 2006 through September 30, 2006, we issued 42,500
      unregistered shares of common stock for consulting, financial advisory and
      legal
      services. The services are being provided over periods ranging up to one year,
      and will result in a professional fees expense of approximately $30,000 over
      the
      service period. None of these shares were issued to Company directors or
      officers.





During
      the period from October 1, 2006 through January 10, 2007, we issued 290,000
      unregistered shares of common stock for consulting, financial advisory and
      legal
      services. The services are being provided over periods ranging up to one year,
      and will result in a professional fees expense of approximately $230,000 over
      the service period. None of these shares were issued to Company directors or
      officers.





On
      November 8, 2006, we issued 59,615 unregistered shares of common stock to SAIC
      as payment for services previously capitalized by us at $62,000 and included
      in
      accounts payable at September 30, 2006. We agreed to include these shares in
      the
      next registration statement filed by us.





During
      November and December 2006, we issued 694,495 unregistered shares of common
      stock as prepayment of $694,495 interest related to a $1.0 million four-year
      loan, which loan principal was also convertible into unregistered common shares
      at $1.00 per share and was thus converted into 1.0 million shares of common
      stock in January 2007. We granted the lending entity demand registration rights,
      effective six months from the October 27, 2006 date of the note, for any
      unregistered common shares issuable under this transaction. Upon such demand,
      we
      will have 60 days to file a registration statement and shall use our best
      efforts to obtain promptly the effectiveness of such registration statement.
      Although the lender is not a Company director or officer, by virtue of this
      transaction the lender became a major shareholder, which is defined as having
      a
      greater than 5% beneficial interest in our outstanding common
      stock.





On
      November 13, 2006, we issued 100,000 unregistered shares of common stock, as
      a
      finder’s fee in connection with this loan, to another individual not affiliated
      with the lending entity and not a director or officer of the Company, but who
      is
      a major shareholder. These shares are valued at approximately $80,000 (based
      on
      the date of the related financing) and carry piggyback registration
      rights.





During
      October and November 2005, we borrowed $450,000 from Neil Berman, a major
      shareholder. The remaining $300,000 commitment from this lender under this
      note,
      collateralized by previously purchased hardware and software, was received
      in
      December 2006, for total proceeds under the five-year note of $750,000.  Following
      Board of Director approval of the modified terms in December 2006, the note
      was
      formally modified in January 2007 to increase  the
      principal amount to $1,500,000, adjust the remaining terms to four years,
      increase the interest rate to 17.75% (which the lender may request prepayment
      of
      in our common shares at $1.00 per share) and modify the note priority to
      unsecured and subordinated to all other debt. In addition, the new terms allow
      us or the lender to convert the loan balance to restricted common stock at
      $1.00
      per share at any time. We received $100,000 of the increased note amount in
      December 2006 and $50,000 in January 2007.





During
      June 2006 we borrowed $300,000 from J&C Resources, LLC, whose President,
      Chairman and CEO is a member of our board of directors. The principal balance
      is
      due one year after the borrowing date or three days after receipt of funding,
      including exercise of warrants, in excess of $1.0 million, whichever occurs
      first. Total interest, origination and legal fess totaling $21,000 cash and
      21,000 common shares are due on maturity. Finders fees of $9,000 cash and 9,000
      common shares are payable at loan maturity to Asset Factoring Ltd, a related
      entity. In January 2007, all fees due upon maturity were paid in cash and stock,
      as applicable. Following Board of Director approval of the modified terms in
      October 2006, the note was formally modified in January 2007 to be convertible
      into common shares at $1.22 per share and to bear interest at 14.67% per annum,
      non-compounding, which we may settle in shares at $1.22 per share. We have
      the
      option to force conversion after 18 months and interest is payable at time
      of
      conversion or repayment.





During
      September 2006, we borrowed $300,000 from Lewis Opportunity Fund LP, a major
      shareholder. Cash interest of 10% was paid in advance. The principal, plus
      additional interest of 90,000 common shares, is due on September 14, 2007. We
      may prepay all or any part of the principal after April 15, 2007 and before
      maturity without penalty, although we must give the lender five days notice
      before repayment to allow them opportunity to exercise rights of conversion.
      In
      the event of early repayment or transfer to another financing, all cash interest
      for the entire term of the loan will be deemed earned but the interest shares
      will be partially earned on the following basis - prepayment within eight months
      - 60,000 shares; thereafter - 90,000 shares. The note is convertible at the
      lender’s option at any time after April 15, 2007, to unregistered common stock
      at the rate of $1.00 per common share. In the event of such a conversion of
      the
      entire principal amount, all cash and interest shares for the entire term of
      the
      loan will be fully earned. We
      granted the lender a secondary lien on up to $300,000 of tangible equipment.





All
      of
      the above securities were issued in private transactions exempt from
      registration under the Securities Act of 1933 in reliance on an exemption
      provided by Section 4(2) of that act. 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.





14


**Securities
      Authorized for Issuance Under Equity Compensation Plans**





The
      following table sets forth securities authorized for issuance under equity
      compensation plans, including our 1996 Stock Option Plan, individual
      compensation arrangements and any other compensation plans as of September
      30,
      2006.








Number
                of
            
            Weighted
            
            Number
                ofsecurities
                to be
            
            average
            
            securities
                remainingissued
                upon
            
            exercise
            
            available
                for futureexercise
                of
            
            price
                of
            
            issuance
                under equityof
                outstanding
            
            outstanding
            
            compensation
                plansoptions,
                warrants
            
            options,
            
            (excluding
                securitiesPlan
                category
            
            and
                rights
            
            warrants
            
            reflected
                in column (a))and
                rights(a)
            
            (b)
            
            (c)1996
                Stock Option Plan (1)
            
            
            4,388,892
            
            
            $  
                  1.28
            
            
            2,084,349Equity
                compensation plansapproved
                by shareholders (2)
            
            
            2,431,390
            
            
            $  
                  2.09
            
            
            noneEquity
                compensation plansnot
                approved by shareholders
            
            
            none
            
            
            -
            
            
            none





(1)
            Our
                1996 Stock Option Plan has previously been approved by our shareholders,
                and reflects the only such equity compensation plan for which we
                have
                sought shareholder approval. On April 11, 2002, an amendment to the
                Plan,
                ratified by the shareholders, reserved an aggregate of 733,334 plan
                options and added an equity compensation component. On December 15,
                2004,
                a majority of our shareholders voted to increase the number of shares
                available for issuance under the plan to 3,500,000. On September
                13, 2005,
                a majority of our shareholders voted to increase the number of shares
                available for issuance under the plan to
                6,500,000.





On
      December 15, 2004 a majority of our shareholders voted to approve the
      cancellation of stock option grants to directors, executive officers, senior
      management and employees covering 292,992 shares (65,216 Non-Plan options and
      227,776 of which were issued under the 1996 Stock Option plan) with a
      weighted-average exercise price of $22.93, with such options to be re-issued
      six
      months and one day from the date of cancellation with an exercise price equal
      to
      the fair market value on the date of the reissue. This cancellation has not
      yet
      been implemented and 226,325 of the options (all 65,216 of the Non-Plan options
      and 161,109 of which were issued under the 1996 Stock Option plan) had expired
      as of September 30, 2006.





(2)
            On
                December 15, 2004, a majority of our shareholders voted to issue
                1,631,390
                Non Plan options to certain executives, directors and other management
                in
                connection with the Onstream Merger and 800,000 Non Plan options
                to
                certain executives in connection with their employment
                contracts.




15


**ITEM
      6.**   **MANAGEMENT'S
      DISCUSSION AND ANALYSIS OR PLAN OF OPERATION**





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





**Overview**





We
      are an
      online service provider of live and on-demand media communication, including
      webcasting, webconferencing, digital asset management and web publishing
      services. Our objective is to provide these services via a fully robust,
      comprehensive platform technology, the Digital Media Services Platform (“DMSP”),
      that virtually any company, government agency or other enterprise having a
      need
      to manage rich media content will be able to utilize in an affordable and highly
      secure environment.





We
      had 64
      full time employees as of December 31, 2006. Our operations are organized into
      two main operating groups:





·  Digital
      Asset Management Group


·  Webcasting
      Group





Our
      Digital Asset Management Group, which operates primarily from facilities in
      San
      Francisco, California, provides digital asset management services. Digital
      asset
      management is a set of coordinated technologies and processes that allow the
      quick and efficient storage, retrieval, and reuse of the digital files that
      are
      essential to all businesses. These digital files include photos, videos, audio
      files, engineering specs, architectural plans, web pages, and many other pieces
      of business collateral. In addition, the Digital Asset Management Group services
      include providing connectivity within the entertainment and advertising
      industries through its private network, which encompasses production and
      post-production companies, advertisers, producers, directors, and talent.





The
      Webcasting Group, which operates primarily from facilities in Pompano Beach,
      Florida, 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.
      Our Webcasting Group also includes our travel production and distribution
      operations, which produces Internet-based multi-media streaming videos related
      to hotels, resorts, time-shares, golf facilities, and other travel destinations.





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





**General**





On
      October 27, 2006 we entered into a four-year promissory note in the aggregate
      principal amount of $1.0 million, which was funded in installments through
      December 2006. The note is unsecured and subordinated to all of our other
      liabilities. We elected to prepay all interest with the aggregate issuance
      of
      694,495 unregistered common shares during November and December 2006. At any
      time after April 27, 2007 or earlier date if agreed by us, the lending entity,
      at its option, may begin converting the outstanding principal to our
      unregistered common stock at the rate of $1.00 per share through October 25,
      2009, and at the rate of $2.00 per share thereafter. We agreed to the conversion
      of this loan to 1.0 million common shares in January 2007.





During
      November and December 2006 and January 2007 to date, we issued an aggregate
      of
      4,812,982 registered common shares as a result of conversions of 8% Senior
      and
      Subordinated Convertible Debentures and Series A-10 Preferred. The debenture
      conversions will result in a one-time non-cash expense of approximately $1.5
      million for the three months ended December 31, 2006, and an additional
      approximately $100,000 for the three months ended March 31, 2007, arising from
      the write-off of unamortized debt discount.





16


During
      December 2006 and January 2007 to date, we received approximately $3.1 million
      from the exercise of previously issued warrants and options, resulting in our
      issuance of 2,076,479 registered common shares. These warrants and options
      had
      exercise prices ranging from $1.00 to $2.00 per share.





During
      October 2006, $450,000 of notes payable included on our September 30, 2006
      balance sheet was renegotiated to include modifications to the interest rate
      and
      to the conversion rights, giving the lender the right to convert the loan at
      $1.00 per share, including the right to require prepaid interest in shares
      converted at that rate. On October 25, 2006 the Board of Directors approved
      a
      $1,050,000 increase in this loan, of which we received $400,000 in December
      2006
      and $50,000 in January 2007, with the balance due on or before March 31, 2007.
      The new note for $1,500,000, including the conversion rights at $1.00 per share,
      was formally executed on January 11, 2007.





During
      November 2006, $300,000 of notes payable included on our September 30, 2006
      balance sheet was renegotiated to include modifications to the interest rate
      and
      to the conversion rights, giving the lender the right to convert the loan at
      $1.22 per share. On December 20, 2006 the Board of Directors approved the
      revised terms and a new note, including the conversion rights at $1.22 per
      share, was formally executed on January 4, 2007.





See
      Liquidity and Capital Resources.





**Revenue
      Recognition**





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





Our
      Digital Asset Management Group recognizes revenues from the acquisition,
      editing, transcoding, indexing, storage and distribution of its customers’
digital media. A customer’s charges are generally based on the activity or
      volume of such media, expressed in megabytes or similar terms, and are
      recognized at the time the service is performed. Fees charged to customers
      for
      customized applications or set-up are recognized as revenue at the time the
      application or set-up is completed. Network usage and bridging revenue based
      on
      the timing of the customer’s usage of those services. Revenue from the sale of
      equipment is recognized when the equipment is installed. Leases of equipment
      to
      customers are generally short-term and cancellable and therefore accounted
      for
      as operating leases and the rental revenue from leases is recognized ratably
      over the life of the lease.





Our
      Webcasting group recognizes revenue from live and on-demand webcasting at the
      time an event is accessible for streaming over the Internet. Travel production
      revenue is recognized at the time of completion of the related video or website.
      Travel distribution revenue is recognized when a user watches a video on the
      Internet, if charged on a per hit basis, or over the term of the contract,
      if
      charged as a fixed monthly fee.




17


**Results
        of Operations**
 
 Our
        consolidated net loss for the year ended September 30, 2006 was approximately
        $6.5 million ($0.47 loss per share) as compared to a loss of approximately
        $9.6
        million ($1.17 loss per share) for
        the
        prior year, a decrease in our loss of approximately $3.2 million (33%). The
        decreased net loss for the year ended September 30, 2006, as compared to
        the
        prior year, was primarily due to lower interest expense arising from the
        absence
        in fiscal 2006 of certain non-cash interest expense items occurring in fiscal
        2005, primarily (i) a penalty related to unregistered shares from a previous
        financing and (ii) the write-off of unamortized discount arising from early
        debt
        repayments with the proceeds of the December 2004 8% Convertible Debenture
        and
        Series A-10 Preferred financing transactions. Interest expense was also affected
        by a fiscal 2006 decline, as compared to fiscal 2005, in conversions to equity
        of the 8% Convertible Debentures and Additional 8% Convertible Debentures
        and a
        resulting decrease in the write-off of unamortized discount. In addition,
        significant non-cash income for the valuation of derivative instruments in
        fiscal 2006 had no corresponding effect in fiscal 2005. These items were
        partially offset by increased operating expenses in fiscal 2006, primarily
        due
        to commencement of depreciation of the DMSP in November 2005.





Although
      the net loss decreased by approximately 33%, it decreased by approximately
      60%
      on a per share basis, due to the approximately 5.4 million, or approximately
      65%, increase in the weighted average number of common shares outstanding for
      fiscal 2006 as compared to fiscal 2005.





The
      following table shows, for the periods presented, the percentage of revenue
      represented by items on our consolidated statements of operations.


PERCENTAGE
                OF REVENUEYear
                Ended September 30,2006
            
            2005Revenue:Digital
                asset management
            
            
            25.5
            %
            
            24.1
            %Network
                usage and services
            
            
            24.9
            
            
            25.1Network
                equipment sales and rentals
            
            
            4.6
            
            
            5.6Webcasting
            
            
            43.0
            
            
            42.6Travel
                production and distribution
            
            
            2.0
            
            
            2.6Total
                revenue
            
            
            100.0
            %
            
            100.0
            %Cost
                of revenue:Digital
                asset management
            
            
            9.0
            
            
            7.8Network
                usage and services
            
            
            10.8
            
            
            14.6Network
                equipment sales and rentals
            
            
            1.8
            
            
            2.4Webcasting
                and related equipment
            
            
            16.3
            
            
            12.3Travel
                production and distribution
            
            
            0.8
            
            
            0.9Total
                costs of revenue
            
            
            38.7
            %
            
            38.0
            %Gross
                margin
            
            
            61.3
            %
            
            62.0
            %Operating
                expenses:General
                administrative:Compensation
            
            
            59.2
            
            
            58.6Professional
                fees
            
            
            27.4
            
            
            34.6Other
            
            
            19.1
            
            
            19.4Impairment
                loss on goodwill
            
            
            -
            
            
            4.0Depreciation
                and amortization
            
            
            25.2
            
            
            14.1Total
                operating expenses
            
            
            130.9
            %
            
            130.7
            %Loss
                from operations
            
            
            (69.6
            )%
            
            (68.7
            )%Other
                income (expense):Interest
                income
            
            
            0.1
            
            
            0.1Interest
                expense
            
            
            (25.3
            )
            
            (49.2
            )Income
                from derivative instruments
            
            
            15.5
            
            
            -Other
                income (expense), net
            
            
            2.5
            
            
            (0.3
            )Total
                other expense, net
            
            
            (7.2
            )%
            
            (49.4
            )%Net
                loss
            
            
            (76.8
            )%
            
            (118.1
            )%




18


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





For
                the year ended
              September
                30,
            
            Increase
                (Decrease)2006
            
            2005
            
            Amount
            
            PercentTotal
                revenue
            
            $
            8,419,451
            
            $
            8,156,394
            
            $
            263,057
            
            
            3.2
            %Total
                costs of revenue
            
            
            3,256,094
            
            
            3,102,860
            
            
            153,234
            
            
            4.9
            %Gross
                margin
            
            
            5,163,357
            
            
            5,053,534
            
            
            109,823
            
            
            2.2
            %General
                and administrative expenses
            
            
            8,899,195
            
            
            9,178,309
            
            
            (279,114
            )
            
            (3.0
            )%Impairment
                loss on goodwill
            
            
            -
            
            
            330,000
            
            
            (330,000
            )
            
            (100.0
            )%Depreciation
                and amortization
            
            
            2,121,161
            
            
            1,152,633
            
            
            968,528
            
            
            84.0
            %Total
                operating expenses
            
            
            11,020,356
            
            
            10,660,942
            
            
            359,414
            
            
            3.4
            %Loss
                from operations
            
            
            (5,856,999
            )
            
            (5,607,408
            )
            
            249,591
            
            
            4.5
            %Other
                expense
            
            
            (609,214
            )
            
            (4,030,480
            )
            
            (3,421,266
            )
            
            (84.9
            )%Net
                loss
            
            $
            (6,466,213
            )
            $
            (9,637,888
            )
            $
            (3,171,675
            )
            
            (32.9
            )%





**Revenues
      and Gross Margin**





Consolidated
      operating revenue was approximately $8.4 million for the year ended September
      30, 2006, an increase of approximately $263,000 (3%) from the comparable prior
      year period. This reflected increased revenues of both the Digital Asset
      Management Group and the Webcasting Group.





Digital
      Asset Management Group revenues were approximately $4.6 million for fiscal
      2006,
      an increase of approximately $154,000 (3%) from the prior year. This increase
      was primarily due to revenues during that period of approximately $641,000
      from
      Discovery Education, a subsidiary of Discovery Communications, Inc., a leading
      global media company, which selected us in May 2006 to process titles, chapters
      and segments of existing educational content for their new COSMEO online
      service. We received a $360,000 non-refundable initial payment in connection
      with this contract, of which $225,000 was included in the $641,000 revenue
      recognized through September 30, 2006. The remaining $135,000 of the initial
      payment will be recognized as revenue during the first quarter of fiscal 2007,
      in addition to separate charges for deliveries during that period.





In
      order
      to accomodate increases in our digital asset management business volume from
      this and other new customers, we have made significant encoding system hardware
      and software upgrades and increased our San Francisco facility, on a
      month-to-month lease basis, by approximately 2,400 square feet. Although the
      Discovery contract resulted in a significant increase to our revenues during
      the
      fourth quarter of fiscal 2006, and to a lesser extent during the first quarter
      of fiscal 2007, we are unable to determine what, if any, impact this contract
      will have on our revenues after that period.





19


This
      revenue increase from Discovery and other new customers was partially offset
      by
      decreased revenues from network equipment sales and rentals, which were
      approximately $384,000 for fiscal 2006, a decrease of approximately $74,000
      (16%) from the prior year. We have reduced our sales focus on this lower margin
      area and are currently evaluating our future involvement in this activity,
      as
      part of the reorganization of our sales function discussed below.





As
      a
      result of the marketing of the DMSP and related products, we expect the fiscal
      2007 revenues of the Digital Asset Management Group, including network usage
      and
      services revenues, to exceed the corresponding prior year amounts, although
      such
      increases cannot be assured. In December 2006, we signed both teaming and
      services agreements with Five Across, Inc., a leading provider of social
      networking and online community platforms. The agreements call for the
      integration of certain DMSP services with the Five Across Connect social
      networking platform. This strategic partnership should allow Onstream Media
      and
      Five Across to deploy the enabling technologies to create social networks based
      on any topic with integrated professional and user generated multimedia content,
      such as found on YouTube, MySpace and other similar platforms. In addition,
      we
      have announced that new Web 2.0 features, automation upgrades including "one
      click" publishing capabilities and enhanced video search capabilities will
      be
      available on our DMSP by March 2007.





Webcasting
      Group revenues were approximately $3.8 million for fiscal 2006, an increase
      of
      approximately $109,000 (3%) from the prior year. Although sales to a single
      large customer began to decline during fiscal 2006, as compared to fiscal 2005,
      this decline was offset by an increase in audio-only webcast sales made to
      another single customer, increased webcast production sales and a continuation
      of the past growth in our sales of higher priced video webcasts. Although the
      number of webcasts produced decreased to approximately 4,500 webcasts for the
      year ended September 30, 2006 compared to approximately 4,800 webcasts for
      the
      prior year, the average revenue per webcast event increased to approximately
      $792 for fiscal 2006 compared to approximately $701 for fiscal
      2005.





We
      expect
      the fiscal 2007 revenues of the Webcasting Group to exceed the corresponding
      prior year amounts, although such increase cannot be assured. This is due to
      our
      focus on building sales in the higher per-event priced product segment that
      capitalizes on our proprietary feature set, including slides, chat, polling
      and
      streaming video solutions. In addition, we are continuously upgrading our
      webcasting software and hardware infrastructure, allowing us to introduce new
      features to the market on an ongoing basis. We have recently completed the
      latest set of feature enhancements to our proprietary Webcasting platform,
      including a webinar service providing the means to hold a virtual seminar
      on-line in real time, and are now developing several additional upgrades
      including a Flash based player, embedded Flash video and animations, rapid
      CD-ROM creation, storage and search of webcasts in the DMSP and both audio
      and
      video editing capabilities. Finally, after initial beta-testing, we recently
      deployed an initial version of Quickcast to a limited customer base. This new
      product enables users to self-deploy PowerPoint presentations online, equipped
      with uploading, viewing, storage, and customization features. Quickcast provides
      the means for clients to inexpensively mass market messages, products and
      services. After beta-testing is complete and a second version is released,
      expected by March 2007, we will begin a mass marketing campaign, and we
      anticipate Quickcast to begin generating meaningful revenues
      thereafter.





20


Consolidated
      gross margin was approximately $5.2 million for the year ended September 30,
      2006, an increase of approximately $110,000 (2%) from the prior year. The
      increase is primarily due to an approximately $330,000 increase in gross margin
      from network usage and services in fiscal 2006 as compared to fiscal 2005,
      arising primarily from the renegotiation of EDNet’s long distance telephone rate
      agreement with a national telecommunications company resulting in approximately
      40% lower rates, which were effective starting January 15, 2006. This increase
      in the gross margin from network usage and services was partially offset by
      an
      decrease in webcasting gross margin of approximately $213,000 in fiscal 2006
      versus fiscal 2005. This decrease in webcasting gross margin was primarily
      due
      to (i) an increase in the number of webcast events requiring us to incur
      incremental production costs to augment our existing infrastructure - such
      costs
      are rebilled to our customers at lower margins than we experience on the
      standard service portion of our business and (ii) an increase in our fixed
      costs
      in anticipation of supporting higher sales levels.





Based
      on
      our sales expectations discussed above, we expect gross margin to exceed the
      corresponding prior year amounts for fiscal year 2007, although such increase
      cannot be assured.





Our
      CEO
      continues to directly supervise the sales function and intends to do so until
      the previously implemented reorganization, which included changes in personnel
      and changes in compensation amounts and methods, results in satisfactorily
      better sales results from better targeting of receptive markets for our products
      and services and from the implementation and/or improved execution of the
      methods and techniques used by our sales force.





**Operating
      Expenses**





Consolidated
      operating expenses were approximately $11.0 million for the year ended September
      30, 2006, an increase of approximately $359,000 (3%) over the prior year,
      primarily from increased depreciation expenses, partially offset by reduced
      expenses for professional fees and impairment loss on goodwill.





Depreciation
      and amortization increased approximately $969,000 (84%) for fiscal 2006 versus
      fiscal 2005, primarily due to the commencement of depreciation of the DMSP,
      a
      limited version of which was placed in service in November 2005. We have
      incurred approximately $1.5 million for capital expenditures during fiscal
      2006
      and the complete version of the DMSP was placed in service during October 2007.
      As a result, we expect increases in depreciation expense for fiscal year 2007
      as
      compared to the corresponding prior year amounts.





Professional
      fees expense for fiscal 2006 decreased approximately $514,000 (18%) versus
      fiscal 2005. This was primarily due to a decrease in expenses for marketing
      and
      financial consulting services, including amounts paid under certain executive
      severance agreements during the prior year period, primarily paid for by the issuance of our common stock and options to buy our
      common stock. This
      decrease was partially offset by marketing expenses from new direct sales and
      other programs not in place during the prior year. We have entered into several
      consulting contracts that have resulted or will result in the issuance of common
      shares and options to purchase common shares, in addition to cash payments.
      Including contracts entered into after September 30, 2006, these contracts
      will
      result in future professional fee expenses of approximately $2.0 million
      recognized during the next twelve months, although the ultimate expense will
      be
      dependent on our valuation of those shares and options at the time they are
      issued. Based on this, as well as expected increased expenditures associated
      with Sarbanes-Oxley compliance and marketing programs, we expect increases
      in
      professional fees expense for fiscal year 2007 as compared to the corresponding
      prior year amounts.





We
      recognized no impairment losses on goodwill during fiscal 2006, versus an
      impairment loss on goodwill of $330,000 for fiscal 2005, to adjust the carrying
      value of the intangible assets arising from the 2001 acquisition of EDNet to
      fair value. Primarily as a result of the increase in EDNet’s gross margin for
      fiscal 2006 as compared to fiscal 2005, the valuation assigned to EDNet’s
      goodwill was sufficient so that no write-down was considered necessary in fiscal
      2006. We also evaluated the September 30, 2006 and 2005 carrying values of
      the
      intangible assets arising from the 2002 acquisition of MOD, as well as the
      December 31, 2005 carrying values of the intangible assets arising from the
      Onstream Merger, and determined that no adjustment was necessary. We were
      assisted by an independent third party appraiser in performing all valuations
      in
      accordance with SFAS 142, which were based on an evaluation of projected cash
      flows from the relevant operations as well as market values of independent
      comparable companies.





21


**Other
      Expense**





Other
      expense decreased to approximately $609,000 for the year ended September 30,
      2006, versus approximately $4.0 million for the previous year, a decrease of
      approximately $3,421,000 (85%). This decrease is primarily due to a decrease
      in
      interest expense of approximately $1.9 million, an increase in other income
      of
      approximately $240,000 and non-cash
      income of approximately $1.3 million for the valuation of derivative instruments
      in fiscal 2006 period having no corresponding effect in fiscal 2005 .





The
      decrease in interest expense for fiscal 2006, versus the prior year, is
      primarily due to higher non-cash interest expense in that prior year period
      -
      approximately $944,000 for a non-cash penalty (payable in common shares) we
      incurred as a result of a delay in registering shares issued in a previous
      financing and approximately $494,000 from the write-off of unamortized discount
      due to early debt repayments. In addition, interest expense was higher in fiscal
      2005 as a result of more conversions of the 8% Convertible Debentures and
      Additional 8% Convertible Debentures to equity - $2,705,000 in fiscal 2005
      versus only $820,000 in fiscal 2006 - and the resulting higher write-off of
      unamortized discount in fiscal 2005 versus fiscal 2006.





As
      a
      result of the sale of 8% Convertible Debentures in December 2004, the sale
      of
      the Additional 8% Convertible Debentures in February and April 2005, and the
      sale of the 8% Subordinated Convertible Debentures in March 2006, and after
      giving effect to conversions through September 30, 2006, approximately $2.3
      million of unamortized debt discount remains on our September 30, 2006 balance
      sheet. In the event of redemption or conversion of the remaining outstanding
      balance of these debts before the end of their four-year term, we would write
      off the unamortized portion of the related debt discount to interest expense
      at
      that time. Accordingly, conversions of approximately $3.8 million occurring
      after September 30, 2006 will result in the write-off to expense of
      approximately $1.5 million unamortized debt discount during the three months
      ending December 31, 2006 and another approximately $100,000 during the three
      months ending March 31, 2007.





The
      above
      debenture conversions, as well as significant warrant exercises occurring after
      September 30, 2006 have reduced the pool of derivatives that we are required
      to
      adjust to market value each quarter in accordance with EITF 00-19. However,
      the
      valuation of our derivative instruments is affected by several factors, one
      of
      the most significant being the underlying market price of our common shares.
      In
      general, an increase in that underlying market price will result in an increased
      valuation of the liability associated with that derivative instrument, which
      will in turn increase the non-cash expense. Conversely, a decrease in that
      underlying market price will generally result in a decreased valuation of the
      liability associated with that derivative instrument, which will in turn reduce
      the non-cash expense or result in non-cash income. The valuation is also
      affected by the calculated volatility of our common shares, with increases
      in
      volatility generally increasing warrant values, as determined under the
      Black-Scholes model. The market price of the Company’s shares increased from
      $0.64 per share at September 30, 2006 to $2.88 per share at January 10,
      2007.





As
      a
      result of our accounting for potential rescission rights, the changes in the
      valuation of certain of these derivative instruments were not reflected in
      our
      results of operations prior to May 23, 2006. The reflection of the changes
      in
      valuation of these same derivative instruments in our results of operations
      after that date could result in greater non-cash expense or income as compared
      to prior periods.





22





**Liquidity
      and Capital Resources**





Although
      our fiscal 2006 financial statements reflect a net loss of approximately $6.5
      million, cash used in operations of approximately $1.5 million and a working
      capital deficit at September 30, 2006 of approximately $3.8 million, as a result
      of significant cash we have received from debt and equity transactions since
      that date, we believe that we have sufficient capital resources to fund our
      continued operations for at least the remainder of fiscal 2007. Our cash balance
      was approximately $2.7 million as of January 10, 2007, resulting
      primarily from the following transactions occurring after September 30, 2006:





On
      October 27, 2006 we entered into a four-year promissory note in the aggregate
      principal amount of $1.0 million, which was funded in installments through
      December 2006. The note is unsecured and subordinated to all of our other
      liabilities. At any time after April 27, 2007 or earlier date if agreed to
      by
      us, the lending entity, at its option, may begin converting the outstanding
      principal to our unregistered common stock at the rate of $1.00 per share
      through October 25, 2009, and at the rate of $2.00 per share thereafter. We
      agreed to the conversion of this loan to 1.0 million common shares on January
      10, 2007.





During
      December 2006 and January 2007 to date, we received approximately $3.1 million
      from the exercise of previously issued warrants and options, resulting in our
      issuance of 2,076,479 registered common shares. These warrants and options
      had
      exercise prices ranging from $1.00 to $2.00 per share.





During
      December 2006, we received the final $300,000 as the final funding installment
      due under a total $750,000 five-year convertible loan. Pursuant to a
      renegotiation of this loan, discussed in more detail below and which
      included the commitment of the lender to advance another $750,000, we received
      another $100,000 in December and $50,000 in January.





The
      working capital deficit of approximately $3.8 million at September 30, 2006
      includes (i) a
      liability of approximately $1.1 million related to detachable warrants and
      embedded conversion features that we do not currently anticipate paying and
      may
      never be paid, although there is no assurance of this, (ii) a liability of
      $726,478 related to the current portion of the 8% Convertible Debentures, which
      as a result of significant conversions to equity occurring after September
      30,
      2006, has been reduced to approximately $183,000, and furthermore would be
      payable in equity if the company’s current common share price were to be
      sustained, and (iii) a liability for the current portion of notes payable which
      includes $300,000 that was subsequently renegotiated to be convertible into
      equity at $1.22 per share at our option and another $271,315 that is convertible
      into equity at $1.00 per share, and that we believe is probable to be converted. The
      working capital deficit also includes approximately $398,000 of prepaid
      expenses, primarily consulting fees paid with
      equity, which will be expensed in future periods over the remaining lives of
      the
      applicable consulting agreements.





During
      March 2006, we sold subordinated secured convertible notes (“8% Subordinated
      Convertible Debentures”), including common stock purchase warrants, for
      aggregate gross proceeds of $2.3 million (which included $375,000 applied from
      previously existing Company indebtedness). The proceeds were used as follows:
      approximately $695,000 to repay previous borrowings and interest, approximately
      $815,000 for operating payables and short-term bridge financing used to pay
      similar expenses, approximately $440,000 for past and future capital
      expenditures and approximately $200,000 for financing fees and expenses, with
      the balance allocated for marketing expenses and working capital.





23


The
      terms
      of the $2.3 million financing allow us to sell an additional $1.2 million
      principal amount of 8% subordinated secured convertible notes, together with
      common stock purchase warrants to purchase an aggregate of 420,000 shares of
      ONSM common stock, all under identical terms to the initial $2.3 million
      transaction but subject to shareholder approval, in accordance with the
      requirements of Rule 4350(i) of the Nasdaq Marketplace Rules. The purchasers
      of
      these securities must remit the purchase price to us within five (5) days of
      being notified of such shareholder approval. We have not determined whether
      we
      will seek this additional financing.





During
      October and November 2005, we borrowed $450,000 from Neil Berman, a major
      shareholder. The remaining $300,000 commitment from this lender under this
      note,
      collateralized by previously purchased hardware and software, was received
      in
      December 2006, for total proceeds under the five-year note of $750,000.  Following
      Board of Director approval of the modified terms in December 2006, the note
      was
      formally modified in January 2007 to increase  the
      principal amount to $1,500,000, increase the interest rate to 17.75% (which
      the
      lender may request prepayment of in our common shares at $1.00 per
      share) and modify the note priority to unsecured and subordinated to all
      other debt. In addition, the new terms allow us or the lender to convert the
      loan balance to restricted common stock at $1.00 per share at any time. We
      received $100,000 of the increased note amount in December 2006 and $50,000
      in
      January 2007.





During
      June 2006 we borrowed $300,000 from J&C Resources, LLC, whose President,
      Chairman and CEO is a member of our board of directors. The principal balance
      is
      due one year after the borrowing date or three days after receipt of funding,
      including exercise of warrants, in excess of $1.0 million, whichever occurs
      first. Total interest, origination and legal fess totaling $21,000 cash and
      21,000 common shares are due on maturity. Finders fees of $9,000 cash and 9,000
      common shares are payable at loan maturity to Asset Factoring Ltd, a related
      entity. In January 2007, all fees due upon maturity were paid in cash and stock,
      as applicable. Following Board of Director approval of the modified terms in
      October 2006, the note was formally modified in January 2007 to be convertible
      into common shares at $1.22 per share and to bear interest at 14.67% per annum,
      non-compounding, which we may settle in shares at $1.22 per share. We have
      the
      option to force conversion after 18 months and interest is payable at time
      of
      conversion or repayment.





During
      August 2006 we borrowed $350,000 from Platinum Credit Group, LLC, secured by
      a
      secondary lien on up to $350,000 of our tangible equipment. In addition, we
      dedicated certain receivables proceeds to pay $100,000 principal installments,
      which were paid when due on November 15 and December 15, 2006 as well as the
      $150,000 principal balance paid when due on January 12, 2007. At the
      time of the borrowing, we paid related fees totaling $50,000 in cash and prepaid
      interest in the form of 80,000
      shares of ONSM common stock. We are subject to a penalty of 20,000 shares per
      month while any portion of the principal is past due.





During
      September 2006, we borrowed $300,000 from Lewis Opportunity Fund LP, a major
      shareholder. Cash interest of 10% was paid in advance. The principal, plus
      additional interest of 90,000 common shares, is due on September 14, 2007.
      We
      may prepay all or any part of the principal after April 15, 2007 and before
      maturity without penalty, although we must give the lender five days notice
      before repayment to allow them opportunity to exercise rights of conversion.
      In
      the event of early repayment or transfer to another financing, all cash interest
      for the entire term of the loan will be deemed earned but the interest shares
      will be partially earned on the following basis - prepayment within eight months
      - 60,000 shares; thereafter - 90,000 shares. The note is convertible at the
      lender’s option at any time after April 15, 2007, to unregistered common stock
      at the rate of $1.00 per common share. In the event of such a conversion of
      the
      entire principal amount, all cash and interest shares for the entire term of
      the
      loan will be fully earned. We
      granted the lender a secondary lien on up to $300,000 of tangible equipment.





24


The
      terms
      of the 8% Convertible Debentures that were issued in December 2004, February
      2005 and April 2005 provide that any remaining unconverted amounts as of a
      certain date will be repaid in nine equal quarterly installments. The repayment
      of the $3.0 million of 8% Convertible Debentures (including the AIR) that were
      unconverted as of September 30, 2006 would require nine equal quarterly
      installments of $333,333. Although the note documents indicate that these
      quarterly payments start on September 30, 2006, this would result in the ninth
      payment being on September 30, 2008, which is 2.5 months earlier than the stated
      note maturity date. Therefore we believe that the intent of the documents was
      for these quarterly payments to start in December 2006 and end with the ninth
      payment in December 2008, the stated maturity date. The
      initial quarterly payment due in December 2006 was satisfied by the Company’s
      issuance of shares, which will be reported as conversions of debt to equity
      and
      accounted for accordingly. The
      September 30, 2006 financial statements reflect a current liability of $726,478,
      which is equal to four of those quarterly payments, net of the related discount.
      However, as a result of significant conversions occurring after September 30,
      2006, the amount of the next four quarterly installments, net of discount,
      has
      been reduced to approximately $183,000.





We
      received a letter from NASDAQ dated August 2, 2006 indicating that we had 180
      calendar days, or until January 29, 2007, to regain compliance with Marketplace
      Rule 4310(c)(4), which is necessary in order to be eligible for continued
      listing on the NASDAQ Capital Market. The letter from NASDAQ indicated that
      our
      non-compliance with that rule was as a result of the bid price of its common
      stock closing below $1.00 per share for the preceding thirty consecutive
      business days. The
      terms
      of the 8% Senior Convertible Debentures and the 8% Subordinated Convertible
      Debentures contain penalty and acceleration clauses in the event our common
      stock is not traded on NASDAQ or a similar national exchange. We
      received a letter from NASDAQ dated December 4, 2006, stating that we had
      regained compliance with NASDAQ Marketplace Rule 4310(c)(4) as of that date,
      by
      having met the $1.00 per share or greater minimum closing bid price requirement
      for a minimum of 10 consecutive business days. The
      closing ONSM share price was $2.88 per share on January 10, 2007.





We
      have
      incurred losses since our inception and our operations have been financed
      primarily through the issuance of equity and debt. Our accumulated deficit
      was
      approximately $77.9 million at September 30, 2006. Our future working capital
      requirements depend primarily on the rate at which we can decrease our use
      of
      cash to fund operations, which is in turn dependent on an increase in our
      revenues. Cash used for operations will be affected by numerous known and
      unknown risks and uncertainties including, but not limited to, our ability
      to
      successfully market and sell the DMSP, market our other existing products and
      services, the degree to which competitive products and services are introduced
      to the market, and our ability to control overhead expenses as we grow.





As
      part
      of expanded marketing and financial management programs, neither of which is
      guaranteed to be successful, we have entered into several consulting contracts
      that will result in the issuance of common shares and options to purchase common
      shares, in addition to cash payments. Including contracts entered into after
      September 30, 2006, these contracts will result in future cash payments of
      approximately $35,000 over the next twelve months, not including amounts payable
      with common shares and options. We also expect increases in our operating
      expenses during the next year arising from a Sarbanes-Oxley 404 compliance
      program, although we cannot guarantee that this program will be successful
      and
      we may be able to defer these expenses based on the status of regulatory changes
      in this area. We also anticipate additional operating expenses in fiscal year
      2007 related to the continuation of our marketing program expansion that began
      in fiscal years 2005 and 2006, although we cannot guarantee that this expansion
      will be implemented or that our marketing efforts will be successful.





25


In
      order
      to accomodate recent increases in our digital asset management business volume
      from Discovery and other new customers, we have made significant encoding system
      hardware and software upgrades and increased our San Francisco facility by
      approximately 2,400 square feet. We have spent $3.6 million for capital
      expenditures during the two years ended September 30, 2006, including
      approximately $370,000 in accounts payable at that date and approximately
      $400,000 for capital expenditures incurred by Acquired Onstream but paid for
      by
      us after the Onstream Merger. Projected capital expenditures for the next twelve
      months total approximately $900,000, which includes ongoing upgrades to the
      DMSP as well as the webcasting and encoding system software and hardware
      infrastructure. We have recently hired several professionals that were
      previously employed with SAIC, including a new Chief Technology Officer, and
      accordingly expect a certain percentage of our future development costs to
      be
      capitalized employee salaries and benefits, which are included in the
      anticipated capital expenditure amounts noted above.





Prior
      to
      August 5, 2005, we owned preferred shares of Curaspan, Inc. with an original
      cost of approximately $108,000, which was fully reserved since 2002 as a result
      of Curaspan’s continuing operating losses and negative financial condition.
      However, on August 5, 2005 we sold those preferred shares to Curaspan for
      $50,000 cash and a $150,000 note from Curaspan, payable over 2 years at 6%
      interest. The note is collateralized by Curaspan’s assets, subordinate to a
      lending bank’s interest in certain of those assets. In addition, the preferred
      shares are being held in escrow and will be returned to us in the event of
      Curaspan’s uncured default under the note. All scheduled payments have been made
      through January 10, 2007.





As
      noted
      above, during December 2006 and through January 10, 2007, we received
      approximately $3.1 million from the exercise of previously issued warrants
      and
      options. As of January 11, 2007, there were still approximately 6.8 million
      registered options and warrants outstanding to purchase ONSM shares with
      exercise prices of $1.65 or less and an average exercise price of approximately
      $1.50 per share. The closing ONSM share price was $2.88 per share on January
      10,
      2007.





Other
      than working capital which may become available to us through the fulfillment
      of
      the outstanding Berman note financing commitment or through the payments on
      the
      Curaspan note, as discussed above, and/or the exercise of outstanding options
      and warrants, we do not presently have any additional sources of working capital
      other than cash on hand and cash, if any, generated from operations. There
      are
      no assurances whatsoever that the outstanding note financing commitment will
      be
      fulfilled, that we will collect any further payments due from Curaspan under
      the
      note, that any options or warrants will be exercised, or that we will increase
      our revenues to a level sufficient to provide positive cash flow.





We
      cannot
      assure that our revenues will continue at their present levels, nor can we
      assure that they will not decrease. We recently completed the DMSP and placed
      a
      limited version of it in initial service with third-party customers in November
      2005, but there have been limited sales to date and we cannot assure what the
      future sales activity will be. As long as our cash flow from sales remains
      insufficient to completely fund operating expenses, financing costs and capital
      expenditures, we will continue depleting our cash and other financial resources.
      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. 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.





There
      can
      be no assurance that acceptable financing, if needed to fund our ongoing
      operations, can be obtained on suitable terms, if at all. Our ability to
      continue our existing operations and/or to continue to implement our growth
      strategy could suffer if we are unable to raise additional funds on acceptable
      terms, which will have an adverse impact on our financial condition and results
      of operations.





26


Cash
      used
      in operating activities was approximately $1.5 million for the year ended
      September 30, 2006, as compared to approximately $1.9 million for the prior
      year. The $1.5 million reflects our net loss of approximately $6.5 million,
      reduced by approximately $4.2 million of non-cash expenses included in that
      loss
      and approximately $750,000 arising from a net decrease in non-cash working
      capital items during the period. The decrease in non-cash working capital items
      for the year ended September 30, 2006 is primarily due to an approximately
      $920,000 increase in accounts payable. This compares to a net decrease in
      non-cash working capital items of approximately $459,000 for the prior year.
      The
      primary non-cash expenses included in our loss for the year ended September
      30,
      2006 were approximately $2.1 million of depreciation and amortization,
      approximately $1.4 million of amortization of discount on debentures and notes
      payable, including amounts arising from early debt repayment, approximately
      $1.4
      million of amortization of deferred professional fee expenses paid for by
      issuing stock and options and approximately $523,000 of interest expense paid
      in
      common shares, offset by approximately $1.3 million non-cash income from the
      valuation of derivative instruments. The primary sources of cash inflows from
      operations are from receivables collected from sales to customers. Future cash
      inflows from sales are subject to our pricing and ability to procure business
      at
      existing market conditions.





Cash
      used
      in investing activities was approximately $1.1 million for the year ended
      September 30, 2006 as compared to approximately $3.8 million for the prior
      year.
      Current period investing activities were primarily acquisition of property
      and
      equipment, primarily related to the DMSP, while the prior year investing
      activities related to approximately $1.5 million for advances to Acquired
      Onstream, primarily payments (i) to Virage for principal and interest due on
      a
      promissory note of Acquired Onstream and guaranteed by the Company and (ii)
      to
      certain selling management of Acquired Onstream for accrued salaries and related
      employer taxes, as well as cash payments associated with the Onstream Merger
      of
      approximately $664,000, including subsequent payment of accounts payable assumed
      at the time of the Onstream Merger and approximately $1.7 million to acquire
      property and equipment, including amounts paid toward the ultimate completion
      of
      the DMSP and equipment used to support those operations.





Cash
      provided by financing activities was approximately $2.9 million for the year
      ended September 30, 2006 as compared to approximately $5.7 million for the
      prior
      year. Current period financing activities primarily related to approximately
      $1.8 million from the 8% Subordinated Convertible Debentures as well as $1.1
      million from short-term equipment and other financing, net of repayments, while
      the prior year financing activities were primarily proceeds from the 8%
      Convertible Debentures and Series A-10 Preferred financing transactions as
      well
      as the repayment, primarily from those proceeds, of all other outstanding debt
      and preferred shares.





**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 both most
      important to the management’s most subjective judgments. The Company’s most
      critical accounting policies and estimates are described as
      follows.





27


Our
      prior
      acquisitions of several businesses, including the Onstream Merger, have resulted
      in significant increases in goodwill and other intangible assets. Unamortized
      goodwill and other intangible assets, which includes acquired customer lists,
      were approximately $9.9 million at September 30, 2006, representing
      approximately 58% of our total assets and 118% of the book value of shareholder
      equity. In addition, property and equipment as of September 30, 2006 includes
      approximately $3.2 million (net of depreciation) related to the
      DMSP.





In
      accordance with GAAP, the Company periodically tests 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 change in our business
      operations, the value of our intangible assets, including the DMSP, could
      decrease significantly. In the event that it is determined that we will be
      unable to successfully market or sell the DMSP, 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.





We
      have
      estimated the fair value of warrants issued in conjunction with the 8%
      Subordinated Convertible Debentures, the 8% Convertible Debentures, the
      Additional 8% Convertible Debentures and the Series A-10, plus the potential
      value arising from a beneficial conversion feature included in the terms of
      those financings, and recorded this estimate, along with the direct costs
      associated with that financing, as a discount to the face amount of the
      financing. The unamortized portion of these discounts as of September 30, 2006
      is approximately $3.7 million.




These
      non-cash amounts will be amortized as dividends and as interest expense over
      the
      balance of the four-year financing terms, although any unamortized portion
      will
      be immediately expensed at the time of a conversion or redemption occurring
      before the end of those terms. Accordingly, debenture conversions of
      approximately $3.8 million occurring after September 30, 2006 will result in
      the
      write-off to expense of approximately $1.5 million unamortized debt discount
      during the three months ending December 31, 2006 and another approximately
      $100,000 during the three months ending March 31, 2007.





**ITEM
      7.** **FINANCIAL
      STATEMENTS**





Our
      financial statements are contained in pages F-1 through F-48, which appear
      at
      the end of this annual report.




**ITEM
      8.   CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
      FINANCIAL DISCLOSURE**





None.




**ITEM
      8A.** **CONTROLS
      AND PROCEDURES**





As
      required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the
      end
      of the period covered by the annual report, being September 30, 2006, we have
      carried out an evaluation of the effectiveness of the design and operation
      of
      our company's disclosure controls and procedures. This evaluation was carried
      out under the supervision and with the participation of our company's
      management, including our company's President along with our company's Chief
      Financial Officer. Based upon that evaluation, our company's President along
      with our company's Chief Financial Officer concluded that our company's
      disclosure controls and procedures are effective. Based upon that evaluation,
      no
      change in our company's internal controls over financial reporting has occurred
      during the quarter then ended, which has materially affected, or is reasonably
      likely to materially affect, our internal control over financial
      reporting.




Disclosure
      controls and procedures and other procedures that are designed to ensure that
      information required to be disclosed in our reports filed or submitted under
      the
      Securities Exchange Act of 1934 is recorded, processed, summarized and reported,
      within the time period specified in the Securities and Exchange Commission's
      rules and forms. Disclosure controls and procedures include, without limitation,
      controls and procedures designed to ensure that information required to be
      disclosed in our reports filed under the Securities Exchange Act of 1934 is
      accumulated and communicated to management including our President and Chief
      Financial Officer as appropriate, to allow timely decisions regarding required
      disclosure.





**ITEM
      8B.**  **OTHER
      INFORMATION**





None. ****


28


**PART
      III**





**ITEM
                9.**
            
            **DIRECTORS,
                EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH
                SECTION
                16(A) OF THE EXCHANGE ACT**





**Executive
      Officers and Directors**




Our
      executive officers and directors, and their ages are as follows:





Name
            
            Age
            PositionRandy
                S. Selman
            
            50
            Chairman
                of the Board, President and Chief Executive OfficerClifford
                Friedland
            
            55
            Vice
                Chairman of the Board, Senior Vice President Business
                DevelopmentAlan
                M. Saperstein
            
            47
            Director,
                Chief Operating Officer and TreasurerDavid
                Glassman
            
            55
            Senior
                Vice President and Chief Marketing OfficerRobert
                E. Tomlinson
            
            49
            Senior
                Vice President and Chief Financial OfficerBenjamin
                Swirsky
            (1)(2)(3)(4)
            65
            DirectorRobert
                J. Wussler
            (1)(2)(3)(4)
            70
            DirectorCharles
                C. Johnston
            (1)
                (3)
            71
            DirectorCarl
                L. Silva
            (1)(2)(3)(4)
            43
            Director





(1)
            Member of the Compensation
              Committee.


(2)
            Member of the Audit
              Committee.


(3)
            Member
                of the Governance and Nominating
                Committee.


(4)
            Member
                of the Finance Committee.





***Randy
      S. Selman*** .
      Since
      our inception in May 1993, Mr. Selman has served as our Chief Executive Officer,
      President, and a director and from September 1996 through June 1999 and from
      August 1 through December 15, 2004, as our Chief Financial Officer. From March
      1985 through May 1993, Mr. Selman was Chairman of the Board, President and
      Chief
      Executive Officer of SK Technologies Corporation (Nasdaq:SKTC), a
      publicly-traded software development company. SKTC develops and markets software
      for point-of-sale with complete back office functions such as inventory, sales
      analysis and communications. Mr. Selman founded SKTC in 1985 and was involved
      in
      their initial public offering in 1989. Mr. Selman's responsibilities included
      management of SKTC, public and investor relations, finance, high level sales
      and
      general overall administration.




***Alan
      M. Saperstein*** .
      Mr.
      Saperstein has served as our Executive Vice President, Treasurer and a director
      since our inception in May 1993, and has been our Chief Operating Officer since
      December 2004. Mr. Saperstein also serves as an alternate member of the
      Compensation Committee of the board of directors. From March 1989 until May
      1993, Mr. Saperstein was a free-lance producer of video film projects. Mr.
      Saperstein has provided consulting services for corporations that have set
      up
      their own sales and training video departments. From 1983 through 1989, Mr.
      Saperstein was the Executive Director/Entertainment Division of NFL Films where
      he was responsible for supervision of all projects, budgets, screenings and
      staffing.





29


***Clifford
      Friedland*** .
      Mr.
      Friedland was appointed as a member of our board of directors in December 2004.
      From June 2001 until the closing of the Onstream Merger in December 2004 he
      had
      served as Chairman, CEO and co-founder of privately held Onstream Media
      Corporation. Mr. Friedland was Vice President of Business Development and
      co-founder of TelePlace, Inc., a developer and owner of internet data centers
      and central offices from December 1999 to May 2001. Mr. Friedland was
      co-founder, Chairman and co-CEO of Long Distance International, Inc., one of
      the
      first competitive European telephone operators from May 1993 to December 1999.
      Mr. Friedland was President of Clifford Friedland Inc., a technology consulting
      firm, from January 1991 to April 1993. Mr. Friedland was a Director and
      co-founder of Action Pay-Per-View, a pay per view cable channel from January
      1988 to December 1990. Mr. Friedland was President and co-founder of Long
      Distance America, one of the first competitive long distance operators after
      the
      breakup of AT&T from June 1984 to December 1987. Mr. Friedland was Vice
      President and co-founder of United States Satellite Systems, Inc., an FCC
      licensed builder and operator of geosynchronous communications satellites from
      April 1981 until December 1983. Mr. Friedland was Director and co-founder of
      United Satellite Communications, Inc., the world’s first direct-to-home
      satellite network from April 1981 until May 1984. Mr. Friedland received a
      B.B.A. cum laude, from City University of New York.





***David
      Glassman*** **.** Mr.
      Glassman has served as our Chief Marketing Officer since December 2004. As
      described below, at such time as an additional independent director is added
      to
      our board, Mr. Glassman will join our board of directors. He served as Vice
      Chairman, President and co-founder of Acquired Onstream from June 2001 until
      joining our company. Mr. Glassman was Vice President of Marketing and co-founder
      of TelePlace, Inc., a developer and owner of internet data centers and central
      offices from December 1999 to May 2001. Mr. Glassman was co-founder, Vice
      Chairman and Co-CEO of Long Distance International, Inc., one of the first
      competitive European telephone operators from May 1993 to December 1999. Mr.
      Glassman was an independent technology consultant from January 1988 to April
      1993. Clients included Action Pay Per View. Mr. Glassman was President and
      co-founder of Long Distance America, one of the first competitive long distance
      operators after the breakup of AT&T from January 1984 to December 1987. Mr.
      Glassman was a communications consultant from January 1981 to January 1984
      providing services to United States Satellite Systems Inc. and United Satellite
      Communications Inc. Mr. Glassman was co-founder and director of All American
      Hero, Inc., from January 1981 until December 1986. Mr. Glassman received a
      B.S.
      in Business Management from Florida International University.





***Robert
      E. Tomlinson.*** On
      December 15, 2004 Mr. Tomlinson was appointed our Chief Financial Officer. Mr.
      Tomlinson joined us as Vice President-Finance in September 2004. Mr. Tomlinson
      started his financial and accounting career in 1977 with the international
      accounting firm of Price Waterhouse. In 1982 he left that firm to join Embraer,
      an international aircraft manufacturing and support firm, at their U.S.
      subsidiary in Fort Lauderdale, Florida, where he managed all financial functions
      and eventually was named Senior Vice President-Finance and a member of the
      U.S.
      firm’s Board of Directors. Mr. Tomlinson left Embraer in 1994 and joined
      staffing and human resource firm OutSource International, serving as its Chief
      Financial Officer and helping to take the company public in 1997. Mr.
      Tomlinson's areas of responsibility at OutSource International included
      corporate accounting, treasury and risk management. From when he left OutSource
      International in February 2000 until 2002 he worked as an independent certified
      public accountant, focusing on accounting and tax services to corporations.
      From
      2002 until joining us, Mr. Tomlinson served as CFO for Total Travel and Tickets,
      a Fort Lauderdale based ticket broker. Mr. Tomlinson has held an active
      Certified Public Accountant license since 1978.





***Benjamin
      Swirsky*** .
      Mr.
      Swirsky has been a member of our board of directors since July 1997 and serves
      on our Audit (as Chairman), Compensation, Governance and Nominating and Finance
      Committees. Mr. Swirsky is the owner of Beswir Properties Inc., an investment
      capital company. From June 1993 until January 1998, Mr. Swirsky was President
      and Chief Executive Officer of Slater Steel, Inc., a publicly-traded company
      listed on the (Toronto Stock Exchange (“TSE”): SSI) with investments in the
      steel, steel service, forging, pole-line hardware and trucking industries.
      Mr.
      Swirsky was Chairman of P.C.Docs International, Inc., a Canadian publicly-traded
      company (Nasdaq: DOCSF, TSE: DXX) from 1997-1999. Mr. Swirsky is also a member
      of the board of directors of Four Seasons Hotel Inc. (NYSE:FS), which owns
      a
      chain of first class hotels located throughout the world, and serves on the
      Audit, Compensation and Governance committees of its Board. Mr. Swirsky also
      sits on the board of directors of a number of other companies, including (i)
      CamVec Corp., a Canadian publicly-traded company (CAT.CV), (ii) Commercial
      Alcohols, Inc., in which he is also a principal shareholder, (iii) Amica Mature
      Lifestyles, Inc., a Toronto Stock Exchange company, and (iv) Alliance Financial,
      Inc., a Canadian publicly-traded company where he serves as
      Chairman.




30


***Robert
      J. Wussler*** .
      Mr.
      Wussler has been a member of our board of directors since July 1999 and serves
      on our Audit, Compensation, Governance and Nominating and Finance Committees.
      Mr. Wussler is currently the President of Ted Turner Pictures LLC and is
      Chairman of the Board of Directors of Team Sports Entertainment, Inc., a
      publicly-traded company (OTC Bulletin Board:TSPT) that is in the closed-wheel
      auto racing business. Prior to that, he served as Chairman, Chief Executive
      Officer and President of U.S. Digital Communications, Inc., a global satellite
      communications firm. From June 1995 to May 1998, Mr. Wussler was President
      and
      Chief Executive Officer of Affiliate Enterprises, Inc., a company formed by
      ABC
      Television affiliates to pursue new business opportunities. From 1989 to 1992,
      he was President and Chief Executive Officer of COMSAT Video Enterprises. From
      1980 to 1990, he was Senior Vice President and Chief Operating Officer of Turner
      Broadcasting System. Mr. Wussler spent 21 years at CBS in various capacities,
      starting in the mailroom, and served as President of CBS Television and Sports
      from 1975 to 1978.





***Charles
      C. Johnston*** .
      Mr.
      Johnston has been a member of our board of directors since April 2003 and serves
      on our Compensation, Governance and Nominating Committees. Mr. Johnston has
      been
      the Chairman of Ventex Technology, Inc., a privately-held neon light transformer
      company, since July 1993. Mr. Johnston has also served as Chairman of Inshore
      Technologies, a private company, since 1994 and J&C Resources, a private
      company, since 1987. Mr. Johnston is a member of the board of directors of
      AuthentiDate Holding Company (Nasdaq National Market: ADAT), Internet Commerce
      Corporation (Nasdaq National Market: ICCA) and McData Corporation (Nasdaq
      National Market: MCDT). Mr. Johnston serves as a Trustee of Worcester
      Polytechnic Institute and earned his B.S. degree from WPI in 1957.





***Carl
      Silva.*** Mr.
      Silva, who was appointed as a member of our Board of Directors in July 2006,
      serves on our Audit, Compensation, Governance and Nominating and Finance
      Committees. Mr. Silva has over 20 years of experience in the telecommunications
      and high tech industry, and he has held a variety of positions in business
      development, sales, marketing, software engineering, and systems engineering
      during this time. In May 2003, Mr. Silva started Anza Borrego Partners (ABP)
      as
      a management consulting firm designed to support entrepreneurs in the growth
      of
      their businesses. Mr. Silva is currently president and CEO or Cognigen Business
      Systems, Inc., a joint venture of ABP and Cognigen Networks, Inc. (NASDAQ:
      CNGW). Mr. Silva was Senior Vice-President for SAIC’s Converged Network
      Professional services organization from July 1998 to May 2003. From September
      1994 to June 1998, he was with Telcordia Technologies (formerly Bell
      Communications Research, or Bellcore), where he implemented the first VoIP
      softswitch in the cable industry.





There
      is
      no family relationship between any of the executive officers and directors.
      Each
      director is elected at our annual meeting of shareholders and holds office
      until
      the next annual meeting of shareholders, or until his successor is elected
      and
      qualified. At present, our bylaws provide for not less than two directors.
      The
      bylaws permit the board of directors to fill any vacancy and such director
      may
      serve until the next annual meeting of shareholders or until his successor
      is
      elected and qualified. The board of directors elects officers annually and
      their
      terms of office are at the discretion of the Board. Our officers devote full
      time to our business.





31


**Expansion
      of our board of directors**





Rule
      4350(c) of the Nasdaq Marketplace Rules to which we are subject requires that
      a
      majority of the members of our board of directors are independent as defined
      in
      Rule 4200 of the Nasdaq Marketplace Rules. Under the terms of the purchase
      and
      sale agreement for our Series A-10 Convertible Preferred Stock the purchasers
      have the right to designate one individual to join our board of directors.
      As of
      the date hereof, no individual has been designated. At such time as such
      individual is designated and elected to our board, and providing that the
      individual is an independent director, as defined in Rule 4200 of the Nasdaq
      Marketplace Rules, Mr. David Glassman will also join our board of directors.





**Directors'
      Compensation**




Directors
      who are not our employees received $3,750 per quarter as compensation for
      serving on the board of directors, as well as reimbursement of reasonable
      out-of-pocket expenses incurred in connection with their attendance at board
      of
      directors' meetings.





From
      time
      to time we issue the members of our board of directors options to purchase
      shares of our common stock as compensation for their services as directors.
      At
      September 30, 2006 members of our board of directors held outstanding options
      to
      purchase an aggregate of 3,871,814 shares of our common stock at prices ranging
      from $0.71 to $22.50 per share. On December 15, 2004 a majority of our
      shareholders voted to approve the cancellation (subject to the option holder’s
      approval) of 53,334 of these stock option grants, with such options to be
      re-issued six months and one day from the date of cancellation with an exercise
      price equal to the fair market value on the date of the reissue.





On
      December 15, 2004 a majority of our shareholders voted additional compensation
      to our directors for the closing of the Onstream Merger. Accordingly, each
      of
      the directors listed below have received immediately exercisable five-year
      options to purchase shares of our common stock with an exercise price of $1.57
      per share (fair market value on the date of issuance) in the amounts set forth
      below. These options were issued outside of our 1996 Stock Option
      Plan:





Name
            
            No.
                of Shares (1)Randy
                S. Selman (1)
            
            
            450,000Alan
                M. Saperstein (1)
            
            
            450,000Benjamin
                Swirsky
            
            
            100,000Robert
                J. Wussler
            
            
            100,000Charles
                C. Johnston
            
            
            100,0001,200,000





(1)
            Excludes
                non-Plan options to purchase 400,000 shares of our common stock with
                an
                exercise price of $2.50 per share (above fair market value on the
                date of
                issuance) that were issued as additional compensation under the new
                employment agreements each of Messrs. Selman and Saperstein executed
                following the closing of the Onstream Merger.





In
      December 2004, we issued immediately exercisable four-year Plan options to
      purchase 50,000 shares of our common stock with an exercise price of $1.57
      per
      share (fair market value on the date of issuance) granted to General Ronald
      W.
      Yates upon his initial appointment to our board of directors. General Yates
      resigned his director position in July 2006.





32








In
      July
      2005 we issued immediately exercisable five-year Plan options to purchase
      1,300,000 shares of our common stock with an exercise price of $1.12 per share
      (fair market value on the date of issuance), allocated as follows:





Name
            
            No.
                of SharesRandy
                S. Selman
            
            
            450,000Alan
                M. Saperstein
            
            
            450,000Benjamin
                Swirsky
            
            
            100,000Robert
                J. Wussler
            
            
            100,000Charles
                C. Johnston
            
            
            100,000Ronald
                W. Yates
            
            
            100,0001,300,000








In
      July
      2006 we issued immediately exercisable four-year Plan options to purchase 50,000
      shares of our common stock with an exercise price of $0.88 per share (fair
      market value on the date of issuance) granted to Mr. Carl L. Silva upon his
      initial appointment to our board of directors.





In
      September 2006 we issued immediately exercisable five-year Plan options to
      purchase 450,000 shares of our common stock with an exercise price of $0.71
      per
      share (above fair market value on the date of issuance), allocated as
      follows:





Name
            
            
            No.
                of SharesRandy
                S. Selman
            
            
            100,000Alan
                M. Saperstein
            
            
            100,000Clifford
                Friedland
            
            
            100,000Benjamin
                Swirsky
            
            
            50,000Robert
                J. Wussler
            
            
            50,000Charles
                C. Johnston
            
            
            50,000450,000








**Audit
      Committee**





The
      Audit
      Committee of the Board of Directors is responsible for the engagement of our
      independent public accountants, approves services rendered by our accountants,
      reviews the activities and recommendations of our internal audit department,
      and
      reviews and evaluates our accounting systems, financial controls and financial
      personnel. The Board has previously adopted a charter for the Audit Committee.
      Pursuant to the requirements of the Securities and Exchange Commission which
      requires that we provide our shareholders with a copy of the Audit Charter
      at
      least once every three years, we have included a copy of the Audit Charter
      as
      Appendix C to our proxy statement for our 2004 Annual Meeting filed with the
      SEC
      on November 14, 2004.





The
      Audit
      Committee is presently composed of Messrs. Swirsky, Wussler and Silva. Mr.
      Swirsky is Chairman of the Audit Committee. Each member of the Audit Committee
      is independent, as independence for audit committee members is defined in the
      listing standards of The Nasdaq Stock Market, Inc., and each of Messrs. Swirsky
      and Wussler is an "audit committee financial expert" within the meaning of
      the
      applicable regulations of the Securities and Exchange Commission promulgated
      pursuant to the Sarbanes-Oxley Act of 2002. The Audit Committee met (in-person
      and/or by telephone conference) seven (7) times in fiscal 2006.





33





**Compensation
      Committee**





The
      Compensation Committee establishes and administers our executive compensation
      practices and policies, reviews the individual elements of total compensation
      for elected officers and recommends salary adjustments to the board of
      directors. In addition, the Compensation Committee administers our 1996 Stock
      Option Plan and determines the number of performance shares and other equity
      incentives awarded to elected officers and the terms and conditions of which
      they are granted, amends compensation plans within the scope of the Compensation
      Committee's authority and recommends plans and plan amendments to the board,
      sets company policy for employee benefit programs and plans and oversees
      administration of employee retirement plans and various other benefit plans
      as
      we may establish from time to time. The Compensation Committee consists of
      Messrs. Swirsky, Wussler, Johnston and Silva. The Compensation Committee met
      in
      fiscal 2006 in conjunction with meetings of the full Board of
      Directors.





**Finance
      Committee**





The
      Finance Committee reviews and makes recommendations concerning:





*  proposed
      dividend actions, stock splits and repurchases,


*  current
      and projected capital requirements,


*  issuance
      of debt or equity securities,


*
            strategic
                plans and transactions, including mergers, acquisitions, divestitures,
                joint ventures and other equity
                investments,


*
            customer
                financing activities, business and related customer finance business
                and
                funding plans,


*  overall
      company risk management program and major insurance programs, and


*
            investment
                policies, administration and performance of the trust investments
                of our
                employee benefit plans.





Messrs.
      Swirsky, Wussler, and Silva are the members of the Finance Committee. The
      Finance Committee met in fiscal 2006 in conjunction with meetings of the full
      Board of Directors.





**Governance
      and Nominating Committee**





While
      we
      have not adopted a formal charter for the Governance and Nominating Committee,
      in June 2003 our Board of Directors adopted Corporate Governance and Nominating
      Committee Principles. A copy of our Corporate Governance and Nominating
      Committee Principles is attached as Exhibit C to the proxy statement for our
      2005 Annual Meeting.





The
      Governance and Nominating Committee reviews and makes recommendations to the
      board of directors with respect to:





*the
                responsibilities and functions of the board and board committees
                and with
                respect to board compensation,


*the
                composition and governance of the board, including recommending candidates
                to fill vacancies on, or to be elected or re-elected to, the
                board,


*candidates
                for election as Chief Executive Officer and other corporate officers,
                and


*monitoring
                the performance of the Chief Executive Officer and our plans for
                senior
                management succession.





The
      consideration of any candidate to become a member of our board of directors
      will
      be based on the board's assessment of the individual's background, skills and
      abilities, and if such characteristics qualify the individual to fulfill the
      needs of the board at that time. The board does not assign any particular weight
      or priority to any particular factor it may consider. Candidates for director
      may be identified by management, other directors or advisors to our company.
      The
      board of directors may employ an executive search firm to assist it in future
      searches for board candidates.





34


Messrs.
      Swirsky, Wussler, Johnston and Silva are members of the Governance and
      Nominating Committee, and are "independent", as independence for nominating
      committee members is defined within the Nasdaq Marketplace Rules. The Governance
      and Nominating Committee met during fiscal 2006 in conjunction with meetings
      of
      the full Board of Directors.





**Code
      of Ethics**





Effective
      December 18, 2003, our board of directors adopted a Code of Business Conduct
      and
      Ethics that applies to, among other persons, our President (being our principal
      executive officer) and our Chief Financial Officer (being our principal
      financial and accounting officer), as well as persons performing similar
      functions. As adopted, our Code of Business Conduct and Ethics sets forth
      written standards that are designed to deter wrongdoing and to
      promote:





*  honest
      and ethical conduct, including the ethical handling of actual or apparent
      conflicts of interest between personal and professional
      relationships;





*  full,
      fair, accurate, timely, and understandable disclosure in reports and documents
      that we file with, or submit to, the Securities and Exchange Commission and
      in
      other public communications made by us;





*  compliance
      with applicable governmental laws, rules and regulations;





*  the
      prompt internal reporting of violations of the Code of Business Conduct and
      Ethics to an appropriate person or persons identified in the Code of Business
      Conduct and Ethics; and





* accountability
      for adherence to the Code of Business Conduct and Ethics.





Our
      Code
      of Business Conduct and Ethics requires, among other things, that all of our
      company's personnel shall be accorded full access to our President and Chief
      Financial Officer with respect to any matter that may arise relating to the
      Code
      of Business Conduct and Ethics. Further, all of our **** company's
      personnel are to be accorded full access to our company's board of directors
      if
      any such matter involves an alleged breach of the Code of Business Conduct
      and
      Ethics by our President or Chief Financial Officer.





In
      addition, our Code of Business Conduct and Ethics emphasizes that all employees,
      and particularly managers and/or supervisors, have a responsibility for
      maintaining financial integrity within our company, consistent with generally
      accepted accounting principles, and federal, provincial and state securities
      laws. Any employee who becomes aware of any incidents involving financial or
      accounting manipulation or other irregularities, whether by witnessing the
      incident or being told of it, must report it to his or her immediate supervisor
      or to our company's President or Chief Financial Officer. If the incident
      involves an alleged breach of the Code of Business Conduct and Ethics by the
      President or Chief Financial Officer, the incident must be reported to any
      member of our board of directors. Any failure to report such inappropriate
      or
      irregular conduct of others is to be treated as a severe disciplinary matter.
      It
      is against our company policy to retaliate against any individual who reports
      in
      good faith the violation or potential violation of our company's Code of
      Business Conduct and Ethics by another.





Our
      Code
      of Business Conduct and Ethics is filed herewith with the Securities and
      Exchange Commission as Exhibit 14.1 to this annual report. We will provide
      a
      copy of the Code of Business Conduct and Ethics to any person without charge,
      upon request. Requests can be sent to: Onstream Media Corporation, 1291 SW
      29
      Avenue, Pompano Beach, Florida 33069.





**COMPLIANCE
      WITH SECTION 16(a) OF THE EXCHANGE ACT**





Based
      solely upon a review of Forms 3 and 4 and amendments thereto furnished to us
      under Rule 16a-3(d) of the Securities Exchange Act of 1934, as amended, during
      the fiscal year ended September 30, 2006 and Forms 5 and amendments thereto
      furnished to us with respect to the fiscal year ended September 30, 2006, as
      well as any written representation from a reporting person that no Form 5 is
      required, we are not aware of any person that failed to file on a timely basis,
      as disclosed in the aforementioned Forms, reports required by Section 16(a)
      of
      the Securities Exchange Act of 1934 during the fiscal year ended September
      30,
      2006, other than indicated below.


Carl
        Silva, one of our directors, has not filed a Form 3 on a timely basis related
        to
        his initial holdings in Onstream Media Corporation as a result of the Onstream
        Merger (14,810 warrants) nor has he filed a Form 3 or Form 4 on a timely
        basis
        related to 50,000 options granted to him by us on July 27, 2006. Mr. Silva
        has
        represented to us that he will file these forms as soon as
        practicable.


35


**ITEM
      10.**  **EXECUTIVE
      COMPENSATION**





The
      following table sets forth certain information relating to the compensation
      of
      (i) our Chief Executive Officer; and (ii) each of our executive officers who
      earned more than $100,000 salary and bonus (excluding severance) during the
      most
      recent fiscal year (collectively, the “Named Executive Officers”):




Annual
                Compensation
            
            Long-Term
                CompensationAwards
            
            PayoutsName,
                PrincipalPosition
            
            Fiscal
              Year
            
            Salary
            
            Bonus
            
            Other
                Annual
              Comp
            
            Restricted
              StockAwards
            
            Securities
              Underlying
                Options/SARs
                (#)
            
            LTIP
              Payouts
              ($)
            
            All
                other comp($)Randy
                S. Selman -
            
            
            2006
            
            
            $ 
                        191,541
            
            
            -0-
            
            
            $ 
                      48,242 (1
            )
            
            -0-
            
            
            100,000
            
            
            -0-
            
            
            -0-President,
                Chief
            
            
            2005
            
            
            $ 
                      175,536
            
            
            -0-
            
            
            $ 
                      47,441 (2
            )
            
            -0-
            
            
            1,300,000
            
            
            -0-
            
            
            -0-Executive
                Officer
            
            
            2004
            
            
            $ 
                      166,350
            
            
            -0-
            
            
            $ 
                      34,945 (3
            )
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-and
                DirectorAlan
                Saperstein -
            
            
            2006
            
            
            $ 
                      177,552
            
            
            -0-
            
            
            $ 
                      54,230 (4
            )
            
            -0-
            
            
            100,000
            
            
            -0-
            
            
            -0-Chief
                Operating
            
            
            2005
            
            
            $ 
                      165,000
            
            
            -0-
            
            
            $ 
                      53,048 (5
            )
            
            -0-
            
            
            1,300,000
            
            
            -0-
            
            
            -0-Officer,
                Treasurer
            
            
            2004
            
            
            $ 
                      165,050
            
            
            -0-
            
            
            $ 
                      40,942 (6
            )
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-and
                DirectorCliff
                Friedland -
            
            
            2006
            
            
            $ 
                      175,400
            
            
            -0-
            
            
            $ 
                      57,278 (7
            )
            
            -0-
            
            
            100,000
            
            
            -0-
            
            
            -0-Senior
                VP Busi-
            
            
            2005
            
            
            $ 
                      124,003
            
            
            -0-
            
            
            $ 
                      44,109 (8
            )
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-ness
                Development
            
            
            2004
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-and
                DirectorDavid
                Glassman -
            
            
            2006
            
            
            $ 
                      175,400
            
            
            -0-
            
            
            $  45,749
                      (9
            )
            
            -0-
            
            
            100,000
            
            
            -0-
            
            
            -0-Senior
                VP
            
            
            2005
            
            
            $ 
                      124,003
            
            
            -0-
            
            
            $35,881
                      (10
            )
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Marketing
            
            
            2004
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-Robert
                Tomlinson-
            
            
            2006
            
            
            $ 
                      161,411
            
            
            -0-
            
            
            $48,977
                      (11
            )
            
            -0-
            
            
            100,000
            
            
            -0-
            
            
            -0-Chief
                Financial
            
            
            2005
            
            
            $ 
                      150,000
            
            
            -0-
            
            
            $43,234
                      (12
            )
            
            -0-
            
            
            250,000
            
            
            -0-
            
            
            -0-Officer
            
            
            2004
            
            
            $     
                      7,981
            
            
            -0-
            
            
            $    
                      375 (13
            )
            
            -0-
            
            
            -0-
            
            
            -0-
            
            
            -0-














36








(1)
            Includes
                $13,242 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $18,000 deferred
                compensation.


(2)
            Includes
                $12,441 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $18,000 deferred
                compensation.


(3)
            Includes
                $9,295 for medical insurance; $12,000 automobile allowance and $13,650
                deferred compensation.


(4)
            Includes
                $19,230 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $18,000 deferred
                compensation.


(5)
            Includes
                $18,048 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $18,000 deferred
                compensation.


(6)
            Includes
                $13,942 for medical insurance; $12,000 automobile allowance and $15,000
                deferred compensation.


(7)
            Includes
                $19,222 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $21,056 deferred compensation and 401(k)
                match.
                Table excludes amounts paid to Mr. Friedland during fiscal 2006 related
                to
                compensation accrued prior to the Onstream
                Merger.


(8)
            Includes
                $13,841 for medical and other insurance; $9,129 automobile allowance;
                $5,000 dues allowance and $16,139 deferred compensation and 401(k)
                match.
                Table excludes amounts paid to Mr. Friedland during fiscal 2005 related
                to
                compensation accrued prior to the Onstream
                Merger.


(9)
            Includes
                $7,693 for medical and other insurance; $12,000 automobile allowance;
                $5,000 dues allowance and $21,056 deferred compensation and 401(k)
                match.


(10)
            Includes
                $5,613 for medical and other insurance; $9,129 automobile allowance;
                $5,000 dues allowance and $16,139 deferred compensation and 401(k)
                match.
                Table excludes amounts paid to Mr. Glassman during fiscal 2005 related
                to
                compensation accrued prior to the Onstream
                Merger.


(11)
            Includes
                $19,164 for medical and other insurance; $9,000 automobile allowance
                and
                $20,813 deferred compensation and 401(k)
                match.


(12)
            Includes
                $17,734 for medical and other insurance; $9,000 automobile allowance
                and
                $16,500 deferred compensation and 401(k)
                match.


(13)
            Includes
                $375 automobile allowance.





**Employment
      Agreements**




Effective
      December 27, 2004 we entered into four-year employment agreements with Messrs.
      Randy Selman (President and CEO) and Alan Saperstein (COO and Treasurer). The
      contracts provide a base salary of $178,000, with 10% annual increases, for
      Mr.
      Selman and a base salary of $165,000, with 10% annual increases, for Mr.
      Saperstein. As additional compensation, each of Messrs. Selman and Saperstein
      are entitled to receive a bonus for each fiscal year during the term of the
      executive's employment by us in an amount equal to 1% of our earnings before
      income tax, depreciation and amortization (EBITDA) in excess of the EBITDA
      for
      the previous fiscal year. The base year for the bonus was fiscal 2003. The
      bonus
      is payable within 30 days of the determination of the amount of the bonus;
      provided that at the executive's sole discretion he may elect to take his bonus
      in cash or in shares of our restricted common stock. The shares of our common
      stock issued as a bonus will be valued at 75% of the average closing price
      of
      our common stock for the five trading days immediately prior to the
      determination of the bonus. No such bonus had been earned or accrued as of
      September 30, 2005 or September 30, 2006.





In
      addition, each executive receives an auto allowance of $1,000 per month, a
      “deferred compensation” payment of $1,500 per month and an annual $5,000
      allowance for the reimbursement of dues. Upon a subsequent change of control
      or
      termination without cause, we would be obligated to pay Messrs. Selman and
      Saperstein their base salaries for a three year period, which can be dispersed
      in a lump sum or over the standard term, at the option of the executive, plus
      full benefits for a period of two years from the date of termination. In
      addition, if the five day average closing price of the common stock is greater
      than or equal to $2.50 per share on the date of termination, all options
      previously granted will be cancelled, with all underlying shares (vested or
      unvested) issued to the executive, and we will pay all taxes for the executive.
      If the five-day average closing price of the common stock is less than $2.50
      per
      share on the date of termination, the options will remain exercisable under
      the
      original term.





37


Effective
      December 27, 2004 we also entered into four-year employment agreements with
      Messrs. Clifford Friedland (Senior Vice President Business Development) and
      David Glassman (Senior Vice President Marketing). The agreements provide a
      base
      salary of $163,000, with 10% annual increases. As additional compensation,
      each
      of Messrs. Friedland and Glassman are entitled to receive a bonus for each
      fiscal year during the term of the executive's employment by us in an amount
      equal to 1% of our earnings before income tax, depreciation and amortization
      (EBITDA) in excess of the EBITDA for the previous fiscal year. The base year
      for
      the bonus was fiscal 2003. The bonus is payable within 30 days of the
      determination of the amount of the bonus; provided that at the executive's
      sole
      discretion he may elect to take his bonus in cash or in shares of our restricted
      common stock. The shares of our common stock issued as a bonus will be valued
      at
      75% of the average closing price of our common stock for the five trading days
      immediately prior to the determination of the bonus. No such bonus had been
      earned or accrued as of September 30, 2005 or September 30, 2006.





In
      addition, each executive receives an auto allowance of $1,000 per month, a
      “deferred compensation” payment of $1,500 per month and an annual $5,000
      allowance for the reimbursement of dues. Upon a change of control or termination
      without cause, we would be obligated to pay Messrs. Glassman and Friedland
      their
      base salaries for a three year period, which can be dispersed in a lump sum
      or
      over the standard term, at the option of the executive, plus full benefits
      for a
      period of two years from the date of termination.





Effective
      March 8, 2005 we entered into an Executive Employment Agreement with Robert
      E.
      Tomlinson (Chief Financial Officer). The term of the agreement is for three
      years, with automatic successive one-year renewals unless both parties agree
      to
      modify the terms of the agreement or one or both parties exercise their
      respective rights of termination under the agreement. The agreement provides
      a
      base salary of $150,000 per year, with annual incremental increases of 10%
      per
      year beginning on December 27, 2005. In addition, he receives an auto allowance
      of $750 per month and a “deferred compensation” payment of $1,500 per month. He
      is entitled to a performance bonus equal to 1% of our earnings before income
      tax, depreciation and amortization (EBITDA) in excess of the EBITDA for the
      previous fiscal year. At his sole discretion this bonus, if earned, is payable
      in cash or shares of Onstream Media's common stock which would be valued at
      75%
      of average closing price for the five prior trading days immediately prior
      to
      the determination of such bonus; his ability to receive shares of common stock,
      however, is subject to shareholder approval. No such bonus had been earned
      or
      accrued as of September 30, 2005 or September 30, 2006. In the event of a change
      of control of the company as described in the agreement all unvested options
      will immediately vest. In the event Mr. Tomlinson is terminated for cause or
      he
      voluntary resigns, all unvested options will automatically
      terminate.





Mr.
      Tomlinson is entitled to (i) participate in any profit-sharing or retirement
      plan and in other employee benefits applicable to our employees and executives,
      (ii) an automobile allowance, business reimbursement expense and fringe benefits
      commensurate with the duties and responsibilities of Mr. Tomlinson, and (iii)
      benefits in the event of disability. The agreement contains certain
      non-disclosure and non-competition provisions and we have agreed to indemnify
      Mr. Tomlinson in certain circumstances.





38


Under
      the
      terms of the agreement, we may terminate the employment of Mr. Tomlinson upon
      his death or disability or with or without cause. If the agreement is terminated
      by us without cause or upon a change of control as described in the agreement,
      the company would be obligated give Mr. Tomlinson three months prior notice
      and
      upon termination pay him six months of total compensation, including benefits,
      under the agreement. If Mr. Tomlinson should voluntarily terminate the agreement
      following two months written notice of his intent to do so, upon the termination
      we are obligated to pay him one month's total compensation, including benefits.
      To the extent that Mr. Tomlinson is terminated for cause, no severance benefits
      are due him. If the agreement is terminated as a result of Mr. Tomlinson's
      death, his estate will receive six months base salary and he will be entitled
      to
      a portion of any bonus he would have earned at the time of his death, and if
      the
      agreement is terminated as a result of his 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.





**Stock
      Option Information**




The
      following table sets forth certain information with respect to stock options
      granted in fiscal 2006 to the Named Executive Officers.





Option
      Grants in Year Ended September 30, 2006


(Individual
      grants)




Name
            No.
                of Securities Underlying OptionsGranted
            %
                of Total Options Granted to Employees inFiscal
                Year
            Exercise
                Price
            ExpirationDateRandy
                S. Selman - President, Chief
            100,000
            7.4%
            $0.71
            9/29/2011Executive
                Officer and DirectorAlan
                Saperstein - Chief Operating
            100,000
            7.4%
            $0.71
            9/29/2011Officer,
                Treasurer and DirectorCliff
                Friedland - Senior VP Business
            100,000
            7.4%
            $0.71
            9/29/2011Development
                and DirectorDavid
                Glassman - Senior VP
            100,000
            7.4%
            $0.71
            9/29/2011MarketingRobert
                Tomlinson- Chief Financial
            100,000
            7.4%
            $0.71
            9/29/2011Officer





39


The
      following table sets forth certain information regarding stock options held
      as
      of September 30, 2006 by the Named Executive Officers.





Aggregate
      Option Exercises in Year Ended September 30, 2006


and
      Year-End Option Values





NO.
                OF SECURITIESSHARES
            
            
            
            UNDERLYING
                UNEXERCISED
            
            VALUE
                OF UNEXERCISEDACQUIRED
            
            
            
            OPTIONS
                AT
            
            IN-THE-MONEY
                OPTIONS ATON
            
            VALUE
            
            SEPTEMBER
                30, 2006
            
            SEPTEMBER
                30, 2006(1)NAME
            
            EXERCISE
            
            REALIZED
            
            EXERCISABLE
            
            UNEXERCISABLE
            
            EXERCISABLE
            
            UNEXERCISABLERandy
                S. Selman,President,
                ChiefExecutive
                Officerand
                Director
            
            
            -
            
            
            $  
                    -
            
            
            1,426,667
                (2
            )
            
            -
            
            
            $  
                    -
            
            
            $  
                  -Alan
                Saperstein,Chief
                OperatingOfficer,
                Treasurerand
                Director
            
            
            -
            
            
            $  
                    -
            
            
            1,426,667
                (2
            )
            
            -
            
            
            $  
                  -
            
            
            $  
                  -Cliff
                Friedland,Senior
                VP BusinessDevelopmentand
                Director
            
            
            -
            
            
            $  
                  -
            
            
            188,860
                (3
            )
            
            -
            
            
            $  
                  -
            
            
            $  
                  -David
                Glassman,Senior
                VPMarketing
            
            
            -
            
            
            $  
                  -
            
            
            188,860
                (3
            )
            
            -
            
            
            $  
                  -
            
            
            $  
                  -Robert
                Tomlinson,Chief
                FinancialOfficer
            
            
            -
            
            
            $
                     -
            
            
            350,000
                (4
            )
            
            -
            
            
            $  
                  -
            
            
            $  
                  -







(1)
            The
                dollar value of the unexercised in-the-money options is calculated
                based
                upon the difference between the option exercise price and $0.64 per
                share,
                being the last sale price of our common stock on September 29, 2006
                as
                reported by the Nasdaq Capital
                Market.





(2)
            Of
                such exercisable options at September 30, 2006, 100,000 were exercisable
                at $0.71 per share, 450,000 were exercisable at $1.12 per share,
                450,000
                were exercisable at $1.57 per share, 400,000 were exercisable at
                $2.50 per
                share and 26,667 were exercisable at $22.50 per share. The 26,667
                options
                are subject to cancellation and repricing as described
                below.





(3)
            Of
                such exercisable options at September 30, 2006, 100,000 were exercisable
                at $0.71 per share and 88,860 were exercisable at $3.376 per
                share.





(4)
            Of
                such exercisable options at September 30, 2006, 100,000 were exercisable
                at $0.71 per share, 100,000 were exercisable at $1.12 per share and
                150,000 were exercisable at $1.21 per
                share.





40


**1996
      Stock Option Plan**





On
      February 9, 1997, the board of directors and a majority of our shareholders
      adopted our 1996 Stock Option Plan (the "Plan"). Pursuant to an amendment to
      the
      Plan ratified by shareholders on September 13, 2005, we have reserved an
      aggregate of 4,500,000 shares of common stock for issuance pursuant to options
      granted under the Plan ("Plan Options") and 2,000,000 shares for restricted
      stock grants (“Stock Grants”) made under the Plan. At December 31, 2006, we have
      options to purchase 4,352,224 shares of our common stock outstanding under
      the
      Plan. Such options were issued to our directors, employees and consultants
      at
      exercise prices ranging from $0.71 to $22.50 per share.





On
      December 15, 2004 a majority of our shareholders voted to approve the
      cancellation (subject to the option holder’s approval) of stock option grants to
      directors, executive officers, senior management and employees covering 292,992
      shares (227,776 of which were issued under the 1996 Stock Option plan) with
      a
      weighted-average exercise price of $22.93, with such options to be re-issued
      six
      months and one day from the date of cancellation with an exercise price equal
      to
      the fair market value on the date of the reissue. This cancellation has not
      yet
      been implemented and 167,777 of the Plan options subject to this cancellation
      and re-issue had expired as of December 31, 2006.





The
      stated purpose of the Plan is to increase our employees', advisors',
      consultants' and non-employee directors' proprietary interest in the company,
      and to align more closely their interests with the interests of our
      shareholders, as well as to enable us to attract and retain the services of
      experienced and highly qualified employees and non-employee directors. The
      Plan
      is administered by the Compensation Committee of our board of directors (“the
      Committee"). The Committee determines, from time to time, those of our officers,
      directors, employees and consultants to whom Stock Grants and Plan Options
      will
      be granted, the terms and provisions of the respective Grants and Plan Options,
      the dates such Plan Options will become exercisable, the number of shares
      subject to each Plan Option, the purchase price of such shares and the form
      of
      payment of such purchase price. Stock Grants may be issued by the Committee
      at
      up to a 10% discount to market at the time of grant. At no time may the
      Committee issue Stock Grants to exceed, in the aggregate, 2,000,000 shares.
      All
      other questions relating to the administration of the Plan, and the
      interpretation of the provisions thereof are to be resolved at the sole
      discretion of the board of directors or the Committee.




Plan
      Options granted under the Plan may either be options qualifying as incentive
      stock options ("Incentive Options") under Section 422 of the Internal Revenue
      Code of 1986, as amended (the "Code"), or options that do not so qualify
      ("Non-Qualified Options"). In addition, the Plan also allows for the inclusion
      of a reload option provision ("Reload Option"), which permits an eligible person
      to pay the exercise price of the Plan Option with shares of common stock owned
      by the eligible person and to receive a new Plan Option to purchase shares
      of
      common stock equal in number to the tendered shares. Any Incentive Option
      granted under the Plan must provide for an exercise price of not less than
      100%
      of the fair market value of the underlying shares on the date of such grant,
      but
      the exercise price of any Incentive Option granted to an eligible employee
      owning more than 10% of our common stock must be at least 110% of such fair
      market value as determined on the date of the grant.





The
      term
      of each Plan Option and the manner in which it may be exercised is determined
      by
      the board of directors or the Committee, provided that no Plan Option may be
      exercisable more than 10 years after the date of its grant and, in the case
      of
      an Incentive Option granted to an eligible employee owning more than 10% of
      our
      common stock, no more than five years after the date of the grant. In any case,
      the exercise price of any stock option granted under the Plan will not be less
      than 85% of the fair market value of the common stock on the date of grant.
      The
      exercise price of Non-Qualified Options is determined by the
      Committee.




41


The
      per
      share purchase price of shares subject to Plan Options granted under the Plan
      may be adjusted in the event of certain changes in our capitalization, but
      any
      such adjustment shall not change the total purchase price payable upon the
      exercise in full of Plan Options granted under the Plan. Officers, directors
      and
      key employees of and consultants to us and our subsidiaries will be eligible
      to
      receive Non-Qualified Options under the Plan. Only our officers, directors
      and
      employees who are employed by us or by any of our subsidiaries thereof are
      eligible to receive Incentive Options.




All
      Plan
      Options are nonassignable and nontransferable, except by will or by the laws
      of
      descent and distribution and, during the lifetime of the optionee, may be
      exercised only by such optionee. If an optionee's employment is terminated
      for
      any reason, other than his death or disability or termination for cause, or
      if
      an optionee is not our employee but is a member of our board of directors and
      his service as a Director is terminated for any reason, other than death or
      disability, the Plan Option granted may be exercised on the earlier of the
      expiration date or 90 days following the date of termination. If the optionee
      dies during the term of his employment, the Plan Option granted to him shall
      lapse to the extent unexercised on the earlier of the expiration date of the
      Plan Option or the date one year following the date of the optionee's death.
      If
      the optionee is permanently and totally disabled within the meaning of Section
      22(c)(3) of the Code, the Plan Option granted to him lapses to the extent
      unexercised on the earlier of the expiration date of the option or one year
      following the date of such disability.




The
      Board
      of Directors may amend, suspend or terminate the Plan at any time, except that
      no amendment shall be made which (i) increases the total number of shares
      subject to the Plan or changes the minimum purchase price therefore (except
      in
      either case in the event of adjustments due to changes in our capitalization)
      without the consent of our shareholders, (ii) affects outstanding Plan Options
      or any exercise right thereunder, (iii) extends the term of any Plan Option
      beyond ten years, or (iv) extends the termination date of the Plan.





Unless
      the Plan has been earlier suspended or terminated by the Board of Directors,
      the
      Plan shall terminate 10 years from the date of the Plan's adoption. Any such
      termination of the Plan shall not affect the validity of any Plan Options
      previously granted thereunder.





The
      potential benefit to be received from a Plan Option is dependent on increases
      in
      the market price of the common stock. The ultimate dollar value of the Plan
      Options that have been or may be granted under the Plan is therefore not
      ascertainable. On January 10, 2007, the closing price of our common stock as
      reported on the Nasdaq Capital Market was $2.88.







42




**ITEM
      11.** **SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**





The
      following table contains information regarding beneficial ownership of our
      common stock as of January 10, 2007 held by:





*  persons
      who own beneficially more than 5% of our outstanding common stock,


*  our
      directors,


*  named
      executive officers, and


*  all
      of
      our directors and officers as a group.





Unless
      otherwise indicated, the address of each of the listed beneficial owners
      identified is c/o Onstream Media Corporation, 1291 Southwest 29 Avenue, Pompano
      Beach, Florida 33069. Unless otherwise noted, we believe that all persons named
      in the table have sole voting and investment power with respect to all shares
      of
      our common stock beneficially owned by them. A person is deemed to be the
      beneficial owner of securities that can be acquired by such a person within
      60
      days from January 10, 2007 (unless otherwise indicated below) upon exercise
      of
      options, warrants or convertible securities. Each beneficial owner's percentage
      of ownership is determined by assuming that options, warrants and convertible
      securities that are held by such a person (but not those held by any other
      person) and are exercisable within 60 days from the date hereof (unless
      otherwise indicated below) have been exercised. All information is based upon
      a
      record list of stockholders as of January 10, 2007. At that date, a pproximately
      59% of the Company's outstanding shares were held by CEDE & Co., which is
      accounted for as a single shareholder of record for multiple beneficial owners,
      but is not listed in the beneficial ownership table. CEDE & Co. is a nominee
      of the Depository Trust Company (DTC), with respect to securities deposited
      by
      participants with DTC, e.g., mutual funds, brokerage firms, banks, and other
      financial organizations. Shares held by Cede & Co. are not reflected in the
      following table.





Shares
                of Common Stock Beneficially OwnedName
                and Address of Beneficial Owner
            
            Number
            
            PercentageRandy
                S. Selman (1)
            
            
            1,436,520
            
            
            5.6
            %Alan
                M. Saperstein (2)
            
            
            1,438,487
            
            
            5.6
            %Benjamin
                Swirsky (3)
            
            
            250,751
            
            
            1.0
            %Robert
                Wussler (4)
            
            
            265,426
            
            
            1.1
            %Charles
                C. Johnston (5)
            
            
            697,616
            
            
            2.8
            %Cliff
                Friedland (6)
            
            
            932,276
            
            
            3.8
            %David
                Glassman (7)
            
            
            932,109
            
            
            3.8
            %Carl
                L. Silva (8)
            
            
            64,810
            
            
            0.3
            %Robert
                E. Tomlinson (9)
            
            
            350,000
            
            
            1.4
            %All
                directors and officers as a group (nine persons) (10)
            
            
            6,367,995
            
            
            22.1
            %Fred
                DeLuca (11)
            
            
            3,467,899
            
            
            12.6
            %Neil
                Berman (12)
            
            
            2,070,632
            
            
            8.0
            %








(1)  Includes
      9,853 shares of our common stock presently outstanding, options to acquire
      100,000 shares of our common stock at an exercise price of $0.71 per share,
      options to acquire 450,000 shares of our common stock at an exercise price
      of
      $1.12 per share, options to acquire 450,000 shares of our common stock at an
      exercise price of $1.57 per share, options to acquire 400,000 shares of our
      common stock at an exercise price of $2.50 per share and options to acquire
      26,667 shares of our common stock at an exercise price of $22.50 per
      share.





43


(2)  Includes
      11,820 shares of our common stock presently outstanding, options to acquire
      100,000 shares of our common stock at an exercise price of $0.71 per share,
      options to acquire 450,000 shares of our common stock at an exercise price
      of
      $1.12 per share, options to acquire 450,000 shares of our common stock at an
      exercise price of $1.57 per share, options to acquire 400,000 shares of our
      common stock at an exercise price of $2.50 per share and options to acquire
      26,667 shares of our common stock at an exercise price of $22.50 per
      share.





(3)  Includes
      751 shares of our common stock presently outstanding, options to acquire 50,000
      shares of our common stock at an exercise price of $0.71 per share, options
      to
      acquire 100,000 shares of our common stock at an exercise price of $1.12 per
      share and options to acquire 100,000 shares of our common stock at an exercise
      price of $1.57 per share. Includes holdings in the name of Swirsky Capitol
      Holdings, Inc., for which Mr. Swirsky is the control person and exercises sole
      voting and dispositive powers over these shares.





(4)  Includes
      616 shares of our common stock presently outstanding, options to acquire 50,000
      shares of our common stock at an exercise price of $0.71 per share, options
      to
      acquire 100,000 shares of our common stock at an exercise price of $1.12 per
      share, options to acquire 100,000 shares of our common stock at an exercise
      price of $1.57 per share and warrants to purchase 14,810 shares of our common
      stock at an exercise price of $3.376 per share.





(5)  Includes
      171,714 shares of our common stock held by J&C Resources, LLC, options to
      acquire 50,000 shares of our common stock at an exercise price of $0.71 per
      share, options to acquire 100,000 shares of our common stock at an exercise
      price of $1.12 per share and options to acquire 100,000 shares of our common
      stock at an exercise price of $1.57 per share. Also includes 245,902 shares
      issuable upon the conversion of a $300,000 principal amount note payable to
      J&C Resources, LLC and 21,000 shares issuable to J&C Resources and 9,000
      shares issuable to Asset Factoring, Ltd. for accrued interest and fees related
      to that note. Mr. Johnston is the control person of J&C Resources, LLC and
      Asset Factoring, Ltd. and exercises sole voting and dispositive powers over
      these shares. Mr. Johnston's holdings exclude our securities owned by CCJ Trust.
      CCJ Trust is a trust for Mr. Johnston's adult children and he disclaims any
      beneficial ownership interest in CCJ Trust.





(6)  Includes
      447,216 shares of our common stock presently outstanding, 148,100 shares of
      our
      common stock held by Titan Trust, 148,100 shares of our common stock held by
      Dorado Trust, options to acquire 100,000 shares of our common stock at an
      exercise price of $0.71 per share and options to acquire 88,860 shares of our
      common stock at an exercise price of $3.376 per share. Mr. Friedland is the
      control person and beneficial owner of both Titan Trust and Dorado Trust and
      exercises sole voting and dispositive powers over these shares.





(7)  Includes
      447,049 shares of our common stock presently outstanding, 148,100 shares of
      our
      common stock held by JMI Trust, 148,100 shares of our common stock held by
      Europa Trust, options to acquire 100,000 shares of our common stock at an
      exercise price of $0.71 per share and options to acquire 88,860 shares of our
      common stock at an exercise price of $3.376 per share. Mr. Glassman is the
      control person and beneficial owner of both JMI Trust and Europa Trust and
      exercises sole voting and dispositive powers over these shares.





(8)  Includes
      options to acquire 50,000 shares of our common stock at an exercise price of
      $0.88 per share and warrants to purchase 14,810 shares of our common stock
      at an
      exercise price of $3.376 per share.





(9)  Includes
      options to acquire 100,000 shares of our common stock at an exercise price
      of
      $0.71 per share, options to acquire 100,000 shares of our common stock at an
      exercise price of $1.12 per share and options to acquire 150,000 shares of
      our
      common stock at an exercise price of $1.21 per share.





44


(10)  See
      footnotes (1) through (9) above.





(11)  Includes
      186,489 shares of our common stock presently outstanding, 140,000 shares of
      our
      common stock issuable upon the exercise of common stock purchase warrants with
      an exercise price of $1.65 per share, 500,000 shares of our common stock
      issuable upon the exercise of a common stock purchase warrant with an exercise
      price of $1.50 per share, 2,781,410 shares of our common stock issuable upon
      the
      conversion of 278,141 shares of Series A-10 Convertible Preferred Stock, and
      400,000 shares of our common stock issuable upon the conversion of $400,000
      principal amount 8% senior secured convertible notes, reduced by 540,000 shares
      due to conversion limitations discussed below. The number of shares of our
      common stock acquired by the holder upon conversion of the 8% senior secured
      convertible notes or the exercise of the $1.65 warrants, which were issued
      in
      connection with those notes, is limited to the extent necessary to ensure that
      following the conversion and/or exercise the total number of shares of our
      common stock beneficially owned by the holder does not exceed 9.999% of our
      issued and outstanding common stock.





(12)  Includes
      326,882 shares of our common stock presently outstanding, 6,250 shares of our
      common stock issuable upon the exercise of a common stock purchase warrant
      with
      an exercise price of $2.65 per share, 87,500 shares of our common stock issuable
      upon the exercise of common stock purchase warrants with an exercise price
      of
      $1.65 per share, 87,500 shares of our common stock issuable upon the exercise
      of
      common stock purchase warrants with an exercise price of $1.50 per share,
      150,000 shares of our common stock issuable upon the exercise of common stock
      purchase options with an exercise price of $1.00 per share and 250,000 shares
      of
      our common stock issuable upon the conversion of $250,000 principal amount
      8%
      subordinated secured convertible notes, reduced by 337,500 shares due to
      conversion limitations discussed below. Also includes 1,500,000 shares issuable
      upon the conversion of a $1,500,000 principal amount note payable ($900,000
      of
      which has been funded to us as of January 10, 2007). The number of shares of
      our
      common stock acquired by the holder upon conversion of the 8% senior secured
      convertible notes or the exercise of the $1.65 warrants, which were issued
      in
      connection with those notes, is limited to the extent necessary to ensure that
      following the conversion and/or exercise the total number of shares of our
      common stock beneficially owned by the holder does not exceed 9.999% of our
      issued and outstanding common stock. The number of shares of our common stock
      acquired by the holder upon conversion of the 8% subordinated secured
      convertible notes or the exercise of the $1.50 warrants, which were issued
      in
      connection with those notes, is limited to the extent necessary to ensure that
      following the conversion and/or exercise the total number of shares of our
      common stock beneficially owned by the holder does not exceed 4.999% of our
      issued and outstanding common stock.





The
      above
      table of beneficial ownership excludes Lewis Asset Management, LAM Opportunity
      Fund, Ltd and Lewis Opportunity Fund, LP, as our records indicate that their
      beneficial ownership is less than 5% based on the criteria outlined above.
      However, we have noted that on November 28, 2006, Lewis Asset Management filed
      a
      Form SC 13G (Statement of Acquisition of Beneficial Ownership by Individuals)
      with the Securities and Exchange Commissions, indicating that Lewis Asset
      Management believed their beneficial ownership interest exceeded 5% as of that
      date, which they confirmed in Form 4 filings with the SEC on December 1, 4
      and
      7. We have not undertaken to request any subsequent update of this information
      from Lewis Asset Management.





**ITEM
      12.** **CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS**





On
      May 7,
      2003 we entered into an agreement with Mr. Fred Deluca which restructured a
      previous loan, including a significant increase in the loaned amount
      outstanding. The new loan was evidenced by a three year promissory note in
      the
      principal amount of $3.0 million, interest payable only on a quarterly basis
      beginning in July 2003 at the rate of 5.25% per annum. The new loan was
      collateralized by a blanket security interest in our assets and a pledge of
      the
      stock of our subsidiaries.





45


We
      issued
      Mr. Deluca 140,000 shares of our newly created Class A-8 Convertible Preferred
      Stock as consideration for entering into the above agreement. At the same time,
      he exchanged approximately 123,667 shares of our common stock already owned
      by
      him for an additional 92,750 shares of Class A-8. We granted Mr. Deluca demand
      and piggy-back registration rights covering the shares of common stock issuable
      upon the conversion of the Class A-8 Convertible Preferred Stock.





In
      December 2004, we repaid $2.0 million of the May 2003 loan and the remaining
      $1.0 million was invested in 100,000 shares of Class A-10 Convertible Preferred
      Stock on the same terms as offered to new investors. Also, Mr. Deluca purchased
      $400,000 of 8% senior secured convertible notes on the same terms as the other
      investors. In addition, Mr. Deluca exchanged all 232,750 shares of Class A-8 for
      139,650 shares of Class A-10, but did not receive accompanying warrants.
      Finally, Mr. DeLuca agreed to accept common shares, valued as of the date of
      issuance, for approximately $149,000 of unpaid interest on the three year
      promissory note.





In
      February 2004, we received a $300,000 loan from J&C Resources, LLC. One of
      the members of our Board Of Directors is the President, Chairman and CEO of
      J&C Resources, LLC. The term of the loan was one year, and all interest was
      prepaid through the issuance of 21,000 shares of common stock. In addition,
      we
      issued 9,000 shares of common stock as an origination fee and 10,000 shares
      of
      common stock for legal and other fees (including 7,500 shares issued to Asset
      Factoring International, Inc., a related entity). The proceeds from this loan
      were used for working capital pending the closing of new financing in December
      2004, at which time this loan was repaid. J&C Resources also received
      $24,500 from us as finder’s fee compensation in the December 2004 financing
      transactions





In
      December 2004, we paid $100,000 to each of Messrs. Clifford Friedland and David
      Glassman, as a partial payment of accrued and unpaid salaries due to them from
      privately held Onstream Media prior to the closing of the Onstream Merger.
      In
      February 2005 we paid an additional $50,000 to each of Messrs. Friedland and
      Glassman as a second partial payment of these accrued salaries. In September
      2006 we paid an additional $15,000 to Mr. Friedland only, as a third partial
      payment of these accrued salaries.





In
      January 2005, we entered into an addendum to an August 2002 consulting agreement
      with Mr. Neil Berman, a major shareholder, calling for the issuance of 5,000
      restricted common shares per month for the year ended December 31, 2005. Under
      that agreement, 32,500 restricted common shares were issued for the year ended
      December 31, 2004. In January 2006, we entered into a one-year consulting
      agreement with Mr. Berman calling for the issuance of 120,000 restricted common
      shares as well as 100,000 four-year common stock options immediately exercisable
      at $1.00 per share.





In
      August
      2005, we received a $300,000 loan from Asset Factoring International, Inc.,
      whose Investment Manager is a member of our board of directors. The term of
      the
      loan is one year, with a 2% loan origination fee and interest of 8% per annum.
      All interest and fees are due and payable in the event of early repayment.
      The
      terms of the loan, which is secured by $600,000 of recently purchased equipment
      and software, requires repayment within 5 days of us obtaining other financing,
      including but not limited to equipment financing. Asset Factoring agreed to
      several extensions for the repayment of this loan after we obtained such other
      financing in October and November 2005 until we repaid $360,000 in April 2006,
      which represented principal and the initially negotiated loan origination fee
      and interest, plus subsequently negotiated extension fees.





46


In
      August
      2005, we entered into a consulting agreement with Allenstown Investments, Ltd.,
      whose Investment Manager is a member of our board of directors. The agreement
      is
      for a term of one year and calls for the issuance of 30,000 restricted common
      shares.





In
      October 2005, we entered into a five-year note with Mr. Neil Berman, a major
      shareholder in the aggregate principal amount of $750,000, collateralized by $800,000 (original purchase price) of recently purchased
      hardware and software. Interest, at 10.85% per annum, is payable upon maturity. At our option, and
      with
      the consent of required security holders, both interest and principal may be
      paid in the form of our Series A-10 Preferred Stock. We received $300,000 of
      the
      note amount as of September 30, 2005, which was reflected in notes payable
      as of
      that date. An additional $150,000 was received in October 2005, resulting in
      a
      notes payable balance of $450,000 as of September 30, 2006. We received the
      remaining $300,000 in December 2006. Following Board of Director approval of
      the
      modified terms on December 20, 2006, the note was formally modified in January
      2007 to increase  the
      principal amount to $1,500,000, adjust the remaining term to four years,
      increase the interest rate to 17.75% (which the lender may request
      prepayment of in our common shares at $1.00 per share) and modify the note
      priority to unsecured and subordinated to all other debt. In addition, the
      new
      terms allow us or the lender to convert the loan balance to restricted common
      stock at $1.00 per share at any time. We received $100,000 of the increased
      note
      amount in December 2006 and $50,000 in January 2007.





In
      July
      2006 we received a $300,000 loan from J&C Resources, LLC. The principal
      balance was due in one year or three days after receipt of funding, including
      exercise of warrants, in excess of $1.0 million, whichever occurs first. Total
      interest, origination and legal fess totaling $21,000 cash and 21,000 common
      shares are due on maturity. Finders fees of $9,000 cash and 9,000 common shares
      are payable at loan maturity to Asset Factoring Ltd, a related entity. In
      January 2007, all fees due upon maturity were paid in cash and stock, as
      applicable. Following Board of Director approval of the modified terms on
      October 25, 2006, the note was formally modified in January 2007 to be
      convertible into common shares at $1.22 per share and to bear interest at 14.67%
      per annum, non-compounding, which the Company may settle in shares at $1.22
      per
      share. The Company has the option to force conversion after 18 months and
      interest is payable at time of conversion or repayment.




On
        October 27, 2006 we entered into a four-year convertible note with SBV
        Capital Corporation in the aggregate principal amount of $1.0 million, which
        was
        funded in installments through December 2006. We elected to prepay all interest
        on a non-compounding, non-refundable basis for the entire remaining term
        of the
        loan, with the aggregate issuance of 694,495 unregistered common shares during
        November and December 2006. The note was converted into 1.0 million unregistered
        common shares on January 10, 2007.  On November 20, 2006, we entered
        into a three-year consulting contract with the principal and beneficial owner
        of
        the lending entity, for the provision of international business development
        and
        financial advice. The contract, which is cancellable upon thirty days notice
        after the first year, calls for the issuance of 60,000 restricted common
        shares
        in advance every six months.


In
      November 2006, we issued 100,000 unregistered shares of common stock, as well
      as
      immediately exercisable four-year options to purchase 50,000 shares at $1.00
      per
      share, to Mr. Neil Berman, a major shareholder, as a finder’s fee in connection
      with a $1.0 million loan from SBV Capital Corporation. These shares are valued
      at approximately $80,000 (based on the date of the related financing) and carry
      piggyback registration rights.





**PART
      IV**





**ITEM
      13.** **EXHIBITS**





The
      following documents are filed as a part of this report or are incorporated
      by
      reference to previous filings, if so indicated:





Number
            Description  2.1
            Agreement
                and Plan of Merger dated as of October 22, 2003 by and between Visual
                Data
                Corporation, OSM, Inc., a subsidiary of Visual Data Corporation,
                and
                Onstream Media Corporation (11)


2.2
            Amendment
                #1 to Agreement and Plan of Merger dated as of October 15, 2004 by
                and
                between Visual Data Corporation, OSM, Inc., a subsidiary of Visual
                Data
                Corporation, and Onstream Media Corporation
                (13)




47




2.3
            Agreement
                and Plan of Merger dated June 4, 2001 among Entertainment Digital
                Network,
                Inc., Visual Data Corporation and Visual Data San Francisco, Inc.
                (6)


2.4
            Agreement
                and Plan of Reorganization between Visual Data Corporation, Media
                on
                Demand, Inc. and Charles Saracino
                (7)


2.5
            Voting
                Agreement (7)


3.1.1
            Articles
                of Incorporation (1)


3.1.2
            Articles
                of Amendment dated July 26, 1993
                (1)


3.1.3
            Articles
                of Amendment dated January 17, 1994
                (1)


3.1.4
            Articles
                of Amendment dated October 11, 1994
                (1)


3.1.5
            Articles
                of Amendment dated March 25, 1995
                (1)


3.1.6
            Articles
                of Amendment dated October 31, 1995
                (1)


3.1.7
            Articles
                of Amendment dated May 23, 1996 (1)


3.1.8
            Articles
                of Amendment dated May 5, 1998 (5)


3.1.9
            Articles
                of Amendment dated August 11, 1998
                (2)


3.1.10
            Articles
                of Amendment dated June 13, 2000
                (4)


3.1.11
            Articles
                of Amendment dated April 11, 2002
                (8)


3.1.12
            Articles
                of Amendment dated June 24, 2003, with regard to Series A-9 Convertible
                Preferred Stock(9)


3.1.13
            Articles
                of Amendment dated June 20, 2003, with regard to reverse stock split
                (10)


3.1.14
            Articles
                of Amendment dated December 23, 2004, with regard to the designations
                for
                Series A-10 Convertible Preferred Stock
                (17)


3.1.15
            Articles
                of Amendment dated December 30, 2004, with regard to corporate name
                change
                (16)


3.1.16
            Articles
                of Amendment dated February 7, 2005 with regard to the designations
                for
                Series A-10 Convertible Preferred Stock
                (18)


3.2
              By-laws
                  (1)


4.1
            Specimen
                Common Stock Certificate (1)


4.2
            Form
                of 8% Senior Secured Convertible Notes
                (17)


4.3
            Form
                of $1.65 Warrant (17)


4.4
            Form
                of $1.50 Warrant (17)


4.5
            Form
                of $1.00 Warrant (23)


4.6
            Form
                of $1.65 Warrant issuable upon exercise of $1.00 Warrant
                (23)


4.7
            Form
                of Subordinated Secured Convertible Note
                (24)


4.8
            Form
                of $1.50 Warrant for Subordinated Secured Convertible Notes
                (24)


10.1
            Form
                of Stock Option Plan and Amendment thereto
                (1)(3)


10.2
            Employment
                Agreement dated December 27, 2004 between Onstream Media Corporation
                and
                Randy S. Selman (13)


10.3
            Employment
                Agreement dated December 27, 2004 between Onstream Media Corporation
                and
                Alan Saperstein (13)


10.4
            Employment
                Agreement dated December 27, 2004 between Onstream Media Corporation
                and
                Cliff Friedland (13)


10.5
            Employment
                Agreement dated December 27, 2004 between Onstream Media Corporation
                and
                David Glassman (13)


10.6
            Employment
                Agreement dated March 8, 2005 between Onstream Media Corporation
                and
                Robert Tomlinson (21)


10.7
            Plan
                of Compensation Package dated April 22, 2005 between Onstream Media
                Corporation and Bradford Tyler (22)


10.8
            Securities
                Purchase Agreement - A-9 Preferred
                (9)


10.9
            Form
                of Securities Purchase Agreement for 8% Senior Secured Convertible
                Notes
                (17)


10.10
            Form
                of Additional Investment Right (17)


10.11
            Form
                of Pledge Agreement (17)


10.12
            Form
                of Security Agreement (17)


10.13
            Form
                of Letter Agreement with Additional Investment Right holders
                (19)




48




10.14
            Deposit
                Control Agreement dated October 2004 (14)


10.15
            Form
                of Subscription Agreement for Subordinated Secured Convertible Notes
                (24)


10.16
            Form
                of Subordination Agreementfor
                Subordinated Secured Convertible Notes(24)


10.17
            Form
                of Security Agreementfor
                Subordinated Secured Convertible Notes(24)


14.1
            Code
                of Business Conduct and Ethics (12)


14.2
            Corporate
                Governance and Nominating Committee Principles
                (23)


14.3
            Audit
                Committee Charter (15)


21.1
            Subsidiaries
                of the registrant (13)


21.2
            Financial
                statements of Acquired Onstream for the years ended December 31,
                2003 and
                2002 and for the three and six months ended June 30, 2004 and 2003
                (20)


23.1
            Consent
                of Independent Registered Public Accounting
                Firm


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





(1)
            Incorporated
                by reference to the exhibit of the same number filed with the registrant's
                registration statement on Form SB-2, registration number 333-18819,
                as
                amended and declared effective by the SEC on July 30,
                1997.


(2)
            Incorporated
                by reference to the registrant's current report on Form 8-K dated
                August
                21, 1998.


(3)
            Incorporated
                by reference to the registrant's Proxy Statement for the year ended
                September 30, 1998.


(4)
            Incorporated
                by reference to the registrant's Quarterly Report on Form 10-QSB
                for the
                period ended June 30, 2000.


(5)
                Incorporated
                    by reference to the registrant’s Annual Report on Form 10-KSB for the year
                    ended September 30,
                    2000.


(6)
            Incorporated
                by reference to the registrant’s current report on Form 8-K filed on June
                12, 2001.


(7)
                Incorporated
                    by reference to the registrant’s current report on Form 8-K filed on
                    February 5, 2002.


(8)
            Incorporated
                by reference to exhibit 3.1 to the registrant's registration statement
                on
                Form S-3, file number 333-89042, declared effective on June 7,
                2002.


(9)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                July 2,
                2003.


(10)
            Incorporated
                by reference to the registrant's Quarterly Report on Form 10-QSB
                for the
                period ended June 30, 2003.


(11)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                October
                28, 2003.


(12)
            Incorporated
                by reference to the registrant’s Annual Report on Form 10-KSB for the year
                ended September 30, 2003.


(13)
            Incorporated
                by reference to the registrant’s Annual Report on Form 10-KSB for the year
                ended September 30, 2004.


(14)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                November
                4, 2004.


(15)
            Incorporated
                by reference to the registrant's Proxy Statement for the 2004 Annual
                Shareholder’s Meeting filed on November 14,
                2004.


(16)
            Incorporated
                by reference to the registrant’s current report on Form 8-K filed on
                January 4, 2005.


(17)
                Incorporated
                    by reference to the registrant’s current report on Form 8-K/A filed on
                    January 4, 2005.


(18)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                February
                11, 2005.


(19)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                February
                17, 2005.


(20)
            Incorporated
                by reference to the registrant's current report on Form 8-K/A filed
                March
                8, 2005.


(21)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                March
                11, 2005.


(22)
            Incorporated
                by reference to the registrant's current report on Form 8-K filed
                July 11,
                2005.


(23)
            Incorporated
                by reference to the registrant's Proxy Statement for the 2005 Annual
                Shareholder’s Meeting filed on August 1,
                2005.


(24)
            Incorporated
                by reference to the registrant's current report on Form 8-K/A filed
                April
                3, 2006.





49





**ITEM
      14.**  **PRINCIPAL
      ACCOUNTANT FEES AND SERVICES**





**Audit
      Fees**





The
      aggregate audit fees billed to us by Goldstein Lewin & Co. for professional
      services rendered for the audit of our annual financial statements included
      in
      our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2006
      and for the review of our quarterly financial statements included in our
      quarterly reports on Form 10-QSB for the quarters ended December 31, 2005,
      and
      March 31 and June 30, 2006 were $220,216.





The
      aggregate audit fees billed to us by Goldstein Lewin & Co. for professional
      services rendered for the audit of our annual financial statements included
      in
      our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2005
      and for the review of our quarterly financial statements included in our
      quarterly reports on Form 10-QSB for the quarters ended December 31, 2004,
      and
      March 31 and June 30, 2005 were $158,652.








**Audit
      Related Fees**





The
      aggregate fees billed to us by Goldstein, Lewin & Co. for assurance and
      related services relating to the performance of the audit of our financial
      statements which are not reported under the caption "Audit Fees" above were
      $42,402 and $87,922 for the fiscal years ended September 30, 2006 and 2005,
      respectively.




**Tax
      Fees**





The
      aggregate tax fees billed to us by Goldstein Lewin & Co. were $9,198 and
      $11,836 for the fiscal years ended September 30, 2006 and 2005, respectively.
      Tax fees include the preparation of federal and state corporate income tax
      returns as well as tax compliance, tax advice and tax planning.








**All
      Other Fees**





Other
      than fees relating to the services described above under “Audit Fees,”
“Audit-Related Fees” and “Tax Fees,” there were no additional fees billed to us
      by Goldstein Lewin & Co. for services rendered for the fiscal years ended
      September 30, 2006 or 2005.








50


**Audit
      Committee Policies**





Effective
      May 6, 2003, the Securities and Exchange Commission adopted rules that require
      that before our independent auditor is engaged by us to render any auditing
      or
      permitted non-audit related service, the engagement be:





*  approved
      by our audit committee; or





*  entered
      into pursuant to pre-approval policies and procedures established by the audit
      committee, provided the policies and procedures are detailed as to the
      particular service, the audit committee is informed of each service, and such
      policies and procedures do not include delegation of the audit committee's
      responsibilities to management.





The
      audit
      committee pre-approves all services provided by our independent auditors,
      including those set forth above. The audit committee has considered the nature
      and amount of fees billed by Goldstein Lewin & Co. and believes that the
      provision of services for activities unrelated to the audit is compatible with
      maintaining Goldstein Lewin & Co.’s independence.





51





**SIGNATURES**





In
      accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused
      this report to be signed on its behalf by the undersigned, thereunto duly
      authorized.





Onstream
      Media Corporation





By: /s/
      Randy S. Selman


Randy
      S.
      Selman, President, Chief


Executive
      Officer





By: /s/
      Robert E. Tomlinson


Robert
      E.
      Tomlinson, Chief Financial Officer








In
      accordance with the Exchange Act, this report has been signed below by the
      following persons on behalf of the registrant and in the capacities and on
      the
      dates indicated.








Signature
            Title
            Date/s/
                Randy S. Selman
            Director,
                President,
            January
                12, 2007Randy
                S. Selman
            Chief
                Executive Officer/s/
                Robert E. Tomlinson
            Chief
                Financial Officer andRobert
                E. Tomlinson
            Principal
                Accounting Officer
            January
                12, 2007/s/
                Clifford Friedland
            Director
                and Senior VP
            January
                12, 2007Clifford
                Friedland
            Business
                Development/s/
                Alan Saperstein
            Director
                and Chief
            January
                12, 2007Alan
                Saperstein
            Operating
                Officer/s/
                Benjamin Swirsky
            Director
            January
                12, 2007Benjamin
                Swirsky/s/
                Robert J. Wussler
            Director
            January
                12, 2007Robert
                J. Wussler/s/
                Charles C. Johnston
            Director
            January
                12, 2007Charles
                C. Johnston/s/
                Carl Silva
            Director
            January
                12, 2007Carl
                Silva




52
  **REPORT
        OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**
 
 
 
 To
        the
        Shareholders of Onstream Media Corporation:
 
 
 We
        have
        audited the accompanying consolidated balance sheets of Onstream Media
        Corporation (formerly Visual Data Corporation) and subsidiaries as of September
        30, 2006 and 2005, and the related consolidated statements of operations,
        stockholders' equity and cash flows for the years then ended. These financial
        statements are the responsibility of the Company's management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. An audit includes examining,
        on a
        test basis, evidence supporting the amounts and disclosures in the financial
        statements. An audit also includes assessing the accounting principles used
        and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the consolidated financial statements referred to above present
        fairly,
        in all material respects, the financial position of Onstream Media Corporation
        and subsidiaries as of September 30, 2006 and 2005, and the results of their
        operations and their cash flows for the years then ended in conformity with
        generally accepted accounting principles in the United States of America.
 
 
 /s/
        Goldstein Lewin & Co.
 Certified
        Public Accountants
 
 GOLDSTEIN
        LEWIN & CO.
 
 Boca
        Raton, Florida
 January
        12, 2007
 F-1
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        BALANCE SHEETS
  September
                  30,2006
              
              2005**ASSETS**CURRENT
                  ASSETS:Cash
                  and cash equivalents
              
              $
              222,963
              
              $
              4,137Restricted
                  cash
              
              
              8,485
              
              
              8,485Accounts
                  receivable, net of allowance for
                doubtful
                  accounts of $28,550 and $28,690, respectively
              
              
              1,529,820
              
              
              1,274,974Prepaid
                  expenses
              
              
              398,203
              
              
              604,928Inventories
              
              
              66,807
              
              
              86,168Other
                  current assets
              
              
              49,271
              
              
              8,914Total
                  current assets
              
              
              2,275,549
              
              
              1,987,606PROPERTY
                  AND EQUIPMENT, net
              
              
              4,898,715
              
              
              4,809,877INTANGIBLE
                  ASSETS, net
              
              
              190,025
              
              
              917,761GOODWILL,
                  net
              
              
              9,692,845
              
              
              9,692,845OTHER
                  NON-CURRENT ASSETS
              
              
              109,078
              
              
              113,998Total
                  assets
              
              $
              17,166,212
              
              $
              17,522,087
 
 
 
 
 
 
 
 (Continued)
 F-2
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        BALANCE SHEETS
 
 (Continued)
  September2006
              
              2005**LIABILITIES
                  AND STOCKHOLDERS' EQUITY**CURRENT
                  LIABILITIES:Accounts
                  payable and accrued liabilities
              
              $
              2,826,676
              
              $
              1,710,808Amounts
                  due to shareholders and officers
              
              
              209,419
              
              
              224,419Deferred
                  revenue
              
              
              268,237
              
              
              170,9718%
                  Convertible Debentures - current portion, net of discount
              
              
              726,478
              
              
              -Notes
                  payable - current portion
              
              
              892,032
              
              
              330,598Detachable
                  Warrants and Embedded Conversion Feature
                associated
                  with 8% Convertible Debentures
              
              
              834,125
              
              
              3,017,168Detachable
                  Warrants and Embedded Conversion Feature
                associated
                  with 8% Subordinated Convertible Debentures
              
              
              281,809
              
              
              -Total
                  current liabilities
              
              
              6,038,776
              
              
              5,453,9648%
                  Convertible Debentures, net of discount and current
                  portion
              
              
              912,657
              
              
              1,243,3228%
                  Subordinated Convertible Debentures, net of discount
              
              
              1,294,870
              
              
              -Notes
                  payable, net of discount and current portion
              
              
              533,758
              
              
              399,600Total
                  liabilities
              
              
              8,780,061
              
              
              7,096,886COMMITMENTS
                  AND CONTINGENCIESEQUITY
                  SECURITIES SUBJECT TO POTENTIAL RESCISSION:Series
                  A-10 Convertible Preferred stock, including potentially redeemable
                  common
                  stock issued upon conversion
              
              
              -
              
              
              4,779,998Detachable
                  warrants associated with 8% Convertible Debentures; beneficial
                  conversion
                  rights included in 8% Convertible Debentures; and potentially redeemable
                  common stock issued upon conversion and/or in lieu of interest
                  on 8%
                  Convertible Debentures
              
              
              -
              
              
              786,027Total
                  equity securities subject to potential rescission
              
              
              -
              
              
              5,566,025STOCKHOLDERS'
                  EQUITY:Series
                  A-10 Convertible Preferred stock, par value $.0001 per share,
                authorized
                  700,000 shares, 430,983 and 416,031 issued and outstanding,
                  respectively
              
              
              43
              
              
              41Common
                  stock, par value $.0001 per share; authorized 75,000,000 shares,
                  15,127,253 and 12,191,001 issued and outstanding,
                  respectively
              
              
              1,513
              
              
              1,219Unamortized
                  discount
              
              
              (1,369,617
              )
              
              (2,067,461
              )Additional
                  paid-in capital
              
              
              87,699,908
              
              
              77,365,612Accumulated
                  deficit
              
              
              (77,945,696
              )
              
              (70,440,235
              )Total
                  stockholders' equity
              
              
              8,386,151
              
              
              4,859,176Total
                  liabilities and stockholders' equity
              
              $
              17,166,212
              
              $
              17,522,087
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
 F-3
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF OPERATIONS
  
 Years
                  Ended,
                September
                  30,2006
              
              2005REVENUE:Digital
                  asset management
              
              $
              2,154,556
              
              $
              1,969,697Network
                  usage and services
              
              
              2,092,928
              
              
              2,049,337Network
                  equipment sales and rentals
              
              
              383,876
              
              
              458,369Webcasting
              
              
              3,620,866
              
              
              3,470,814Travel
                  production and distribution
              
              
              167,225
              
              
              208,177Total
                  revenue
              
              
              8,419,451
              
              
              8,156,394COSTS
                  OF REVENUE:Digital
                  asset management
              
              
              757,871
              
              
              633,801Network
                  usage and services
              
              
              905,905
              
              
              1,192,456Network
                  equipment sales and rentals
              
              
              155,147
              
              
              201,435Webcasting
              
              
              1,367,347
              
              
              1,003,962Travel
                  production and distribution
              
              
              69,824
              
              
              71,206Total
                  costs of revenue
              
              
              3,256,094
              
              
              3,102,860GROSS
                  MARGIN
              
              
              5,163,357
              
              
              5,053,534OPERATING
                  EXPENSES:General
                  and administrative:Compensation
              
              
              4,979,920
              
              
              4,778,694Professional
                  fees
              
              
              2,310,116
              
              
              2,824,400Other
              
              
              1,609,159
              
              
              1,575,215Impairment
                  loss on goodwill
              
              
              -
              
              
              330,000Depreciation
                  and amortization
              
              
              2,121,161
              
              
              1,152,633Total
                  operating expenses
              
              
              11,020,356
              
              
              10,660,942Loss
                  from operations
              
              
              (5,856,999
              )
              
              (5,607,408
              )OTHER
                  (EXPENSE) INCOME:Interest
                  income
              
              
              4,978
              
              
              11,355Interest
                  expense
              
              
              (2,128,362
              )
              
              (4,015,504
              )Income
                  from derivative instruments
              
              
              1,300,959
              
              
              -Other
                  (expense) income, net
              
              
              213,211
              
              
              (26,331
              )Total
                  other (expense) income, net
              
              
              (609,214
              )
              
              (4,030,480
              )Net
                  loss
              
              $
              (6,466,213
              )
              $
              (9,637,888
              )Loss
                  per share - basic and diluted:Net
                  loss per share
              
              $
              (0.47
              )
              $
              (1.17
              )Weighted
                  average shares of common stock outstanding - basic and
                  diluted
              
              
              13,624,786
              
              
              8,261,642
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 F-4
 
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENT OF STOCKHOLDERS' EQUITY
 YEARS
        ENDED SEPTEMBER 30, 2005 AND 2006
  Preferred
                  StockSeries
                A8
              
              Series
                  A10
              
              Series
                  A11
              
              
              
              Common
                  Stock
              
              Additional
                  Paid-in
                Capital
              
              AccumulatedShares
              
              Shares
              
              Shares
              
              Amount
              
              Shares
              
              Amount
              
              Gross
              
              Discount
              
              Deficit
              
              TotalBalance,
                  September 30, 2004
              
              
              232,750
              
              
              -
              
              
              25,000
              
              $
              26
              
              
              4,666,324
              
              $
              467
              
              $
              62,473,209
              
              $
              -
              
              $
              (59,676,915
              )
              $
              2,796,787Issuance
                  of shares, warrants and options for Acquired Onstream
                  purchase
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              2,207,966
              
              
              221
              
              
              7,311,672
              
              
              -
              
              
              -
              
              
              7,311,893Issuance
                  of Series A-10 preferred shares, net
              
              
              -
              
              
              315,000
              
              
              -
              
              
              32
              
              
              -
              
              
              -
              
              
              5,905,919
              
              
              (2,928,041
              )
              
              -
              
              
              2,977,910Conversion
                  of Series A-8 shares into Series A-10 preferred shares
              
              
              (232,750
              )
              
              139,650
              
              
              -
              
              
              (9
              )
              
              -
              
              
              -
              
              
              9
              
              
              -
              
              
              -
              
              
              -Conversion
                  of 8% Convertible Debentures to common shares
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              2,725,659
              
              
              273
              
              
              2,725,386
              
              
              -
              
              
              -
              
              
              2,725,659Conversion
                  of Series A-10 preferred shares to common shares
              
              
              -
              
              
              (61,969
              )
              
              -
              
              
              (6
              )
              
              619,690
              
              
              62
              
              
              (56
              )
              
              356,550
              
              
              (356,550
              )
              
              -Issuance
                  of shares, warrants and options for services and
                  incentives
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              712,626
              
              
              71
              
              
              1,678,794
              
              
              -
              
              
              -
              
              
              1,678,865Redemption
                  of Series A-11 shares
              
              
              -
              
              
              -
              
              
              (25,000
              )
              
              (3
              )
              
              -
              
              
              -
              
              
              (499,997
              )
              
              -
              
              
              -
              
              
              (500,000
              )Warrants
                  issued with 8% Convertible Debentures (includes beneficial
                  conversion)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              4,246,483
              
              
              -
              
              
              -
              
              
              4,246,483Common
                  shares issued for severance and professional services
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              300,000
              
              
              30
              
              
              470,970
              
              
              -
              
              
              -
              
              
              471,000Common
                  shares issued for financing penalty
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              606,000
              
              
              61
              
              
              943,779
              
              
              -
              
              
              -
              
              
              943,840Common
                  shares issued for interest on 8% Convertible Debentures and Notes
                  Payable
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              352,736
              
              
              34
              
              
              459,140
              
              
              -
              
              
              -
              
              
              459,174Series
                  A-10 preferred shares issued for interest
              
              
              -
              
              
              8,562
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              85,620
              
              
              -
              
              
              -
              
              
              85,620Dividends
                  accrued on Series A-10 preferred
              
              
              -
              
              
              14,788
              
              
              -
              
              
              1
              
              
              -
              
              
              -
              
              
              147,877
              
              
              504,030
              
              
              (768,882
              )
              
              (116,974
              )Equity
                  securities subject to potential rescission
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (8,583,193
              )
              
              -
              
              
              -
              
              
              (8,583,193
              )Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (9,637,888
              )
              
              (9,637,888
              )Balance,
                  September 30, 2005
              
              
              -
              
              
              416,031
              
              
              -
              
              $
              41
              
              
              12,191,001
              
              $
              1,219
              
              $
              77,365,612
              
              $
              (2,067,461
              )
              $
              (70,440,235
              )
              $
              4,859,176
 
 
 (Continued)
 
 F-5
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENT OF STOCKHOLDERS' EQUITY
 YEARS
        ENDED SEPTEMBER 30, 2005 AND 2006
 (Continued)
  Preferred
                  StockSeries
                A8
              
              
              Series
                  10
              
              
              Series
                      A11
              
              
              
              
              
              Common
                  Stock
              
              
              Additional
                    Paid-in
                  Capital
              
              
              AccumulatedShares
              
              
              Shares
              
              
              Shares
              
              
              Amount
              
              
              Shares
              
              
              Amount
              
              
              Gross
              
              
              Discount
              
              
              Deficit
              
              
              TotalBalance,
                  September 30, 2005
              
              
              -
              
              
              416,031
              
              
              -
              
              $
              41
              
              
              12,191,001
              
              $
              1,219
              
              $
              77,365,612
              
              $
              (2,067,461
              )
              $
              (70,440,235
              )
              $
              4,859,176Conversion
                  of 8%Convertible
                Debentures
                  tocommon
                  shares
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              906,506
              
              
              91
              
              
              906,415
              
              
              -
              
              
              -
              
              
              906,506Conversion
                  of Series A-10 preferred shares to common shares
              
              
              -
              
              
              (18,874
              )
              
              -
              
              
              (2
              )
              
              188,740
              
              
              19
              
              
              (17
              )
              
              69,463
              
              
              (69,463
              )
              
              -Warrants
                  issued with 8% Subordinated Convertible Debentures (includes beneficial
                  conversion)
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              917,917
              
              
              -
              
              
              -
              
              
              917,917Issuance
                  of shares, warrants and options for equipment, services and
                  incentives
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              1,092,715
              
              
              109
              
              
              1,449,999
              
              
              -
              
              
              -
              
              
              1,450,108Common
                  shares issued for interest on 8% Convertible Debentures and Notes
                  Payable
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              727,458
              
              
              73
              
              
              534,585
              
              
              -
              
              
              -
              
              
              534,658Common
                  shares issued upon exercise of Warrants
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              20,833
              
              
              2
              
              
              20,831
              
              
              -
              
              
              -
              
              
              20,833Dividends
                  accrued on Series A-10 preferred
              
              
              -
              
              
              33,826
              
              
              -
              
              
              4
              
              
              -
              
              
              -
              
              
              338,264
              
              
              628,381
              
              
              (969,785
              )
              
              (3,136
              )Decrease
                  in equity securities subject to potential rescission
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              7,084,219
              
              
              -
              
              
              -
              
              
              7,084,219Reclassification
                  to liability of
                Detachable
                  WarrantsandEmbedded
                ConversionFeature
                  associated with
                8%Subordinated
                  Convertible
                Debentures
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (917,917
              )
              
              -
              
              
              -
              
              
              (917,917
              )Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              (6,466,213
              )
              
              (6,466,213
              )Balance,
                  September 30, 2006
              
              
              -
              
              
              430,983
              
              
              -
              
              $
              43
              
              
              15,127,253
              
              $
              1,513
              
              $
              87,699,908
              
              $
              (1,369,617
              )
              $
              (77,945,696
              )
              $
              8,386,151
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 F-6
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF CASH FLOWS
 
 
 Years
                  Ended
                September
                  30,2006
              
              2005CASH
                  FLOWS FROM OPERATING ACTIVITIES:Net
                  loss
              
              $
              (6,466,213
              )
              $
              (9,637,888
              )Adjustments
                  to reconcile net loss to net cash (used in) operating
                  activities:Depreciation
                  and amortization
              
              
              2,121,161
              
              
              1,152,633Amortization
                  of discount on notes payable
              
              
              54,364
              
              
              494,150Amortization
                  of discount on convertible debentures
              
              
              1,387,716
              
              
              2,065,592Interest
                  penalty payable in common shares
              
              
              -
              
              
              943,840Interest
                  expense paid in common shares
              
              
              523,313
              
              
              367,838Interest
                  expense paid in A-10 preferred shares
              
              
              -
              
              
              85,620Interest
                  expense on notes converted to 8% Subordinated
                Convertible
                  Debentures
              
              
              25,000
              
              
              -Amortization
                  of deferred services and incentives, including
                shares
                  issued for severance and services
              
              
              1,397,775
              
              
              1,768,598Income
                  from derivative instruments
              
              
              (1,300,959
              )
              
              -Impairment
                  loss on goodwill
              
              
              -
              
              
              330,000Loss
                  on equity basis investment in Acquired Onstream
              
              
              -
              
              
              100,025(Increase)
                  Decrease in allowance for doubtful accounts
              
              
              (1,130
              )
              
              694Gain
                  from settlements of obligations
              
              
              (11,691
              )
              
              (44,079
              )Loss
                  on disposition/retirement of fixed assets
              
              
              -
              
              
              28,252Changes
                  in assets and liabilities, net of effects from
                the
                  Onstream Merger:(Increase)
                  Decrease in accounts receivable
              
              
              (253,716
              )
              
              89,936Decrease
                  in prepaid expenses
              
              
              6,785
              
              
              108,524(Increase)
                  in other current assets
              
              
              (40,357
              )
              
              (1,270
              )Decrease
                  (Increase) in inventories
              
              
              19,361
              
              
              (35,125
              )Increase
                  in accounts payable and accrued liabilities
              
              
              920,225
              
              
              253,709Increase
                  in deferred revenue
              
              
              97,266
              
              
              43,260Net
                  cash (used in) operating activities
              
              
              (1,521,100
              )
              
              (1,885,691
              )CASH
                  FLOWS FROM INVESTING ACTIVITIES:Advances
                  to Acquired Onstream
              
              
              -
              
              
              (1,457,811
              )Costs
                  of Onstream Merger
              
              
              -
              
              
              (153,317
              )Payment
                  of accounts payable and accrued liabilities assumed
                at
                  time of Onstream Merger
              
              
              (15,000
              )
              
              (510,373
              )Acquisition
                  of property and equipment
              
              
              (1,105,249
              )
              
              (1,732,815
              )Sale
                  of assets
              
              
              -
              
              
              50,000Net
                  cash (used in) investing activities
              
              
              (1,120,249
              )
              
              (3,804,316
              )
  
 (Continued)
 F-7
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
        STATEMENTS OF CASH FLOWS
 
 (Continued)
 Years
                  Ended
                September
                  30,2006
              
              2005CASH
                  FLOWS FROM FINANCING ACTIVITIES:Proceeds
                  from sale of 8% Subordinated Convertible Debentures,
                net
                  of expenses
              
              $
              1,756,634
              
              $
              -Proceeds
                  from issuance of common shares upon exercise of Warrants
              
              
              20,833
              
              
              -Proceeds
                  from sale of 8% Convertible Debentures, net of expenses
              
              
              -
              
              
              6,129,213Proceeds
                  from Series A-10 convertible preferred, net of expenses
              
              
              -
              
              
              1,977,910Proceeds
                  from restricted cash
              
              
              -
              
              
              200,000Proceeds
                  from loans and notes payable
              
              
              2,022,815
              
              
              750,000Dividends
              
              
              -
              
              
              (116,974
              )Repayment
                  of loans, notes and leases payable
              
              
              (940,107
              )
              
              (2,760,274
              )Payment
                  of Series A-11 convertible preferred
              
              
              -
              
              
              (
                  500,000
              )Net
                  cash provided by financing activities
              
              
              2,860,175
              
              
              5,679,875NET
                  INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              218,826
              
              
              (10,132
              )CASH
                  AND CASH EQUIVALENTS, beginning of period
              
              
              4,137
              
              
              14,269CASH
                  AND CASH EQUIVALENTS, end of period
              
              $
              222,963
              
              $
              4,137SUPPLEMENTAL
                  DISCLOSURES OF CASH FLOW INFORMATION:Cash
                  payments for interest
              
              $
              208,646
              
              $
              55,606SUPPLEMENTAL
                  SCHEDULE OF NON-CASH INVESTING AND FINANCING
                  ACTIVITIES:Issuance
                  of shares, options and warrants in conjunction with the
                Onstream
                  Merger
              
              $
              -
              
              $
              7,311,893Issuance
                  of warrants with 8%Subordinated Convertible Debentures
              
              $
              424,459
              
              $
              -Issuance
                  of warrants with 8% Convertible Debentures
              
              $
              -
              
              $
              1,926,257Issuance
                  of warrants with Series A-10 convertible preferred
              
              $
              -
              
              $
              922,756Conversion
                  of note payable to Series A-10 convertible preferred
              
              $
              -
              
              $
              1,000,000Conversion
                  of Series A-8 convertible preferred to Series A-10 convertible
                preferred
              
              $
              -
              
              $
              1,396,500Conversion
                  of Series A-10 convertible preferred to common shares
              
              $
              188,740
              
              $
              619,690Conversion
                  of 8% Convertible Debentures to common shares
              
              $
              906,506
              
              $
              2,725,659Net
                  (decrease) increase in amount of equity securities becoming subject
                  to
                potential
                  rescission, including portion classified as liability
              
              $
              (7,084,219
              )
              $
              8,583,193Derivative
                  instruments reclassified from equity to liability
              
              $
              917,917
              
              $
              -Issuance
                  of shares, warrants and options for deferred services and
                incentives
              
              $
              1,123,064
              
              $
              1,678,865Issuance
                  of shares for payment of accounts payable
              
              $
              327,044
              
              $
              -Issuance
                  of common shares for severance, services and financial
                  penalties
              
              $
              -
              
              $
              1,414,840Issuance
                  of common shares for interest
              
              $
              534,658
              
              $
              459,174Issuance
                  of A-10 preferred shares for interest and dividends
              
              $
              338,268
              
              $
              233,498Sale
                  of Curaspan investment for promissory note (fully
                  reserved)
              
              $
              -
              
              $
              150,000Disposal
                  of property and equipment
              
              $
              641,860
              
              $
              -
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 F-8
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
 
 Nature
        of
        Business
 
 Onstream
        Media Corporation (formerly Visual Data Corporation) (the "Company" or
        "Onstream" or "ONSM"), organized in 1993, is an online service provider of
        live
        and on-demand rich media communications, including digital asset management
        services and webcasting. Digital asset management services are provided
        primarily to entertainment, advertising and financial industry customers.
        Webcasting services are provided primarily to corporate, education, government
        and travel industry customers.
 
 See
        Note
        2 regarding the Company’s December 23, 2004 acquisition of Acquired Onstream. As
        a result of that acquisition, the Company changed its name to Onstream Media
        Corporation in January 2005 and has reorganized the previous three operating
        groups into two groups - Digital Asset Management and Webcasting. The Digital
        Asset Management group includes the previous Networking Solutions Group,
        as well
        as the operations resulting from software licenses and other assets acquired
        from Virage, Inc. and Acquired Onstream. The new Webcasting Group includes
        the
        previous Webcasting and Travel groups.
 
 Our
        Digital Asset Management Group, which operates from facilities in San Francisco,
        California, provides digital asset management services. Digital asset management
        is a set of coordinated technologies and processes that allow the quick and
        efficient storage, retrieval, and reuse of the digital files that are essential
        to all businesses. These digital files include photos, videos, audio files,
        engineering specs, architectural plans, web pages, and many other pieces
        of
        business collateral. Digital asset management provides the business rules
        and
        processes needed to acquire, store, index, secure, search, export and transform
        these assets and their descriptive information ***.*** ****
 
 In
        addition, through our subsidiary doing business under the name EDNet, the
        Digital Asset Management Group provides connectivity within the entertainment
        and advertising industries through its managed network, which encompasses
        production and post-production companies, advertisers, producers, directors,
        and
        talent. The global network, with approximately 500 active clients in cities
        throughout the United States, Canada, Mexico, Europe, and the Pacific Rim,
        enables high-speed exchange of high quality audio, compressed video and
        multimedia data communications, utilizing long distance carriers, regional
        phone
        companies, satellite operators, and major internet service providers. EDNet
        also
        provides systems integration and engineering services, application-specific
        technical advice, audio equipment, proprietary and off-the-shelf codecs,
        teleconferencing equipment, and other innovative products to facilitate the
        Company's broadcast and production applications. EDNet generates revenues
        from
        the sale, rental and installation of equipment, network usage, distribution
        fees
        and other related fees.
 
 The
        Webcasting Group provides an array of web-based media services to the corporate
        market including live audio and video webcasting, packaged corporate
        announcements, and rich media information storage and distribution for any
        business entity. The Webcasting Group also produces Internet-based multi-media
        streaming videos related to hotels, resorts, time-shares, golf facilities,
        and
        other travel destinations. The Company warehouses this travel content on
        its own
        on-line travel portal - www.travelago.com ("Travelago"). See Note 3 regarding
        the disputed sale of these travel related assets and operations. The Webcasting
        Group generates revenues through production and distribution fees.
 F-9
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Liquidity
 
 The
        consolidated financial statements have been presented on the basis that the
        Company is a going concern, which contemplates the realization of assets
        and the
        satisfaction of liabilities in the normal course of business. The Company
        has
        incurred losses since its inception, and has an accumulated deficit of
        approximately $77.9 million as of September 30, 2006. The Company's operations
        have been financed primarily through the issuance of equity and debt. For
        the
        year ended September 30, 2006, ONSM had a net loss of approximately $6.5
        million
        and cash used in operations of approximately $1.5 million. The Company had
        a
        working capital deficit of $3,763,227 at September 30, 2006, which is before
        the
        effect of significant cash proceeds to the Company from the exercise of warrants
        and options, conversions of 8% Senior and Subordinated Convertible Debentures
        to
        ONSM common stock, and long-term financing, all occurring after September
        30,
        2006 - see Note 9.
 
 The
        Company is constantly evaluating its cash needs and existing burn rate, in
        order
        to make appropriate adjustments to operating expenses. Depending on its actual
        future cash needs, the Company may need to raise additional debt or equity
        capital to provide funding for ongoing future operations, or to refinance
        existing indebtedness. No assurances can be given that the Company will be
        successful in obtaining additional capital, or that such capital will be
        available on terms acceptable to the Company. The Company's continued existence
        is dependent upon its ability to raise capital and to market and sell its
        services successfully. The financial statements do not include any adjustments
        to reflect future effects on the recoverability and classification of assets
        or
        amounts and classification of liabilities that may result if the Company
        is
        unsuccessful.
 
 Basis
        of
        Consolidation
 
 The
        accompanying consolidated financial statements include the accounts of Onstream
        Media Corporation and its subsidiaries - Entertainment Digital Network, Inc.,
        Media On Demand, Inc., HotelView Corporation and OSM Acquisition, Inc.. All
        significant intercompany accounts and transactions have been eliminated in
        consolidation. The Company uses the equity method of accounting for investments
        where its ownership is between 20% and 50%.
 
 Accounting
        Estimates
 
 The
        preparation of financial statements in conformity with accounting principles
        generally accepted in the United States, requires management to make estimates
        and assumptions that affect the reported amounts of assets and liabilities
        and
        disclosure of contingent assets and liabilities at the date of the financial
        statements and the reported amounts of revenue and expenses during the reporting
        period. Estimates are used when accounting for allowances for doubtful accounts,
        revenue reserves, inventory reserves, depreciation and amortization, taxes,
        contingencies and impairment allowances. Such estimates are reviewed on an
        on-going basis and actual results could materially differ from those
        estimates.
 
 F-10
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Cash
        and
        cash equivalents
 
 Cash
        and
        cash equivalents consists of all highly liquid investments with original
        maturities of three months or less.
 
 Restricted
        cash
 
 Restricted
        cash consisted of amounts provided by a major investor in conjunction with
        a
        loan. The restricted cash is to be utilized by the Company at the lender’s
        discretion.
  Fair
        Value of Financial Instruments
 
 The
        carrying amounts of cash and cash equivalents, restricted cash, accounts
        receivable, accounts payable, accrued expenses and notes payable approximate
        fair value due to the short maturity of the instruments.
 
 Bad
        Debt
        Reserves
 
 The
        Company evaluates the collectibility of its accounts receivable based on
        a
        combination of factors. In cases where the Company is aware of circumstances
        that may impair a specific customer's ability to meet its financial obligations
        to the Company, the Company records a specific allowance against amounts
        due to
        us, and thereby reduce the net recognized receivable to the amount the Company
        reasonably believes will be collected. For all other customers, the Company
        recognizes allowances for doubtful accounts based on the length of time the
        receivables are past due, the current business environment and historical
        experience. At both September 30, 2006 and 2005, bad debt reserves were
        approximately $29,000.
 
 Concentration
        of Credit Risk
 
 The
        Company at times has cash in banks in excess of FDIC insurance limits and
        places
        its temporary cash investments with high credit quality financial institutions.
        The Company performs ongoing credit evaluations of its customers' financial
        condition and does not require collateral from them. Reserves for credit
        losses
        are maintained at levels considered adequate by management. See
        Note
        7 regarding revenues from significant customers.
 
 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. The Company evaluates 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, the Company management estimates the amount of provisions made
        for
        obsolete or slow moving inventory.
 
 Property
        and Equipment
 
 Property
        and equipment are recorded at cost, less accumulated depreciation. Property
        and
        equipment under capital leases are stated at the lower of the present value
        of
        the minimum lease payments at the beginning of the lease term or the fair
        value
        at the inception of the lease. Depreciation is computed using the straight-line
        method over the estimated useful lives of the related assets. Amortization
        expense on assets acquired under capital leases is included in depreciation
        expense. The costs of leasehold improvements are amortized over the lesser
        of
        the lease term or the life of the improvement.
 F-11
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Software
 
 Included
        in property and equipment is computer software developed for internal use,
        including the Digital Media Services Platform (“DMSP”) - see notes 2 and 3. Such
        amounts have been accounted for in accordance with Statement of Position
        98-1
“Accounting for the Costs of Computer Software Developed or Obtained for
        Internal Use” and Emerging Issues Task Force pronouncement (“EITF”) 00-2
“Accounting for Web Site Development Costs”. Such costs are amortized on a
        straight-line basis over three years, commencing when the related asset has
        been
        substantially placed in service.
 
 Goodwill
        and other intangible assets
 
 Statement
        of Financial Accounting Standards (“SFAS”) 142, “Goodwill and Other Intangible
        Assets”, adopted by the Company effective October 1, 2001, provides that
        goodwill is no longer amortized but is reviewed annually (or more frequently
        if
        impairment indicators arise) for impairment. Other intangible assets, such
        as
        customer lists, continue to be amortized to expense over their estimated
        useful
        lives, although they are still subject to review and adjustment for
        impairment.
 
 The
        Company reviews its long-lived assets for impairment whenever events or changes
        in circumstances indicate that the carrying amount of an asset may not be
        recoverable. The Company assesses 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 amount of an
        impairment, if any, is calculated based on the excess of the carrying amount
        over the fair value of those assets.
 
 See
        Note
        2 - Goodwill and other Acquisition-Related Intangible Assets.
 
 Revenue
        Recognition
 
 Revenues
        from sales of goods and services are recognized when (i) persuasive evidence
        of
        an arrangement between the Company and the customer exists, (ii) the good
        or
        service has been provided to the customer, (iii) the price to the customer
        is
        fixed or determinable and (iv) collectibility of the sales prices is reasonably
        assured.
 
 The
        Digital Asset Management Group recognizes revenues from the acquisition,
        editing, transcoding, indexing, storage and distribution of its customers’
digital media. The customer charges are generally based on the activity or
        volume of such media, expressed in megabytes or similar terms, and are
        recognized at the time the service is performed. Fees charged to customers
        for
        customized applications or set-up are recognized as revenue at the time the
        application or set-up is completed.
 
 The
        EDNet
        division of the Digital Asset Management Group generates revenues from customer
        usage of digital telephone connections controlled by the Company, bridging
        services and the sale of equipment. The Company 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 use of those services.
 F-12
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Revenue
        Recognition (Continued)
 
 The
        equipment EDNet sells is various audio codecs and video transport systems.
        The
        audio codecs and video transport systems enable 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 a free trial period. All sales are final and there are no refund rights
        or
        rights of return. The Company 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 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 the Company’s 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 the Company has difficulty in producing
        the webcast, it 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 the Company hosts 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 the Company has referred
        to
        these separately billed transactions as verifiable and objective evidence
        of the
        amount of its revenues related to on-demand services. In addition, the Company
        has determined that the material portion of all views of archived webcasts
        take
        place within the first ten days after the live webcast.
 
 Based
        on
        its review of the above data, the Company has determined that the material
        portion of its revenues for on-demand webcasting services are recognized
        during
        the period in which those services are provided, which complies with the
        provisions of Staff Accounting Bulletin (“SAB”) No. 101 and SAB 104, “Revenue
        Recognition”, and EITF 00-21, “Accounting for Revenue Arrangements with Multiple
        Elements”. Furthermore, the Company has determined that the maximum potentially
        deferrable revenue from on-demand webcasting services charged for but not
        provided as of September 30, 2006 and 2005 is immaterial in relation to the
        Company’s recorded liabilities.
 
 The
        Webcasting Group recognizes a portion of their travel contract revenue at
        the
        time of completion of video production services with the remaining revenue
        recognized over the term of the contract. Per hit charges are recognized
        when
        users watch a video on the Internet. Fixed monthly fees are recognized on
        a
        monthly basis consistent with the terms of the contract. Commissions on bookings
        are recognized when the stays are completed.
 
 Deferred
        revenue represents amounts billed to customers for webcasting, EDNET or digital
        asset management services to be provided in future accounting periods. As
        projects or events are completed and/or the services provided, the revenue
        is
        recognized. The Company received $135,000 in fully earned, non-refundable
        digital asset management fees during the year ended September 30, 2006 that
        are
        not included in the revenue reported for that period. Based on applicable
        accounting literature, including Staff Accounting Bulletin (“SAB”) Number 104,
“Revenue Recognition”, the Company has included this amount on its September 30,
        2006 balance sheet under the caption “Deferred Revenue” and expects to include
        it as revenue during the first quarter of fiscal 2007.
 
 
 F-13
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Comprehensive
        Income or Loss
 
 The
        Company has no components of other comprehensive income or loss, and
        accordingly, net loss equals comprehensive loss for all periods
        presented.
 
 Advertising
        and marketing
 
 Advertising
        and marketing costs, which are charged to operations as incurred, were
        approximately $348,000 and $204,000 for the years ended September 30, 2006
        and
        2005, respectively.
 
 Derivatives
 
 The
        Company accounts for non-hedging contracts that are indexed to, and potentially
        settled in, its own common stock in accordance with the provisions of EITF
        00-19, “Accounting for Derivative Financial Instruments Indexed to, and
        Potentially Settled in, a Company’s Own Stock”. These non-hedging contracts
        accounted for in accordance with EITF 00-19 include freestanding warrants
        to
        purchase the Company’s common stock as well as embedded conversion features that
        have been bifurcated from the host financing contract in accordance with
        the
        requirements of SFAS 133 ,
        “Accounting for Derivative Instruments and Hedging Activities”. Under certain
        circumstances that could require the Company to settle these equity items
        in
        cash or stock, and without regard to probability, EITF 00-19 could require
        the
        classification of all or part of the item as a liability and the adjustment
        of
        that reclassified amount to fair value at each reporting date, with such
        adjustments reflected in the Company’s statement of operations, subject to the
        accounting for equity securities that were subject to potential rescission
        as
        discussed in Note 4.
 
 Income
        Taxes
 
 As
        part
        of the process of preparing our consolidated financial statements, the Company
        is required to estimate its income taxes in each of the jurisdictions in
        which
        it operates. 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 the Company’s consolidated balance sheet.
        The Company then assesses the likelihood that the deferred tax assets will
        be
        recovered from future taxable income and to the extent it believes that recovery
        is not likely, it establishes a valuation allowance. To the extent the Company
        establishes a valuation allowance or changes this allowance in a period,
        it
        includes an expense or a benefit within the tax provision in the Company’s
        statement of operations.
 
 The
        Company has approximately $68.9 million in net operating loss carryforwards
        at
        of September 30, 2006, which expire in 2011 through 2026. The utilization
        of
        approximately $16.0 million of the net operating loss carryforward, acquired
        from the 2001 acquisition of EDNET and the 2002 acquisition of MOD and included
        in this total, against future taxable income may be limited as a result of
        ownership changes and other limitations. The Company also has an approximately
        $3.5 million capital loss carryforward which expires in 2008.
 
 F-14
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Income
        Taxes (continued)
 
 Significant
        judgment is required in determining the Company’s provision for income taxes,
        its deferred tax assets and liabilities and any valuation allowance recorded
        against those deferred tax assets. The
        Company has a deferred tax asset of approximately $25.9 million primarily
        resulting from the net operating loss carryforwards. A full valuation allowance
        has been recorded related to the deferred tax asset due
        to
        the uncertainty of realizing the benefits of certain net operating loss
        carryforwards before they expire . The
        valuation allowance is based on the Company’s historical taxable income and its
        estimates of future taxable income in each jurisdiction in which it operates
        and
        the period over which its deferred tax assets will be recoverable. Management
        will continue to assess the likelihood that the deferred tax asset will be
        realizable and the valuation allowance will be adjusted
        accordingly.
 
 Accordingly,
        no income tax benefit has been recorded in the accompanying consolidated
        statement of operations as a result of the net tax losses of approximately
        $6.6
        million and $5.5 million for the years ended September 30, 2006 and 2005,
        respectively. The primary differences between the net loss for book and tax
        purposes are non-taxable book income from derivative instruments as well
        as the
        following items expensed for book purposes but not deductible for tax purposes
        -
        amortization of loan discount, amortization of customer lists, valuation
        allowance of goodwill, losses on an equity basis from Acquired Onstream,
        inventory and receivable reserves, and expenses for stock options and shares
        issued in payment for consulting and other professional fees but not exercised
        by the recipients, or in the case of shares, not registered for or eligible
        for
        resale. There are no significant cumulative temporary differences as of
        September 30, 2006.
 
 Net
        Loss
        Per Share
 
 For
        the
        years ended September 30, 2006 and 2005, net loss per share is based on the
        weighted average number of shares of common stock outstanding, which includes the
        effect of 2,000 common shares per day that the Company was obligated to issue
        through June 29, 2005, and did issue on such date, under the terms of a penalty
        provision contained in a March 2004 convertible debenture agreement. On June
        29,
        2005, the Company issued 606,000 common shares in full satisfaction of this
        penalty. The Company also recorded interest expense of $943,840 for the year
        ended September 30, 2005 related to its valuation of this stock, which was
        based
        on the closing share price for each day that the penalty was
        incurred.
 
 Since
        the
        effect of common stock equivalents was anti-dilutive, all such equivalents
        were
        excluded from the calculation of net loss per share. The total outstanding
        options and warrants, which have been excluded from the calculation of net
        loss
        per share, were 15,212,431 and 15,114,093 at September 30, 2006 and 2005,
        respectively. The September 30, 2005 number includes warrants contingent
        on the
        exercise of warrants that expired unexercised in September 2006 - see Notes
        4
        and 8.
 
 In
        addition, the potential dilutive effects of the following convertible securities
        outstanding at September 30, 2006 have been excluded from the calculation
        of net
        loss per share: (i) 430,983 shares of Series A-10 Convertible Preferred Stock
        (“Series A-10”) which could potentially convert into 4,309,830 shares of our
        common stock and (ii) $3,000,000 of senior secured convertible notes (“8%
        Convertible Debentures”) and $2,225,000 of subordinated convertible notes (“8%
        Subordinated Debentures”), which in aggregate could potentially convert into
        5,225,000 shares of our common stock. The potential dilutive effects of the
        following convertible securities outstanding at September 30, 2005 have been
        excluded from the calculation of net loss per share: (i) 416,031 shares of
        Series A-10 Convertible Preferred Stock (“Series A-10”) which could potentially
        convert into 4,160,310 shares of our common stock and (ii) $3,820,000 of
        senior
        secured convertible notes (“8% Convertible Debentures”) which could potentially
        convert into 3,820,000 shares of our common stock.
 F-15
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 Stock
        Compensation
 
 The
        Company has a stock based compensation plan for its employees (the “Plan”). The
        Company has elected to continue using Accounting Principles Board Opinion
        (“APB”) 25, "Accounting for Stock Issued to Employees," in accounting for
        employee stock options. The following table summarizes the pro forma
        consolidated results of operations of the Company as though the fair value
        based
        accounting method in “Accounting for Stock-Based Compensation" ("SFAS 123") had
        been used in accounting for employee options issued within the Plan (“Plan
        Options”) and outside the Plan (“Non-Plan Options”).
 For
                    the years ended September 30,2006
                
                
                2005Net
                    loss, as reported
                
                $
                (
                    6,466,213
                )
                $
                (
                    9,637,888
                )Total
                    stock based compensation expense *
                
                
                (
                    1,397,297
                )
                
                (
                    2,477,967
                )Pro
                    forma net loss
                
                $
                (
                    7,863,510
                )
                $
                (12,115,855
                )Net
                    loss per share - basic and diluted:Net
                    loss per share, as reported
                
                $
                (
                    0.47
                )
                $
                (
                    1.17
                )Net
                    loss per share, pro forma
                
                $
                (
                    0.58
                )
                $
                (
                    1.47
                )
 *
        Total
        stock based compensation expense is determined by applying the fair value
        based
        method for all employee awards, net of tax.
 
 The
        fair
        value of each option granted is estimated on the date of grant using the
        Black-Scholes model with the following assumptions: expected volatility of
        44%
        to 75%, risk-free interest rate of 6.25%, expected dividends of $0 and expected
        term is the full term of the related option, ranging from 4 to 5
        years.
 
 In
        December 2004, the Company issued 1,350,000 Non-Plan Options to directors
        and
        management as additional compensation for the closing of the Onstream Merger,
        which it accounted for in accordance with APB 25. The compensation value
        of
        these options, approximately $1.0 million, is included in the above table
        for
        the year ended September 30, 2005, as it is considered to be an internal
        cost
        associated with a business combination, which is expensed in accordance with
        SFAS 141, “Business Combinations”. See Note 2.
 
 The
        Company has granted Non-Plan Options to consultants and other third parties.
        These options have been accounted for under SFAS 123, under which the fair
        value
        of the options at the time of their issuance is reflected in the Company’s
        consolidated financial statements and expensed at the time the services
        contemplated by the options are provided to the Company.
 
 In
        December 2004, the FASB issued SFAS 123R *,* “Share-Based
        Payments”, which requires all companies to measure compensation cost for all
        share-based payments, including employee stock options, at fair value. In
        April
        2005, the Securities and Exchange Commission (“SEC”) made certain changes to the
        effective dates of SFAS 123R. SFAS 123R, as amended by the SEC, is effective
        for
        public companies for the first interim or annual period of their fiscal year
        beginning after June 15, 2005, except small business issuers (as defined
        in SEC
        Regulation S-B), for which it is effective for the first fiscal year beginning
        after December 15, 2005. The Company is in the process of determining the
        impact
        of this statement on its consolidated financial statements, although our
        ability
        to quantify the future impact is limited due to the lack of our ability to
        predict future share-based payments, the potential variability of these payments
        between accounting periods as well the future volatility of our common stock
        and
        other factors affecting the Black-Sholes valuation model.
 
 See
        Note
        8 for additional information related to all stock option issuances.
 F-16
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Employee
        401(k) plan
 
 The
        Company’s 401(k) plan, the Onstream Media Corporation 401(k) Retirement Plan and
        Trust (the “Plan”), is available to all full-time employees and provides them
        with tax deferred salary reductions and alternative investment options (directly
        solely by the employees). Employees may contribute a portion of their salary,
        subject to certain limitations, including an annual maximum established by
        the
        Internal Revenue Code. The Company matches employees’ contributions to the Plan,
        up to the first 8% of eligible compensation, at a 25% rate. The Company’s
        matching contribution was approximately $42,000 and $38,000 for the years
        ended
        September 30, 2006 and 2005, respectively. The Company expensed approximately
        $34,000 and $28,000 in those fiscal years, respectively, with the remaining
        amounts of $8,000 and $10,000, respectively, satisfied by amounts previously
        funded by the Company but forfeited by terminated employees. The Company’s
        contributions to the Plan vest over five years.
 
 Reclassifications
 
 Certain
        prior year amounts have been reclassified to conform to the current year
        presentation.
 
 Effects
        of Recent Accounting Pronouncements
 
 In
        June
        2005, the Financial Accounting Standards Board (“FASB”) issued Statement of
        Financial Accounting Standards (“SFAS”) 154, “Accounting Changes and Error
        Corrections”, which replaced APB Opinion 20, “Accounting Changes” and SFAS 3,
“Reporting Accounting Changes in Interim Financial Statements”. SFAS 154 changes
        the requirements for the accounting and reporting of a change in an accounting
        principle. APB 20 required that most voluntary changes in accounting principle
        be recognized by including the cumulative effect of the new principle in
        net
        income for the period of the change. SFAS 154 now requires retrospective
        application of changes in an accounting principle to prior period financial
        statements, unless it is impracticable to determine the necessary information.
        SFAS 154 is effective for fiscal years beginning after December 15, 2005
        and
        adoption by the Company is not expected to have a material impact to the
        Company's overall results of operations or financial position.
 
 In
        June
        2005, the Emerging Issues Task Force (“EITF”) issued EITF 05-2, “The Meaning of
        Conventional Convertible Debt Instrument in Issue No. 00-19”. EITF 05-2 retained
        the definition of a conventional convertible debt instrument as set forth
        in
        EITF 00-19, and which is used in determining certain exemptions to the
        accounting treatments prescribed under SFAS 133, “Accounting for Derivative
        Instruments and Hedging Activities”. EITF 05-2 also clarified that certain
        contingencies related to the exercise of a conversion option would not be
        outside the definition of “conventional” and determined that convertible
        preferred stock with a mandatory redemption date would also qualify for similar
        exemptions if the economic characteristics of the preferred stock are more
        akin
        to debt than equity. EITF 05-2 is effective for new instruments entered into
        and
        instruments modified in periods beginning after June 29, 2005 We adopted
        the
        provisions of EITF 05-2 on July 1, 2005, which did not have a material effect
        on
        our financial statements. However, see Notes 4 and 5 related to classification
        of certain amounts related to detachable warrants and embedded conversion
        features as a liability as of September 30, 2006 and 2005, which was based
        on
        our application of EITF 00-19 as well as other authoritative
        literature.
 F-17
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        1:
        NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued)
 
 Effects
        of Recent Accounting Pronouncements (Continued)
 
 In
        July
        2005, the FASB issued FASB Staff Position (“FSP”) 150-5, “Accounting Under SFAS
        150 for Freestanding Warrants and Other Similar Instruments on Redeemable
        Shares”. FSP 150-5 clarifies that warrants on shares that are redeemable or
        puttable immediately upon exercise and warrants on shares that are redeemable
        or
        puttable in the future qualify as liabilities under SFAS 150, regardless
        of the
        redemption feature or redemption price. The FSP is effective for the first
        reporting period beginning after June 30, 2005, with resulting changes to
        prior
        period statements reported as the cumulative effect of an accounting change
        in
        accordance with the transition provisions of SFAS 150. We adopted the provisions
        of FSP 150-5 on July 1, 2005, which did not have a material effect on our
        financial statements. However, see Note 4 related to classification of certain
        amounts related to detachable warrants and
        embedded conversion features as a liability as of September 30, 2006 and
        2005,
        which was based on our application of SFAS 150 as well as other authoritative
        literature.
 
 In
        July
        2005, the FASB issued EITF 05-6, “Determining the Amortization period for
        Leasehold Improvements Purchased After Lease Inception or Acquired in a Business
        Combination”, which addressed the amortization period for leasehold improvements
        made on operating leases acquired significantly after the beginning of the
        lease. The EITF is effective for leasehold improvements made in periods
        beginning after June 29, 2005. We adopted the provisions of EITF 05-6 on
        July 1,
        2005, which did not have a material impact to the Company's overall results
        of
        operations or financial position.
 
 In
        June
        2006, the FASB issued FASB Interpretation (“FIN”) No. 48 “Accounting for
        Uncertainty in Income Taxes”, which clarifies SFAS 109, “Accounting for Income
        Taxes” by prescribing 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. FIN 48 will be effective for the Company’s
        fiscal year beginning October 1, 2007 and the Company is currently reviewing
        the
        effect FIN 48 will have on its financial statements.
 
 
 
 F-18
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        2:
        GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
 
 Information
        regarding the Company’s intangible assets is as follows:
 
 September
                  30, 2006
              
              September
                  30, 2005Gross
                  Carrying Amount
              
              Accumulated
                Amortization
              
              Net
                  Book
                Value
              
              Gross
                  Carrying Amount
              
              Accumulated
                Amortization
              
              Net
                  Book
                ValueGoodwill-Acquired
                  Onstream
              
              $
              8,421,401
              
              $
              -
              
              $
              8,421,401
              
              $
              8,421,401
              
              $
              -
              
              $
              8,421,401Goodwill
                  - EDNet
              
              
              1,271,444
              
              
              -
              
              
              1,271,444
              
              
              1,271,444
              
              
              -
              
              
              1,271,444Customer
                  Lists - MOD
              
              
              3,071,722
              
              
              (2,918,136
              )
              
              153,586
              
              
              3,071,722
              
              
              (2,303,791
              )
              
              767,931Customer
                  Lists - Virage
              
              
              332,000
              
              
              (
                  295,561
              )
              
              36,439
              
              
              332,000
              
              
              (
                  182,170
              )
              
              149,830$
              13,096,567
              
              $
              (3,213,697
              )
              $
              9,882,870
              
              $
              13,096,567
              
              $
              (2,485,961
              )
              $
              10,610,606
 
 On
        October 22, 2003 the Company executed an agreement and plan of merger agreement
        with privately held Acquired Onstream to acquire the remaining 74% of Acquired
        Onstream not already owned by the Company. On December 23, 2004, after approval
        by a majority of the Company’s shareholders in a duly constituted meeting,
        Acquired Onstream was merged with and into OSM Acquisition Inc., a Delaware
        corporation and the Company’s wholly owned subsidiary (the “Onstream Merger”).
        At that time, all outstanding shares of Acquired Onstream capital stock and
        options not already owned by the Company were converted into 2,207,966 shares
        of
        the ONSM restricted common stock and 463,554 options and warrants to purchase
        ONSM common stock at an exercise price of $3.376 per share. The Company also
        issued common stock options to directors and management as additional
        compensation for the Onstream Merger - see “stock compensation” in Note 1. An
        investment banking firm issued a fairness opinion regarding this transaction
        to
        the Company’s board of directors.
 
 Acquired
        Onstream was a development stage company founded in 2001 that began the
        development of 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 new product (the “Digital Media Services
        Platform” or “DMSP”) 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
        summarized balance sheet of Acquired Onstream as of the December 23, 2004
        Onstream Merger is as follows, showing the fair values assigned by the Company
        to Acquired Onstream’s assets and liabilities in accordance with SFAS 141 and
        recorded by the Company at that time.
 
 Cash
                  and other current assets
              
              $
              36,059Property
                  and equipment
              
              
              2,667,417Total
                  assets
              
              $
              2,703,476Accounts
                  payable and accrued expenses
              
              $
              814,739Notes
                  payable and capitalized lease
              
              
              335,179Total
                  liabilities
              
              
              1,149,918Shareholder’s
                  equity
              
              
              1,553,558Total
                  liabilities and shareholder’s equity
              
              $
              2,703,476
  F-19
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        2:
        GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
        (Continued)
 
 Property
        and equipment in the above table represents the partially completed Digital
        Media Services Platform (“DMSP”), primarily Acquired Onstream’s payments to its
        vendors SAIC, Virage, North Plains and Nine Systems. This was the primary
        asset
        included in the purchase of Acquired Onstream, and was recorded at fair value
        as
        of the December 23, 2004 closing, in accordance with SFAS 141 - see Note
        3. The
        fair value, determined by an independent third party appraiser, was primarily
        based on the discounted projected cash flows related to this asset for the
        next
        five years, as projected by the Company’s and Acquired Onstream’s management on
        a stand-alone basis without regard to the Onstream Merger. The discount rate
        utilized by the independent third party appraiser considered equity risk
        factors
        (including small stock risk and bridge/IPO stage 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
        $8,421,401 excess included in the $9,974,959 (see below) paid by the Company
        for
        100% of Acquired Onstream over $1,553,558 (the fair values assigned to the
        tangible and intangible assets, net of liabilities at fair value) was recorded
        by the Company as goodwill, subject to regular future valuations and adjustments
        as required by SFAS 142.
 
 Accounts
        payable of $435,000 was comprised of amounts due to SAIC, North Plains and
        other
        vendors, which have been paid by the Company as of April 1, 2005 and therefore
        the carrying values were determined to be a reasonable approximation of fair
        value.
 
 Accrued
        expenses included $362,000 of salary and expenses due to Company shareholders
        and officers, who were major shareholders in Acquired Onstream. This amount
        is
        after reduction for $200,000 paid by the Company at the time of the Onstream
        Merger and the repayment of these remaining amounts is subject to mutual
        agreement by the Company and the officers. Therefore, the carrying values
        were
        determined to be a reasonable approximation of fair value. $100,000 of the
        remaining amount was paid by the Company in February 2005.
 
 A
        note
        payable of $181,500 bearing interest was repaid by the Company in February
        2005
        and therefore the carrying value plus the interest included in accrued expenses
        is determined to be a reasonable approximation of fair value. The capitalized
        lease liability of $153,000 bears interest at rates approximating market
        - see
        notes 4 and 5.
 
 The
        $9,974,959 paid by the Company for 100% of Acquired Onstream, was comprised
        of
        the following:
 
 $6,623,898
        - the value of 2,207,966 shares of ONSM restricted common stock, issued in
        exchange for all outstanding shares of Acquired Onstream capital stock and
        options not already owned by the Company as of December 23, 2004 and valued
        based on the Company’s share value of $3.00 on October 22, 2003, the date the
        Company executed the merger agreement for the remaining 74% of Acquired Onstream
        not already owned by the Company, such valuation date established in accordance
        with the requirements of SFAS 141.
 
 F-20
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        2:
        GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
        (Continued)
 
 $688,000
        - the value of 462,073 options and warrants to purchase ONSM common stock
        at an
        exercise price of $3.376 per share, valued based on Black-Sholes
        methodology.
 
 $402,563
        - the carrying value of the Company’s investment in Acquired Onstream prior to
        the Onstream Merger, comprised of prior investments of $950,000 in cash and
        stock, reduced by $547,437 representing the Company’s share of Acquired Onstream
        operating losses, accounted for by the Company on the equity basis through
        December 23, 2004.
 
 In
        March
        2003, the Company increased its initial $200,000 investment in Acquired Onstream
        by an additional $750,000 through the issuance of Series A-7 Convertible
        Preferred Stock. At that time, the Company appointed two of the four members
        of
        the Acquired Onstream board of directors and began to account for its investment
        in Acquired Onstream under the equity method. Included in other income and
        expense for the nine months ended June 30, 2005 and 2004 are losses of
        approximately $100,000 and $223,000, respectively, which represent approximately
        28% of Acquired Onstream’s net loss for those periods. The equity method of
        accounting was discontinued after the Onstream Merger.
 
 $2,098,832
        - Cash and other advances made to or on behalf of Acquired Onstream prior
        to the
        Onstream Merger, including the Company’s payment of $1,477,438 for principal and
        interest on Acquired Onstream’s note payable to Virage, guaranteed by the
        Company.
 
 $161,666
        - Direct costs of the Acquired Onstream purchase, including a fairness opinion
        from an investment banking firm.
 
 The
        carrying value of the Company’s investment in Acquired Onstream at September 30,
        2004 was $502,589, included in the balance sheet caption other non-current
        assets. Also included in other non-current assets at that date was $642,671
        advanced from the Company to or on behalf of Acquired Onstream.
 
 The
        following table sets forth the unaudited pro-forma consolidated results of
        operations for the year ended September 30, 2005, giving effect to the Onstream
        Merger, as if the acquisition had occurred as of the beginning of that
        period:
 
 For
                    the year ended
                  September
                    30,2005(unaudited)Revenue
                
                $
                8,166,469Net
                    loss
                
                $
                (
                    8,267,456
                )Net
                    loss applicable to common stock
                
                $
                (
                    9,363,187
                )Net
                    loss per common share
                
                $
                (0.94
                )Net
                    loss applicable to common stock per
                    common share
                
                $
                (1.06
                )
  F-21
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        2:
        GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
        (Continued)
 
 The
        above
        pro-forma numbers include the effects of the $6.5 million in debt and equity
        financing discussed in Notes 4 and 6, since that financing was a condition
        of
        the Onstream Merger. The effect of including the pro-forma adjustments for
        this
        financing decreases the pro-forma net loss for the year ended September 30,
        2005, as presented above, by approximately $1,629,000. The difference between
        the pro-forma net loss and the pro-forma net loss applicable to common stock
        as
        presented above is entirely related to the inclusion of the effects of the
        equity portion of this $6.5 million financing.
 
 EDNet,
        which is part of the Digital Asset Management Group, was purchased by the
        Company in June 2001. MOD, which is part of the Webcasting Group, was purchased
        by the Company in February 2002. In February 2004, the Company acquired certain
        assets and licensed certain software from Virage, Inc., which operations
        are
        part of the Digital Asset Management Group. The
        consideration was (i) $400,000 cash upon closing and (ii) a convertible secured
        note payable of $206,250, which was repaid on June 21, 2004.
 
 SFAS
        142,
        Goodwill and Other Intangible Assets, which addresses the financial accounting
        and reporting standards for goodwill and other intangible assets subsequent
        to
        their acquisition, requires that goodwill no longer be amortized, and instead,
        be tested for impairment on a periodic basis. The Company performed impairment
        tests on two reporting units, the Webcasting Group and EDNet (the previous
        Networking Solutions Group) as of September 30, 2005 and 2006, as well as
        Acquired Onstream as of December 31, 2005. The Company, assisted by an
        independent third party appraiser, assessed the fair value of the net assets
        of
        each of those reporting units by considering the projected cash flows of
        those
        two groups and by analysis of comparable companies, including such factors
        as
        the relationship of the comparable companies’ revenues to their respective
        market values. Based on these factors, the Company reduced the carrying value
        of
        EDNet’s net assets by $330,000 as of September 30, 2005. The Company also
        concluded that there was no impairment of EDNet’s net assets as of September 30,
        2006, no impairment of the Webcasting Group’s net assets as of September 30,
        2005 and 2006 and no impairment of Acquired Onstream’s net assets as of December
        31, 2005.  The
        valuations of EDNet, the Webcasting Group and Acquired Onstream incorporate
        management’s estimates of sales growth, which sales estimates are dependent on
        the effect of the introduction of the DMSP, which is yet to be
        realized.
 
 The
        Company is required to perform reviews for impairment in future periods,
        at
        least annually, that may result in future periodic write-downs. Tests for
        impairment between annual tests may be required if events occur or circumstances
        change that would more likely than not reduce the fair value of the net carrying
        amount.
 
 Amortization
        expense of the customer lists was approximately $728,000 for each of the
        years
        ended September 30, 2006 and 2005, respectively. Amortization expense for
        the
        fiscal year 2007 will be $190,000, after which the customer lists will be
        fully
        amortized.
 
 As
        of
        September 30, 2004, the Company owned preferred shares representing a minority
        interest in Curaspan, Inc. having an original cost of approximately $108,000.
        This investment was fully reserved since 2002 as a result of Curaspan’s
        continuing operating losses and negative financial condition. However, on
        August
        5, 2005 the Company sold those preferred shares to Curaspan for $50,000 cash
        and
        a $150,000 note from Curaspan, payable in equal monthly installments over
        2
        years at 6% interest, commencing October 4, 2005. The note is collateralized
        by
        Curaspan’s assets, subordinate to a lending bank’s interest in certain of those
        assets. In addition, the preferred shares are being held in escrow and will
        be
        returned to the Company in the event of Curaspan’s uncured default under the
        note. Due to Curaspan’s continued operating losses and negative financial
        condition, proceeds from this sale will be recognized by the Company as other
        income on a cash basis as received. All scheduled payments have been made
        through January 10, 2007.
 F-22
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        3:
        PROPERTY AND EQUIPMENT
 
 Property
        and equipment, including equipment acquired under capital leases, consists
        of:
 
 September
                  30,
              
              September
                  30,
              
              Useful
                  Lives2006
              
              2005
              
              (Years)Equipment
                  and Software
              
              $
              7,493,679
              
              $
              7,231,429
              
              
              1-5DMSP
              
              
              4,081,978
              
              
              3,503,879
              
              
              3Travel
                  video library
              
              
              1,368,112
              
              
              1,368,112
              
              
              2Furniture
                  and fixtures
              
              
              179,205
              
              
              231,905
              
              
              5-7Capitalized
                  internal use software
              
              
              333,485
              
              
              333,485
              
              
              3Leasehold
                  improvements
              
              
              288,745
              
              
              234,988
              
              
              513,745,204
              
              
              12,903,798Less:
                    Accumulated depreciationand amortization
              
              
              (
                  8,846,489
              )
              
              (
                  8,093,921
              )Net
                  book value
              
              $
              4,898,715
              
              $
              4,809,877
 
 
 Depreciation
        and amortization of property and equipment included in the statements of
        operations amounted to approximately $1,393,000 and $413,000 for the years
        ended
        September 30, 2006 and 2005, respectively.
 
 The
        DMSP
        is comprised of four separate “products”, only two of which were available on an
        individual basis at the time of the Onstream Merger. The four separate products
        are transcoding, storage, search and retrieval and distribution. Effective
        April
        29, 2005, all four products were accessible on an integrated basis via an
        SAIC
        designed interface using North Plains technology and incorporating security
        features available through SAIC. A limited version of the DMSP, which included
        three of the four products, was first placed in service with third-party
        customers in November 2005, at which time depreciation of 75% (for three
        of the
        four products in service, based on guidance in SFAS 86, “Accounting for the
        Costs of Computer Software to be Sold, Leased or Otherwise Marketed”) of the
        DMSP’s carrying cost began and has continued through September 30, 2006. The
        fourth product was placed in service during October 2006. See Note 2 regarding
        the initial purchase of this asset from Acquired Onstream and Note 5 regarding
        the SAIC contract.
 
 On
        May
        18, 2005 the Company agreed to sell its travel video library, as well as
        all
        rights associated with that library, including the customer contracts and
        the related websites, for $455,000. The Company received a $50,000
        non-refundable deposit at the time of the initial agreement, with the remaining
        balance due upon closing, originally anticipated to be no later than
        September 2005. As part of the sale, the buyer also agreed to pay the
        Company $15,000 per month for a three-year period, in exchange for hosting
        and
        streaming services for the travel video library and similar content obtained
        elsewhere by the buyer. On September 23, 2005 the buyer filed a legal action
        against the Company alleging that the Company did not deliver the assets
        as
        agreed and seeking return of the $50,000 deposit plus reimbursement of due
        diligence expenses alleged to be approximately $354,000 plus attorney fees
        and
        interest. On December 4, 2005, the Company filed a response objecting to
        all
        claims by the buyer, which it believes are without merit. As of January 10,
        2007
        both the Company and the buyer are continuing to conduct their respective
        discovery and a trial date has been set for March 13, 2007. The Company has
        not
        refunded the deposit, which is included in deferred revenue as of September
        30,
        2006 and 2005. The Company does not believe that the ultimate resolution
        of this
        matter will have a material impact on its financial condition or results
        of
        operations. Pending closing of this transaction, the Company had the right
        to
        continue, and has continued, its travel production and distribution
        operations. The cost of the travel video library is fully depreciated as
        of
        September 30, 2006 and the associated travel production and distribution
        revenues were $167,225 and $208,177, respectively, for the years ended September
        30, 2006 and 2005.
 F-23
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE
 
 8%
        Subordinated Convertible Debentures
 
 In
        March
        2006 the Company sold to 14 accredited investors $2.3 million principal amount
        of 8% subordinated secured convertible notes (“8%
        Subordinated Convertible Debentures”) ,
        together with common stock purchase warrants to purchase an aggregate of
        805,000
        shares of ONSM common stock for $1.50 per share. Of the $2.3 million total,
        $1,850,000 (which includes $375,000 applied from previously existing Company
        indebtedness, as discussed below) was received by the Company as of March
        31,
        2006 and $450,000 was received by the Company on April 3, 2006.
 
 The
        Company entered into a security agreement
        with Cantera (Switzerland) S.A., as agent
        for the purchasers of the 8%
        Subordinated Convertible Debentures ,
        wherein
        the Company pledged all of its assets as collateral for the notes, although
        such
        pledge is subordinate to all other existing indebtedness, including the 8%
        senior secured convertible notes and property and equipment financing. It
        is
        also subordinate to future purchase money and capital lease indebtedness,
        but
        only to the extent of assets covered thereby.
 
 Additional
        terms of the 8% Subordinated Convertible Debentures include:
 
 *  unless
        converted or redeemed as described below, the initial $2.3 million principal
        amount of the 8% Subordinated Convertible Debentures are due on or before
        March
        28, 2010 and a permitted future $1.2 million principal amount will be due
        on or
        before the date four years after the required shareholder approval is obtained,
        as discussed below,
 
 *  subject
        to certain exceptions, while the notes are outstanding the Company cannot
        purchase, redeem or otherwise acquire any capital stock, issue any variable
        priced equity securities or variable price equity linked securities and for
        a
        period of one year after the closing, may not issue an equity or equity-linked
        issuance below the $1.00 conversion price, with the exception of certain
        items
        such as employee stock options. The Company has also agreed not to redeem
        or
        repurchase any portion of its Series A-10 Preferred Stock, or any other
        preferred stock, common stock or equity equivalent prior to either the maturity
        date of the notes or until all the notes have been converted without the
        consent
        of the holders of 51% of the outstanding notes,
 
 *  the
        notes
        are convertible at any time at the option of the holder into shares of ONSM
        common stock at a conversion price of $1.00 per share which is subject to
        adjustment upon the occurrence of certain specified events, including stock
        dividends and stock splits, pro rata distributions of equity securities,
        evidences of indebtedness, rights or warrants to purchase common stock or
        cash
        or any other asset, mergers or consolidations, or certain issuances of common
        stock at a price below $1.00 per share, subject to adjustment as set forth
        above,
 
 *   if
        at any
        time while all or any portion of the 8% Subordinated Convertible Debentures
        are
        outstanding the
        trading price of ONSM common stock exceeds $1.50 per share for a minimum
        of 20
        days during a 30 day period, then an amount of the notes equal to the total
        volume for the 30 day period multiplied by the average daily closing price
        multiplied by 20% will automatically convert into shares of ONSM common stock
        at
        the conversion price of $1.00 per share, with each note converted on a pro-rata
        basis based on initial principal and subject to adjustment as set forth above. The
        closing ONSM share price was $2.88 per share on January 10, 2007, which
        represented the nineteenth consecutive day in excess of $1.50 per
        share,
 
 *  the
        number of shares of ONSM common stock acquired by any holder upon conversion
        of
        the notes is limited to the extent necessary to ensure that following the
        conversion the total number of shares of ONSM common stock beneficially owned
        by
        the holder does not exceed 4.999% of the Company’s issued and outstanding common
        stock,
  F-24
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (continued)
 
 8%
        Subordinated Convertible Debentures (continued)
  *  the
        Company can prepay all or any portion of the principal amount of the notes,
        plus
        any accrued but unpaid interest. If the Company should elect to prepay the
        notes, the holders will have five trading days to convert the notes into
        shares
        of ONSM common stock. Prepayment of the notes must be pro-rata amongst the
        holders in an amount equal to 115% of the principal amount of the notes being
        redeemed, and
 
 *  beginning
        at the end of the 24th month following the issuance date the principal
        outstanding on any remaining 8% Subordinated
        Convertible Debentures will
        be
        paid in nine equal quarterly installments on the last day of each successive
        quarter. The Company has the option to pay the quarterly installments in
        shares
        of ONSM common stock if the volume weighted average price during the preceding
        quarter is greater than $1.18 per share. The portion that can be paid in
        common
        stock is based upon a formula of 20% of the total trading volume for the
        quarter
        multiplied times the average closing price. In any quarter where this formula
        would result in the issuance of shares of common stock that exceed the amount
        of
        the quarterly installment, at the holders option an additional amount of
        up to
        20% may be converted and applied to the final quarterly payment. The
        closing ONSM share price was $2.88 per share on January 10, 2007.
 
 In
        connection with the 8% Subordinated Convertible Debentures, the Company issued
        five year common stock purchase warrants to purchase an aggregate of 805,000
        shares of our common stock, exercisable starting six months after issuance.
        These warrants have an exercise price of $1.50 per share, subject to adjustment
        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, mergers or consolidations, or certain
        issuances of common stock at a price below $1.50 per share. Starting one
        year
        after issuance, the warrants include a cashless exercise feature, that
        terminates at the time the shares underlying the warrants are
        registered, which
        provides that in the event the shares are not subject to an effective
        registration statement at the time of exercise, the holder could elect a
        “cashless exercise” whereby the Company would issue shares based on the excess
        of the market price at the time of the exercise over the warrant exercise
        price. The
        number of shares of ONSM common stock that can be issued upon the exercise
        of
        the warrants 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 4.999% of the Company’s issued and outstanding common
        stock.
 
 The
        Company agreed to file with the Securities and Exchange Commission (“SEC”) on or
        prior to thirty (30) days after the final closing a Registration Statement
        (the
“Registration Statement”) providing for the sale of the common shares underlying
        the 8% Subordinated Convertible Debentures and related $1.50 warrants (the
        “Registrable Securities”) by the holders thereof, and to use commercially
        reasonable efforts to have such Registration Statement declared effective
        by the
        SEC as soon as practicable. If the Registration Statement was not filed as
        set
        forth above or not declared effective within ninety (90) days following the
        Closing (or 150 days in the event of a review of the Registration Statement
        by
        the SEC), the Company would be obligated to pay the holders of the Registrable
        Securities an amount equal to one percent (1%) of the aggregate purchase
        price
        of the Registrable Securities on such date and one and one-half percent (1.5%)
        on the monthly anniversary of each such date thereafter, until the Registration
        Statement is declared effective, up to a maximum of fifteen percent (15%).
 
 The
        Company filed the initial version of the Registration Statement with the
        SEC on
        June 9, 2006 and an amended version, responding to inquiries resulting from
        the
        SEC’s review of the initial Registration Statement, was declared effective by
        the SEC on July 26, 2006.
  F-25
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (continued)
 
 8%
        Subordinated Convertible Debentures (continued)
 
 The
        $2.3
        million financing transaction, as described above and as included in the
        registration statement, was originally structured as a $2.5 million transaction.
        However, as of the date of the initial filing of the Registration Statement,
        certain purchasers had not remitted the aggregate $200,000 committed to by
        them
        for purchase of 8% Subordinated Convertible Debentures and as a result the
        Company notified them at that time that it would be unable to accept funds
        from
        them for securities issued as part of this transaction. It is the Company’s
        position, based on its evaluation of the subscription agreement and other
        relevant loan documents, that while individual purchases were closed as early
        as
        March 28, 2006 that the final closing for purposes of determining the deadline
        and related penalties for filing the Registration Statement could not occur
        until the originally contemplated $2.5 million proceeds had been fully remitted,
        or until the offering was alternatively closed by the Company’s cancellation of
        the unfunded subscriptions on June 9, 2006. Accordingly, the Company has
        determined that it is not liable for penalties related to the Registration
        Statement’s filing or effective date, and furthermore that any penalty asserted
        based on a March or April 2006 closing date would not be material to its
        results
        of operations or financial condition.
 
 The
        Company is only required to expend commercially reasonable efforts to keep
        the
        Registration Statement continuously effective. However, in the event the
        Registration Statement or the ability to sell shares thereunder lapses for
        any
        reason for 30 or more consecutive days in any 12 month period or more than
        twice
        in any 12 month period, the purchasers of the 8% Subordinated Convertible
        Debentures may require the Company to redeem (i) any such notes still
        outstanding for 115% of the face value (or 115% of the market value of the
        underlying shares for the previous five days, if greater) plus (ii) any shares
        obtained from the conversion of those notes and still held, for 115% of the
        market value for the previous five days. The same penalty provisions apply
        if
        the Company’s common stock is not listed or quoted, or is suspended from trading
        on an eligible market for a period of 20 or more trading days (which need
        not be
        consecutive).
 
 Based
        on
        the Company’s application of EITF 00-19 and SFAS 133, it determined that the
        requirement, discussed above, that the Company file a registration statement
        including the shares underlying the 8%
        Subordinated Convertible Debenture and the
        related $1.50 warrants would require that the amount originally recorded
        as
        equity for the embedded conversion feature in the 8% Subordinated Convertible
        Debentures, as well as the related $1.50 warrants, be reclassified from equity
        to liability. Although the warrants were not exercisable until six months
        after
        their issuance, as discussed above, the Company has determined that EITF
        00-19
        prohibits equity classification for any provision in a contract that could
        require net-cash settlement and does not appear to contain an exception for
        such
        provisions that are not yet applicable. Even after the registration statement
        was filed by the Company on June 9, 2006, and declared effective by the SEC
        on
        July 26, 2006, the “cashless exercise” option discussed above would also result
        in the continued classification as a liability of the amount recorded for
        the
        $1.50 warrants as of September 30, 2006, although that option only becomes
        available to investors one year after issuance of the warrants and only in
        the
        event there is no effective registration statement. Although the filing of
        the
        registration statement was no longer a basis for recording the embedded
        conversion feature as a liability as of September 30, 2006, the existence
        of
        penalties for lack of an effective registration and/or listing for the Company’s
        shares, as discussed above, would result in the continued classification
        as
        liability at that date of the amount recorded for the embedded conversion
        feature. Although the Company does not believe that actual payments in
        connection with these provisions is likely, EITF 00-19 requires that the
        accounting for them be done without regard to probability. EITF 00-19 also
        requires that the amount reclassified as a liability be adjusted to fair
        value
        at each reporting period. Accordingly, the Company has reflected a liability
        of
        $281,809 on its September 30, 2006 balance sheet, $917,917 of such amount
        representing the initial reclassification to liability of the $1.50 warrants
        and
        the embedded conversion feature in the 8% Subordinated Convertible Debentures
        and the difference of $636,108 representing the adjustment of those reclassified
        amounts to fair value since that date. This adjustment to fair value was
        included under the caption “income from derivative instruments” in the Company’s
        statement of operations for the year ended September 30, 2006.
 F-26
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (continued)
 
 8%
        Subordinated Convertible Debentures (continued)
 
 In
        March
        and April 2006 the Company paid the selling agents fees totaling $163,000
        and
        issued them 182,500 common stock purchase warrants with terms identical to
        the
        warrants sold with the initial $2.3 million principal 8% subordinated secured
        convertible notes.
 
 The
        estimated fair value of all warrants given in connection with the 8%
        Subordinated Convertible Debentures plus the value of the 8% Subordinated
        Convertible Debentures’ beneficial conversion feature is $917,917, which was
        calculated in accordance with EITF 98-05 (“Accounting for Convertible Securities
        with Beneficial Conversion Features”) and EITF 00-27 (“Application of Issue No.
        98-5 to Certain Convertible Instruments”) and allocated to additional paid in
        capital and debt discount. The Company’s management calculated the discount
        based on its estimate of the fair value of the warrants and the fair value
        of
        the notes, which were allocated on a pro-rata basis as a percentage of the
        face
        value of the convertible securities, and the intrinsic value of the beneficial
        conversion feature. The fair value of the warrants was calculated using the
        Black-Scholes model including the following assumptions: expected volatility
        of
        56% and risk free interest rate of 6.25%. The estimated fair value of the
        note
        was based on the present value of the expected cash flows, discounted at
        approximately 13% per annum, which Company management determined to be an
        appropriate interest rate for this financing on a stand-alone basis. The
        intrinsic value of the beneficial conversion feature was based on the closing
        price of the stock at the date of issuance, its relationship to the conversion
        price of the instrument and the value of the warrants. The debt discount,
        which
        totals $1,102,033 after inclusion of other direct costs associated with the
        financing, will be amortized to interest expense over the four year term
        of the
        8% Subordinated Convertible Debentures. In addition, the unamortized portion
        of
        the discount related to converted securities will be expensed as interest
        at the
        time of the conversion.
 
 The
        terms
        of the $2.3 million financing allow the Company to sell an additional $1.2
        million principal amount of 8% subordinated secured convertible notes, together
        with common stock purchase warrants to purchase an aggregate of 420,000 shares
        of ONSM common stock, all under identical terms to the initial $2.3 million
        transaction but subject to shareholder approval, in accordance with the
        requirements of Rule 4350(i) of the Nasdaq Marketplace Rules. The purchasers
        of
        these securities must remit the purchase price to the Company within five
        (5)
        days of being notified of such shareholder approval. The Company has not
        determined whether it will seek this additional financing.
 
 The
        interest on the Subordinated Convertible Debentures of 8% per annum is payable in
        arrears with the first interest payment due on September 28, 2006 and payment
        dates quarterly thereafter in cash,
        or common shares (at 85% of the market price per share) at the Company’s option.
        The Company issued 165,068 common shares in lieu of the $93,284 interest
        accrued
        during the year ended September 30, 2006, which included 1,917 shares issued
        for
        $1,917 interest due on conversions during that period.
 
 F-27
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (continued)
 
 8%
        Subordinated Convertible Debentures (continued)
 
 
 As
        of
        September 30, 2006, $75,000 of 8% Subordinated Convertible Debentures, plus
        accrued interest, had been converted into 76,917 common shares and $2,225,000
        of
        the 8% Subordinated Convertible Debentures had not been converted. See Note
        9
        regarding significant conversions occurring after September 30,
        2006.
 
 The
        above
        transactions are summarized as follows through September 30, 2006:
 
 Initial
                  gross proceeds
              
              $
              2,300,000Less:
                  conversions to common shares
              
              
              (
                  75,000
              )Less:
                  initial discount
              
              
              (
                  1,102,033
              )Plus:
                  amortization of discount
              
              
              171,9038%
                  Subordinated Convertible Debentures
              
              $
              1,294,870
 
 
 8%
        Senior Convertible Debentures
 
 On
        December 23, 2004, the Company sold senior secured convertible notes (“8%
        Convertible Debentures”), which have a $1.00 conversion rate per common share
        and include five-year warrants to purchase 1,522,500 common shares of ONSM
        for
        $1.65 per share, to several accredited investors for gross proceeds of $4.35
        million. The 8% Convertible Debentures are collateralized by a blanket security
        interest in our assets and a pledge of the stock of our
        subsidiaries.
 
 The
        8%
        Convertible Debentures included an Additional Investment Right (“AIR”) of $2.175
        million, of which $2.050 million was exercised in February 2005 and the
        remaining $125,000 was exercised in April 2005. The debentures issued under
        the
        AIR (the “Additional 8% Convertible Debentures”) have substantially the same
        terms as the 8% Convertible Debentures, although additional warrants were
        granted to induce the early exercise. The Additional 8% Convertible Debentures
        included five-year warrants to purchase 761,250 common shares of ONSM for
        $1.65
        per share and one-year warrants to purchase 2,175,000 common shares of ONSM
        for
        $1.00 per share. The one-year warrants were subject to the approval of a
        majority of the Company’s shareholders, which was obtained at the September 13,
        2005 shareholder meeting, and at which time the one-year term of those warrants
        began. In the event the one-year warrants are exercised, the Company will
        issue
        additional five year warrants, exercisable at $1.65 per share, to purchase
        50%
        of the common shares of ONSM acquired upon the exercise of the one-year
        warrants. During
        April 2006, the Company issued a five-year warrant to purchase 10,417 common
        shares for $1.65 per share as the result of a single investor’s exercise of a
        warrant for 20,833 common shares at $1.00 per share. Effective September
        13,
        2006, the remaining $1.00 warrants expired without having been exercised.
        See
        Note 8.
 
 The
        8%
        Convertible Debentures contain a provision requiring mandatory redemptions
        of up
        to $1.0 million by June 2006, with at least $500,000 of that occurring by
        December 2005. These redemption amounts are reduced by the amount of securities
        converted into common shares before those dates. As of September 30, 2005,
        $2,705,000 of 8% Convertible Debentures had been converted into common shares
        and accordingly, the Company classified the entire outstanding balance of
        the 8%
        Convertible Debentures as a non-current liability as of that date.
 F-28
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 8%
        Senior Convertible Debentures (continued)
 
 In
        addition to the above mandatory redemption, all 8% Convertible Debentures
        outstanding as of a certain date are required to be repaid in nine equal
        quarterly installments. Although the note documents indicate that these
        quarterly payments start on September 30, 2006, this would result in the
        ninth
        payment being on September 30, 2008, which is 2.5 months earlier than the
        stated
        note maturity date. Therefore the Company believes that the intent of the
        documents was for the quarterly repayments to start in December 2006 and
        end
        with the ninth payment in December 2008, the stated maturity date. The September
        30, 2006 financial statements reflect a current liability of $726,478, which
        is
        equal to four of those quarterly payments, net of the related discount. However,
        as a result of significant conversions occurring after September 30, 2006
        (see
        Note 9), the amount of the next four quarterly installments, net of discount,
        has been reduced to approximately $183,000.
  All
        or
        part of these nine quarterly installments may be paid in ONSM common shares
        subject to a formula based on trading volume and share price and provided
        that
        the volume weighted average share price during the quarter prior to payment
        exceeds $1.18 per share. However, the number of shares acquired by any holder
        upon conversion is limited so that following the conversion the total number
        of
        shares owned by the holder does not exceed 9.999% of the Company’s issued and
        outstanding stock. The initial quarterly payment due in December 2006 was
        satisfied by the Company’s issuance of shares, which will be reported as
        conversions of debt to equity and accounted for accordingly.
 
 The
        Company included the common shares underlying the 8% Convertible Debentures
        (including the AIR shares) on a registration statement declared effective
        by the
        SEC on June 29, 2005. Beginning on the date of such registration, and provided
        that the average price during at least 20 days of the 30-day period prior
        to
        conversion exceeds $1.63 per share, all or part of the 8% Convertible Debentures
        will automatically convert to common shares, the dollar amount of the 8%
        Convertible Debentures being converted based on a formula incorporating the
        trading volume and share price of ONSM stock. Beginning in September 2007,
        any
        remaining 8% Convertible Debentures will be paid in nine equal quarterly
        installments. All or part of these installments may be paid in ONSM common
        shares subject to a formula based on trading volume and share price and provided
        that the volume weighted average share price during the quarter prior to
        payment
        exceeds $1.18 per share. However, the number of shares acquired by any holder
        upon conversion is limited so that following the conversion the total number
        of
        shares owned by the holder does not exceed 9.999% of the Company’s issued and
        outstanding stock . The
        closing ONSM share price was $2.88 per share on January 10, 2007, which
        represented the nineteenth consecutive day in excess of $1.50 per
        share.
 
 The
        8%
        Convertible Debentures and the Additional 8% Convertible Debentures provide
        cash
        penalties of 1% of the original purchase price for each month that (a) the
        Company’s common shares are not listed on the Nasdaq Capital Market for a
        period of 3 trading days or (b) the common shares underlying those securities
        and the related warrants are not saleable subject to an S-3 or other
        registration statement then effective with the SEC. The latter penalty only
        applies for a five-year period beginning with the June 29, 2005 registration
        statement effective date and does not apply to shares saleable under the
        provisions of Rule 144(k).
 
 The
        $1.65
        warrants provide that in the event the shares are not subject to an effective
        registration statement at the time of exercise, the holder could elect a
        “cashless exercise” whereby the Company would issue shares based on the excess
        of the market price at the time of the exercise over the warrant exercise
        price.
 
 F-29
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (continued)
 
 8%
        Senior Convertible Debentures (continued)
 
 Based
        on
        the Company’s application of EITF 00-19 and SFAS 133, it determined that the
        existence of the 1% per month penalties for lack of an effective registration
        and/or listing for the company’s shares, as well as the “cashless exercise”
option, all discussed above, required that the amount originally recorded
        as
        equity for the $1.00 warrants, the $1.65 warrants and the embedded conversion
        feature in the 8% Convertible Debenture and Additional 8% Convertible Debenture
        be classified as a liability. Although the Company does not believe that
        the
        actual assessment of these penalties is likely, EITF 00-19 requires that
        the
        accounting for them be done without regard to probability. These amounts,
        totaling $834,125 and $3,017,168 at September 30, 2006 and 2005, respectively,
        were also subject to the accounting for potential rescission through May
        23,
        2006, which is discussed in Note 5. EITF 00-19 requires that the amount recorded
        as a liability be adjusted to fair value at each reporting period. Since
        the
        Company determined that there was no material difference between the original
        amounts recorded for these items in the aggregate and their fair value as
        of
        September 30, 2005 in the aggregate, there was no effect on the statement
        of
        operations related to this matter for the year ended September 30, 2005.
        Although the fair value of the liability decreased during year ended September
        30, 2006, the portion of this reduction through May 23, 2006 has been reflected
        on the financial statements for those periods by a reduction in the liability
        and an increase in “Equity Securities Subject to Potential Rescission”, with no
        net effect to the statement of operations, as it was determined these amounts
        were still subject to the accounting for potential rescission through May
        23,
        2006 and were treated accordingly. See Note 5. The effect of the adjustment
        of
        the liability to fair value after May 23, 2006 was $664,851 and was included
        under the caption “income from derivative instruments” in the Company’s
        statement of operations for the year ended September 30, 2006.
 
 The
        placement agent fees and direct issue costs for the 8% Convertible Debentures
        financing were approximately $336,000 in cash plus five-year warrants to
        purchase 435,000 shares of ONSM common stock for $1.65 per share. The broker
        dealer fees and legal expenses for the Additional 8% Convertible Debentures
        were
        approximately $57,500 plus warrants to purchase 217,500 shares of ONSM common
        stock for $1.65 per share.
 
 The
        estimated fair value of all warrants given in connection with the 8% Convertible
        Debentures plus the value of the 8% Convertible Debentures’ beneficial
        conversion feature is $2,131,025, which, in accordance with EITF 98-05
        (“Accounting for Convertible Securities with Beneficial Conversion Features”)
        and EITF 00-27 (“Application of Issue No. 98-5 to Certain Convertible
        Instruments”), was allocated to additional paid in capital and debt discount.
        The Company’s management calculated the discount based primarily on its estimate
        of the fair value of the warrants as a percentage of the face value of the
        convertible securities. The estimate was based on the closing price of the
        stock
        at the date of the agreement and the relationship to the conversion price
        of the
        instrument and the exercise price of the warrants. The debt discount, which
        totals $2,467,269 after inclusion of other direct costs associated with the
        financing, is being amortized to interest expense over the four year term
        of the
        8% Convertible Debentures. In addition, the unamortized portion of the discount
        related to converted securities is expensed as interest at the time of the
        conversion.
 
 The
        estimated fair value of the warrants (including warrants subject to shareholder
        approval and contingent warrants) given in connection with the Additional
        8%
        Convertible Debentures plus the value of the Additional 8% Convertible
        Debentures’ beneficial conversion feature, plus other direct costs associated
        with the financing, exceed the face value of the Additional 8% Convertible
        Debentures. In accordance with EITF 98-05 and EITF 00-27, which limits the
        recorded discount to the face value of the related debt, $2,175,000 was
        allocated to additional paid in capital and debt discount and is being amortized
        to interest expense over the four year term of the Additional 8% Convertible
        Debentures. In addition, the unamortized portion of the discount related
        to
        converted securities is expensed as interest at the time of the
        conversion.
 
 F-30
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 8%
        Senior Convertible Debentures (continued)
 
 The
        interest on the Convertible Debentures of 8% per annum is payable quarterly
        in
        cash, or common shares (at 85% of the market price per share) at the Company’s
        option. The Company issued 368,209 common shares in lieu of the $302,206
        interest accrued during the year ended September 30, 2006, which included
        9,589
        shares issued for $9,589 interest due on conversions during that period.
        During
        the year ended September 30, 2005, the Company issued 267,248 common shares
        in
        lieu of the $310,427 interest accrued and due through that date.
 
 As
        of
        September 30, 2006, $3,525,000 of 8% Convertible Debentures (including the
        AIR),
        plus accrued interest, had been converted into 3,555,248 common shares and
        $3,000,000 of the 8% Convertible Debentures (including the AIR) had not been
        converted. See Note 9 regarding significant conversions occurring after
        September 30, 2006.
 
 The
        above
        transactions are summarized as follows through September 30, 2006:
 
 Initial
                  gross proceeds
              
              $
              6,525,000Less:
                  conversions to common shares
              
              
              (
                  3,525,000
              )Less:
                  initial discount
              
              
              (
                  4,642,269
              )Plus:
                  amortization of discount
              
              
              3,281,4048%
                  Senior Convertible Debentures, net of discount
              
              $
              1,639,135Less:
                  current portion, net of discount
              
              
              (
                  726,478
              )8%
                      Senior Convertible Debentures, net of discount and current
                      portion
              
              $
              912,657
 
 Notes
        Payable
 
 Notes
        payable consist of the following as of September 30:
 
 2006
              
              2005Notes
                  payable to two different affiliates of a director of the Company,
                  the
                  first loan repaid in April 2006 and the second loan funded in June
                  2006
                  and due in June 2007. Subsequent to September 30,
                  2006 renegotiated to a convertible note at $1.22 per share, with
                  eighteen-month maturity.
              
              $
              300,000
              
              $
              300,000Note
                  payable to a major shareholder of the Company, with original funding
                  in
                  September 2005 and additional funding in October 2005. Due in October
                  2010. Subsequent to September 30, 2006 renegotiated to a convertible
                  note at $1.00 per share, with four year maturity.
              
              
              450,000
              
              
              300,000Note
                  payable to a major shareholder of the Company, with original funding
                  in
                  September 2006. Convertible to common stock at $1.00 per
                  share.
              
              
              300,000
              
              
              -Note
                  payable to third party, with original funding in August 2006. Principal
                  balance is due in three monthly installments staring November 2006
                  and was
                  paid in full as of January 12, 2007.
              
              
              350,000
              
              
              -Capitalized
                  software lease
              
              
              114,355
              
              
              130,198Total
                  notes payable
              
              
              1,514,355
              
              
              730,198Less:
                  discounts on notes payable
              
              
              (
                  88,565
              )
              
              (
                  -
              )Notes
                  payable, net of discount
              
              
              1,425,790
              
              
              730,198Less:
                  current portion
              
              
              (
                  892,032
              )
              
              (
                  330,598
              )Long
                  term notes payable, net of discount
              
              $
              533,758
              
              $
              399,600
  F-31
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes
        Payable (continued)
 
 As
        part
        of the Onstream Merger, the Company assumed a capitalized lease for software,
        which had an outstanding principal balance of $114,355 and $130,198 as of
        September 30, 2006 and 2005, respectively. The balance is payable in equal
        monthly payments of $3,366 through May 2009, which includes interest at
        approximately 7% per annum. The principal balance shown at September 30,
        2006 is
        after reduction for $10,098 included in accounts payable at that date and
        paid
        in December 2006 and January 2007. See Notes 2 and 5.
 
 Interest
        expense to related parties (including amortization of debt discount) was
        approximately $105,000 and $70,000 for the years ended September 30, 2006
        and
        2005, respectively. Related parties include Company directors and employees,
        and
        their affiliates, but exclude major shareholders.
 
 On
        August
        19, 2005, the Company received a $300,000 loan from Asset Factoring
        International, Inc., whose Investment Manager is a member of the Company’s board
        of directors. The term of the loan was one year, with a 2% loan origination
        fee
        and interest of 8% per annum. All interest and fees were due and payable
        in the
        event of early repayment. The terms of the loan, which was collateralized
        by
        $600,000 (original purchase price) of recently purchased equipment and software,
        required repayment within 5 days of the Company obtaining other financing,
        including but not limited to equipment financing. Asset Factoring agreed
        to
        several extensions for the repayment of this loan after the Company obtained
        such other financing in October and November 2005. The Company repaid $360,000
        in April 2006, which represented principal and the initially negotiated loan
        origination fee and interest, plus subsequently negotiated extension fees.
 
 On
        June
        1, 2006 the Company borrowed $300,000 from J&C Resources, LLC, whose
        President, Chairman and CEO is a member of the Company’s board of directors. The
        principal balance was due one year after the borrowing date or three days
        after
        receipt of funding, including exercise of warrants, in excess of $1.0 million,
        whichever occurs first. Total interest, origination and legal fess totaling
        $21,000 cash and 21,000 common shares are due on maturity. Finders fees of
        $9,000 cash and 9,000 common shares are payable at loan maturity to Asset
        Factoring Ltd, a related entity. In January 2007, all fees due upon maturity
        were paid in cash and stock, as applicable. Following Board of Director approval
        of the modified terms on October 25, 2006, the note was formally modified
        in
        January 2007 to be convertible into common shares at $1.22 per share and
        to bear
        interest at 14.67% per annum, non-compounding, which the Company may settle
        in
        shares at $1.22 per share. The Company has the option to force conversion
        after
        18 months and interest is payable at time of conversion or
        repayment.
 
 On
        October 11, 2005, the Company entered into a five-year note with Neil Berman,
        a
        major shareholder, in the aggregate principal amount of $750,000, collateralized by $800,000 (original purchase price) of recently purchased
        hardware and software. Interest, at 10.85% per annum, is payable upon maturity. At the Company's
        option, and with the consent of required security holders, both interest
        and
        principal may be paid with Series A-10 Preferred Stock. The Company received
        $300,000 of the note amount as of September 30, 2005, which was reflected
        in
        notes payable as of that date. An additional $150,000 was received in October
        2005, resulting in a notes payable balance of $450,000 as of September 30,
        2006.
        The Company received the remaining $300,000 in December 2006. Following Board
        of
        Director approval of the modified terms on December 20, 2006, the note was
        formally modified in January 2007 to increase  the
        principal amount to $1,500,000, adjust the remaining term to four
        years, increase the interest rate to 17.75% (which the lender may request
        prepayment of in common shares at $1.00 per share) and modify the note priority
        to unsecured and subordinated to all other debt. In addition, the new terms
        allow the Company or the lender to convert the loan balance to restricted
        common
        stock at $1.00 per share at any time. The Company received $100,000 of the
        increased note amount in December 2006 and $50,000 in January 2007.
 
 F-32
 
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        4:
        CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes
        Payable (continued)
 
 On
        November 30, 2005, the Company borrowed $300,000 from Platinum Credit Group,
        LLC, secured by a secondary lien on up to $300,000 of the Company’s tangible
        equipment and other assets. In addition, the Company dedicated certain
        receivables and financing proceeds to assure the repayment of the Note on
        or
        before its due date of March 1, 2006. At the time of the borrowing, the Company
        paid related fees totaling $30,000 in cash and prepaid interest in the form
        of 44,444
        shares of ONSM common stock. The Company repaid the loan principal on March
        15,
        2006, along with a negotiated
        late payment penalty of an
        additional 15,000
        common shares.
 
 During
        August 2006, the Company borrowed $350,000 from Platinum Credit Group, LLC,
        collateralized by a secondary lien on up to $350,000 of the Company’s tangible
        equipment. In addition, the Company dedicated certain receivables proceeds
        to
        pay $100,000 principal installments, which were paid when due on November
        15 and
        December 15, 2006, as well as the $150,000 principal balance paid
        when due on January 12, 2007. At the time of the borrowing, the Company
        paid related fees totaling $50,000 in cash and prepaid interest in the form
        of 80,000
        shares of ONSM common stock. The Company is subject to a penalty of 20,000
        shares per month while any portion of the principal is past due.
 
 During
        February 2006, the Company borrowed $100,000 from Lewis Opportunity Fund
        LP, a
        major shareholder. The principal, plus cash interest of 10% plus 10,000 common
        shares, was due on February 17, 2007. The Company was also required to repay
        the
        loan, including the full amount of interest, within 15 days of obtaining
        financing in excess of $100,000. Accordingly, the outstanding principal of
        $100,000 was designated by Lewis Opportunity Fund LP to purchase an equivalent
        amount of 8% Subordinated Convertible Debentures, which we issued to that
        entity
        in March 2006 (as part of the total $2.3 million financing) along with the
        10,000 ONSM shares and $10,000 also due for interest.
 
 On
        September 14, 2006, the Company borrowed $300,000 from Lewis Opportunity
        Fund
        LP, a major shareholder. Cash interest of 10% was paid in advance. The
        principal, plus additional interest of 90,000 common shares, is due on September
        14, 2007. The Company may prepay all or any part of the principal after April
        15, 2007 and before maturity without penalty, although the Company must give
        Lender five days notice before repayment to allow Lender opportunity to exercise
        rights of conversion. In the event of early repayment or transfer to another
        financing all cash interest for the entire term of the loan will be deemed
        earned but the interest shares will be partially earned on the following
        basis -
        prepayment within eight months - 60,000 shares; thereafter - 90,000 shares.
        The
        note is convertible at Lender’s option at any time after April 15, 2007, to
        unregistered common stock at the rate of $1.00 per common share, which exceeds
        the fair market value at the time of the loan. In the event of such a conversion
        of the entire principal amount, all cash and interest shares for the entire
        term
        of the loan will be fully earned. Company
        granted Lender a secondary lien on up to $300,000 of tangible equipment.
 
 During
        February 2006, the Company borrowed $250,000 from Mr. David Namoff. The
        principal, plus cash interest of 10% plus 25,000 common shares, was due on
        January 31, 2007. The Company was also required to repay the loan, including
        the
        full amount of interest, within 15 days of obtaining financing in excess
        of $1.0
        million. Accordingly, the outstanding principal plus the cash interest due
        on
        this loan, totaling $275,000, was designated by Mr. Namoff to purchase an
        equivalent amount of 8% Subordinated Convertible Debentures, which we issued
        to
        him in March 2006 (as part of the total $2.3 million financing) along with
        the
        25,000 ONSM shares also due for interest.
  During
          the year ended September 30, 2006, the Company borrowed $325,000 from directors,
          officers and employees on a very short-term basis, which it also repaid
          during
          the same period along with cash interest totaling $10,000.
 All
        notes
        payable outstanding as of September 30, 2004 were satisfied by December 2004
        payments of approximately $2.4 million and issuance of 100,000 shares of
        Series
        A-10, which included five-year warrants to purchase 500,000 ONSM common shares
        for $1.50 per share. In connection with this, the Company wrote off unamortized
        discount of approximately $494,000, included in interest expense for the
        year
        ended September 30, 2005. In January 2005, the Company issued 85,488 common
        shares for approximately $149,000 of related interest.
 F-33
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        5:
        COMMITMENTS AND CONTINGENCIES
 
 NASDAQ
        letter - The
        Company received a letter from NASDAQ dated August 2, 2006 indicating that
        the
        Company had 180 calendar days, or until January 29, 2007, to regain compliance
        with Marketplace Rule 4310(c)(4), which is necessary in order to be eligible
        for
        continued listing on the NASDAQ Capital Market. The letter from NASDAQ indicated
        that the Company’s non-compliance with that rule was as a result of the bid
        price of its common stock closing below $1.00 per share for the preceding
        thirty
        consecutive business days. The
        terms of the 8% Senior Convertible Debentures and the 8% Subordinated
        Convertible Debentures contain penalty and acceleration clauses in the event
        the
        Company’s common stock is not traded on NASDAQ or a similar national exchange -
        See Note 4. The
        Company received a letter from NASDAQ dated December 4, 2006, stating that
        the
        Company had regained compliance with NASDAQ Marketplace Rule 4310(c)(4) as
        of
        that date, by having met the $1.00 per share or greater minimum closing bid
        price requirement for a minimum of 10 consecutive business days. The
        closing ONSM share price was $2.88 per share on January 10, 2007.
 
 Rescission
        rights - Prior to May 23, 2006, certain investors which purchased the 8%
        Convertible Debentures, the Additional 8% Convertible Debentures and the
        Series
        A-10 Preferred Stock may have been entitled to certain rescission rights. The
        resale registration statement of shares of common stock underlying these
        securities and the related warrants was originally filed by the Company on
        February 23, 2005. Pursuant to the Securities Act of 1933 and the related
        rules
        and regulations, as interpreted by the Securities and Exchange Commission,
        as a
        result of a portion of the additional investment rights granted with the 8%
        Convertible Debentures ,
        which
        were the
        basis
        of the sale of the Additional 8% Convertible Debentures, being
        unexercised at the time the resale registration statement was originally
        filed,
        the private offerings have not been completed and accordingly, the public
        and
        private offerings would be integrated and result in a violation of Section
        5 of
        the Securities Act. Accordingly, certain of the investors who purchased the
        private placement securities may have had a number of remedies available
        to
        them, including the potential right to rescind the purchase of those securities
        plus, potentially, any amount representing damage to such investors. Regardless
        of the above, the Company has determined that to the extent 8% Convertible
        Debentures, Additional 8% Convertible Debentures and Series A-10 Preferred
        Stock
        had been converted into common shares and those common shares sold by the
        original purchaser for at least the per share conversion price, and related
        interest shares sold for at least the stated interest dollar obligation for
        which those shares were issued, upon such sale the Company believes that
        the
        purchaser no longer had any damage claim for rescission.
 
 In
        addition to the above, the Company determined that once the affected purchasers
        had been on sufficient notice for at least one year as to these potential
        rescission rights, those purchasers should no longer have any damage claim
        for
        rescission. Based on two documents filed by the Company with the SEC disclosing
        these matters - Form NT 10-Q on May 17, 2005 and Form 10-QSB on May 23, 2005
        -
        the Company established May 23, 2005 as the date sufficient notice had been
        provided to all purchasers. Therefore, as of the one-year anniversary of
        that
        notice (May 23, 2006), the Company discontinued its previous reclassification
        of
        a portion of the potentially rescissionable proceeds from shareholders’ equity,
        where it was originally recorded, to the balance sheet classification “equity
        securities subject to potential rescission”, in accordance with Emerging Issues
        Task Force Topic D-98, “Classification and Measurement of Redeemable
        Securities”. This amount was $7,084,219, which was reflected as an increase in
        the Company’s additional paid-in capital for the year ended September 30, 2006.
        However, the portion of the potentially rescissionable proceeds that was
        reclassified to the liability “Detachable Warrants and Embedded Conversion
        Feature associated with 8% Convertible Debentures” as of May 23, 2006, was
        retained at that date and established as the initial liability subject to
        future
        periodic adjustments to fair value in accordance with EITF 00-19 and other
        applicable accounting, and as discussed in Note 4.
 
 F-34
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        5:
        COMMITMENTS AND CONTINGENCIES (Continued)
 
 Consulting
        agreements - The Company is obligated under agreements to issue approximately
        633,000 common shares and options to purchase approximately 395,000 shares
        (with
        exercise prices from $1.00 to $2.46) for consulting services subsequent to
        September 30, 2006, which will be valued at fair value as of the date of
        issuance and expensed under SFAS 123. These contracts also call for future
        cash
        payments of approximately $35,000. None of these contracts are with Company
        directors or officers.
 
 SAIC
        agreement - As part of the December 2004 Onstream Merger (see Note 2), the
        Company became obligated under a Basic
        Ordering Agreement for Professional Solutions ("BOA") entered into by Acquired
        Onstream and SAIC in June 2003, pursuant to which SAIC would build an outsourced
        solution for customers that allows for management and use of digital rich
        media
        and offers flexible applications, including collaboration and re-purposing
        (the
“DMSP”). SAIC agreed to design the DMSP, as hosted and managed by SAIC, to allow
        for the addition and customization of applications to fit the specific needs
        of
        customers. SAIC also agreed to provide certain hosting and back-office services
        directly to the Company, as Acquired Onstream’s successor, and in support of the
        Company’s customers. SAIC agreed that its services under the BOA would be billed
        at a discount to its regular rates throughout the term of the BOA.
 
 The
        original term of the BOA ran from June 12, 2003 through December 31, 2006
        and as
        part of a November 2006 agreement between the Company and SAIC, the contract
        term was extended through June 30, 2008, rescinding all previous contractual
        extension options. As part of this November 2006 agreement, SAIC’s previous
        option to cancel the contract if the Company’s minimum expenditures did not
        reach a certain level, was rescinded. The Company may terminate the BOA prior
        to
        the expiration of the term for convenience upon 30 days notice. SAIC may
        terminate the BOA if the Company is otherwise in material breach of its
        obligations, including timely payments of amounts due. Cancellation of the
        contract among other things releases SAIC to offer the Onstream Media Solution
        directly or indirectly to third parties.
 
 Contemporaneously
        with the BOA, Acquired Onstream and SAIC entered into a Stock Issuance
        Agreement, pursuant to which Acquired Onstream, at its option, could pay
        up to
        20% of $1,250,000 of invoices for services subsequent to the execution of
        the
        Stock Issuance Agreement, with its common stock. Such common stock would
        be
        valued at the lesser of $0.50 per share or fair market value as of the date
        of
        issuance. Prior to the Onstream Merger, Acquired Onstream had issued 158,910
        shares of its common stock to SAIC under this arrangement, valued at
        approximately $59,000 and converted to 23,535 ONSM shares in December 2004.
        Acquired Onstream granted to SAIC certain piggyback registration rights in
        connection with any such shares of common stock issued to SAIC.
 
 Within
        30
        days after notice of a forward merger of Acquired Onstream with another entity,
        or the sale of all or substantially all of the assets of Acquired Onstream
        to
        another entity, SAIC had the right to terminate the Stock Issuance Agreement.
        SAIC did not terminate the Agreement as a result of the Onstream Merger and
        the
        Company has continued to pay 20% of SAIC invoices with ONSM common stock
        -
        87,715 ONSM shares valued at $130,153 were issued to SAIC subsequent to the
        Onstream Merger and through September 30, 2006, including $57,142 included
        in
        Acquired Onstream’s accounts payable at the time of the Onstream Merger - see
        Note 2. SAIC has not objected to the use of a fair market value for ONSM
        shares
        consistent with the December 2004 conversion of its Acquired Onstream shares
        to
        ONSM shares, even though such valuation is higher than the $0.50 per share
        maximum established in the Stock Issuance Agreement.
 F-35
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        5:
        COMMITMENTS AND CONTINGENCIES (Continued)
 
 As
        of
        September 30, 2006, SAIC had been paid approximately $1,786,000 in cash or
        common stock (which includes approximately $909,000 paid under a predecessor
        professional services agreement for design and technology demonstration of
        a
        media asset management system, not considered BOA expenditures) and was owed
        approximately $112,000, which is included in accounts payable on the Company’s
        balance sheet at that date. As part of the November 2006 agreement between
        the
        Company and SAIC, this balance was settled by the payment of $50,000 cash
        and
        the issuance of 59,615 unregistered ONSM common shares.
 
 Employment
        Contracts and Severance
 
 On
        December 27, 2004, in connection with the Company’s closing of Onstream Merger
        (see Note 2), the Company entered into four-year employment contracts with
        the
        Company’s President, Executive Vice President, Chief Marketing Officer and
        Executive Vice President of Business Development. The contracts provide for
        base
        annual salaries of $163,000 ($178,000 for the President) increasing 10% per
        year. Each executive also receives a combined auto allowance, deferred
        compensation allocation and dues reimbursement allowance of $35,000 per year.
        In
        the event of a subsequent change of control or termination without cause,
        the
        Company is obligated to make payments of base salary for three years, which
        the
        executive may elect to take in a lump sum payment, plus benefits for two
        years.
        On March 8, 2005 the Company entered into a similar three-year employment
        agreement with its Chief Financial Officer, with a base salary of $150,000
        (increasing 10% each year, with the first increase effective December 27,
        2005)
        and other compensation of $27,000 per year. In the event of a subsequent
        change
        of control or termination without cause, the company is obligated to make
        payments of base salary and benefits for nine months.
 
 Lease
        Commitments
 
 In
        September 2002, the Company completed the sale and lease back of its principal
        executive offices in Pompano Beach, Florida. In connection with the agreement
        the Company entered into a five-year operating lease ending in September
        2007.
        The lease provides for one five-year renewal option. The monthly base rental
        is
        currently approximately $17,600 (including the Company's share of property
        taxes
        and common area expenses) with annual three percent (3%) increases.
        Approximately $159,000 is included in accounts payable at September 30, 2006
        related to amounts due under this lease.
 
 In
        May
        2004, the Company entered into a five-year operating lease for office space
        in
        San Francisco. The lease provides for one five-year renewal option at 95%
        of
        fair market value. The monthly base rental (including month-to-month parking)
        is
        approximately $16,300 with annual increases up to five percent (5%).
 
 In
        December 2006, the Company extended its annual operating lease for office
        space
        in New York City, through December 31, 2007. The monthly base rental is
        approximately $6,200.
 F-36
  
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        5:
        COMMITMENTS AND CONTINGENCIES (Continued)
 
 Lease
        Commitments (continued)
  
 Future
        minimum lease payments required under the non-cancelable leases, plus the
        capital lease included in Notes Payable as more fully discussed in Note 4,
        are
        as follows:
  Operating
              
              Capital
              
              AllYear
                  Ending September 30:
              
              Leases
              
              Lease
              
              Leases2007
              
              $
              483,115
              
              $
              63,958
              
              $
              547,0732008
              
              
              225,137
              
              
              40,394
              
              
              265,5312009
              
              
              116,870
              
              
              26,931
              
              
              143,8012010
              
              
              -
              
              
              -
              
              
              -Total
                  minimum lease payments
              
              $
              825,122
              
              $
              131,283
              
              $
              956,405Less:
                  amount representing interest
              
              
              
              
              
              16,928Present
                  value of net minimum lease payments
              
              
              
              
              $
              114,355Less:
                  current portion
              
              
              
              
              
              30,597Long-term
                  portion
              
              
              
              
              $
              83,758
 
  Total
        rental expense for all operating leases was approximately $467,000 and $452,000
        for the years ended September 30, 2006 and 2005, respectively.
  Annual
        Long Distance Purchase Commitment
 
 EDNet
        entered into a two-year long distance telephone rate agreement with a national
        telecommunications company, which included a telephone services purchase
        commitment of approximately $384,000 (before taxes) per year. The Company
        was in
        compliance with this agreement, which expired in March 2006, and in December
        2005 completed negotiations for a two-year renewal that included a telephone
        services purchase commitment of approximately $120,000 (before taxes) per
        year
        with approximately 40% lower rates, which were effective starting January
        15,
        2006.
 
 NOTE
        6:
        CAPITAL STOCK
 
 Common
        Stock
 
 In
        December 2004, the Company issued 2,207,966 shares of its common stock in
        connection with the Onstream Merger - see Note 2.
 
 During
        the year ended September 30, 2005, the Company issued 2,725,659 ONSM common
        shares as a result of a eleven individual investors’ conversions of $2,705,000
        8% Convertible Debentures and Additional 8% Convertible Debentures, plus
        accrued
        interest through the respective conversion dates - see Notes 4 and 5. Also
        during the year ended September 30, 2005, the Company issued 619,690 ONSM
        common
        shares as a result of four individual investors’ conversions of a total of
        61,969 shares of Series A-10 preferred shares, which included accrued dividends
        through the respective conversion dates - see Note 5 and below.
 F-37
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        6:
        CAPITAL STOCK (Continued)
 
 Common
        Stock (Continued)
 
 During
        the year ended September 30, 2005, the Company issued 712,626 shares of common
        stock for consulting, financial, advisory and other services, as
        follows:
 
 497,135
        shares valued at approximately $779,000 and recognized as professional fees
        expense over the various service periods of up to 24 months. 12,273 of these
        shares were issued to a company controlled by the Company’s former CFO. None of
        the remaining shares were issued to Company directors or officers. See Note
        5
        regarding the Company’s obligation to issue additional shares under such
        agreements.
 
 10,000
        shares issued to an employee as a bonus, with an immediately expensed value
        of
        approximately $12,100 and 26,759 shares of common stock to employees under
        the
        Plan valued at approximately $34,000.
 
 87,715
        shares issued to SAIC for services in connection with the DMSP, valued at
        $130,153 - see Note 5.
 
 91,017
        shares for legal services valued at approximately $134,000, including $14,400
        included in Acquired Onstream’s accounts payable at the time of the Onstream
        Merger - see Note 2.
 
 During
        the year ended September 30, 2005, the Company issued options to purchase
        its
        common shares, in exchange for consulting and financial advisory services,
        such
        options valued at approximately $590,000. The Company recognized professional
        fee expenses arising from these and prior issuances of shares and options
        for
        consulting and financial advisory services, including amounts related to
        certain
        executive severance agreements discussed above, of approximately $1,398,000
        and
        $1,769,000 for the years ended September 30, 2006 and 2005, respectively.
        As a
        result of previously granted or issued options, warrants or shares for
        consulting expenses, the Company had approximately $566,000 in deferred equity
        compensation expense at September 30, 2005, which will be amortized over
        the
        remaining periods of service for these issuances, which range from two to
        21
        months. The deferred equity compensation expense is included in the balance
        sheet captions prepaid expenses and other non-current assets.
 
 In
        January 2005, also in connection with the Onstream Merger and pursuant to
        Board
        and shareholder approval received in December 2004, the Company issued 150,000
        shares of ONSM common stock to Envision Management Group, a consulting firm
        controlled by Ms. Gail Babitt, our former CFO, and the Company issued 100,000
        shares of ONSM common stock to Mr. George Stemper, our former COO currently
        employed by the Company in another capacity. The Company recorded the issuance
        of these common shares at $392,500, based on the fair value of the 250,000
        shares at the date of Board and shareholder authorization, which was included
        in
        professional fee expense during the year ended September 30, 2005.
 
 In
        January 2005, pursuant to Board approval received in December 2004, the Company
        issued Mr. Stemper 50,000 shares of ONSM common stock as an advance against
        sales commissions to be earned by him through August 31, 2005 in connection
        with
        a professional services agreement. The Company recorded the issuance of these
        common shares at $78,500, based on the fair value of the 50,000 shares at
        the
        date of Board authorization. Based on an August 1, 2005 employment agreement
        entered into between the Company and Mr. Stemper, these shares are considered
        fully earned by him as of August 31, 2005 and were expensed by the Company
        as of
        that date.
 
 F-38
 
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        6:
        CAPITAL STOCK (Continued)
 
 Common
        Stock (Continued)
 
 On
        June
        29, 2005, the Company issued 606,000 ONSM common shares, to satisfy in full
        a
        penalty of 2,000 common shares per day for every day starting August 31,
        2004,
        that certain common shares issued in April 2004 (arising from March 2004
        convertible debentures) were not registered. The Company recorded interest
        expense of $943,840 for the year ended September 30, 2005, related to its
        valuation of this stock issued in satisfaction of this penalty. The valuation
        was based on the closing share price for each day that the penalty was incurred
        through June 29, 2005, when a registration statement filed with the SEC and
        containing these shares was declared effective.
 
 During
        the year ended September 30, 2005, the Company issued 267,248 common shares
        in
        lieu of the $310,427 interest accrued and due through that date on the 8%
        Convertible Debentures and Additional 8% Convertible Debentures. During January
        2005, the Company issued 85,488 shares of common stock in repayment of
        approximately $149,000 of interest due on a $3.0 million note through the
        date
        of repayment. See Note 4.
 
 During
        the year ended September 30, 2006, the Company issued (i) 906,506 ONSM common
        shares as a result of six investors’ conversion of $895,000 of 8% Convertible
        Debentures, plus accrued interest and (ii) 188,740 ONSM common shares as
        a
        result of five investors’ conversion of 18,874 shares of Series A-10 Preferred -
        see Note 5 and below.
 
 During
        the year ended September 30, 2006, the Company issued 1,092,715 shares of
        common
        stock for equipment and consulting, financial, advisory and other services,
        as
        follows:
 
 686,143
        shares valued at approximately $606,000 and recognized as professional fees
        expense over various service periods of up to 6 months. None of these shares
        were issued to Company directors or officers. However, 135,000 of these shares
        were issued under a consulting agreement with an individual having greater
        than
        5% beneficial ownership in the Company as of September 30, 2005 and 2006.
        See
        Note 5 regarding the Company’s obligation to issue additional shares under such
        agreements.
 
 406,572
        common shares as satisfaction for equipment purchases of approximately $252,000
        included in accounts payable at September 30, 2005, plus another $75,000
        of
        equipment purchases to be received after that date.
 
 During
        the year ended September 30, 2006, the Company issued options to purchase
        its
        common shares, in exchange for consulting and financial advisory services,
        such
        options valued at approximately $517,000. The Company recognized professional
        fee expenses arising from these and prior issuances of shares and options
        for
        consulting and financial advisory services, including amounts related to
        certain
        executive severance agreements, of approximately $1,398,000 and $1,769,000
        for
        the years ended September 30, 2006 and 2005, respectively. As a result of
        previously granted or issued options, warrants or shares for consulting
        expenses, the Company has approximately $258,000 in deferred equity compensation
        expense at September 30, 2006, which will be amortized over the remaining
        periods of service for these issuances, which range from two to 12 months.
        The
        deferred equity compensation expense is included in the balance sheet caption
        prepaid expenses.
 
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        6:
        CAPITAL STOCK (Continued)
 
 Common
        Stock (Continued)
 
 During
        the year ended September 30, 2006, the Company issued (i) 368,209 common
        shares
        in lieu of the $302,206 interest accrued and due through September 30, 2006
        on
        the 8% Convertible Debentures and the Additional 8% Convertible Debentures
        (which included 9,589 shares issued for $9,589 interest due on conversions
        during that period), (ii) 165,068 common shares in lieu of the $93,284 interest
        accrued and due through September 30, 2006 on the 8% Subordinated Convertible
        Debentures (which included 1,917 shares issued for $1,917 interest due on
        conversions during that period), (iii) 44,444 common shares as prepaid interest
        and 15,000 common shares as late payment penalty on $300,000 borrowed from
        Platinum Credit Group, LLC - see Note 4, (iv) 80,000 common shares as prepaid
        interest on $350,000 borrowed from Platinum Credit Group, LLC - see Note
        4, (v)
        35,000 common shares as partial interest on an aggregate $350,000 borrowed
        from
        David Namoff and Lewis Opportunity Fund LP in February 2006 - see Note 4
        and (vi) 31,243 common shares as interest to various vendors.
 
 During
        the nine months ended June 30, 2006, the Company issued 20,833 common shares
        as
        a result of the exercise of warrants at $1.00 per share - see Notes 5 and
        8.
 
 Preferred
        Stock
 
 *Series
        A-10 Convertible Preferred Stock*
 
 As
        of
        September 30, 2006 and 2005, the only preferred stock outstanding is Series
        A-10
        Convertible Preferred Stock (“Series A-10”). Prior to May 23, 2006 c ertain
        purchasers of the Series A-10 may have been entitled to certain rescission
        rights - see Note 5.
 
 The
        Series A-10 has a coupon of 8% per annum, payable annually in cash (or
        semi-annually at the Company’s option in cash or in additional shares of Series
        A-10), has a stated value of $10.00 per preferred share and has a conversion
        rate of $1.00 per common share. Series A-10 dividends are cumulative and
        must be
        fully paid by the Company prior to the payment of any dividend on its common
        shares. The Series A-10 is not redeemable by the Company and any shares of
        Series A-10 that are still outstanding as of December 2008 will automatically
        convert into common shares. Series A-10 is senior to all other preferred
        share
        classes that may be issued by the Company and the Company may not incur any
        additional indebtedness greater than $1.5 million in aggregate, and excluding
        trade and purchase money payables, without the consent of the holders of
        at
        least 50% of the outstanding Series A-10 shares. The Series A-10 holders
        have
        the right to designate one member of the Company’s board of directors. Except as
        explicitly required by applicable law, the holders of Series A-10 shall not
        be
        entitled to vote on any matters as to which holders of the Company’s common
        shares are entitled to vote. In February 2005, the board of directors and
        the
        holders of a majority of the issued and outstanding shares of Series A-10
        voted
        to approve an increase in the authorized number of Series A-10 from 500,000
        shares to 700,000 shares to provide for the possible issuance of shares of
        Series A-10 as dividends on Series A-10 presently outstanding.
 
 On
        December 23, 2004, the Company sold 215,000 shares of Series A-10 for $2.15
        million to sixteen accredited investors, plus 100,000 shares of Series A-10
        for
        $1.0 million of previously outstanding debt to a single accredited investor
        -
        see Note 4. The 315,000 shares of Series A-10 included five-year warrants
        to
        purchase 1,575,000 common shares of ONSM for $1.50 per share. Another 8,562
        shares of Series A-10 were issued to the purchasers in January 2005 as
        compensation for their funds being held in escrow from June 2004 through
        December 2004, pending shareholder approval, in accordance with Nasdaq
        Marketplace Rule 4350(i), of the issuance in excess of 19.99% of the Company’s
        common stock. In December 2004, a single shareholder converted all 232,750
        shares of Series A-8 held by him into 139,650 shares of Series
        A-10.
 
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        6:
        CAPITAL STOCK (Continued)
 
 Preferred
        Stock (Continued)
 
 The
        Company’s Board of Directors declared a dividend payable on May 15, 2005 to
        Series A-10 shareholders of record as of May 10, 2005 of 13,974 Series A-10
        preferred shares, in lieu of a $139,738 cash payment. In addition, the Company
        issued 814 Series A-10 shares in lieu of $8,140 dividends due on conversions
        during the year ended September 30, 2005. The Company’s Board of Directors
        declared a dividend payable on November 15, 2005 to Series A-10 shareholders
        of
        record as of November 10, 2005 of 16,641 Series A-10 preferred shares, in
        lieu
        of a $166,413 cash payment. The Company’s Board of Directors declared a dividend
        payable on May 15, 2006 to Series A-10 shareholders of record as of May 10,
        2006
        of 16,701 Series A-10 preferred shares, in lieu of a $167,014 cash payment.
        In
        addition, the Company issued 484 Series A-10 shares in lieu of $4,840 dividends
        due on conversions during the year ended September 30,
        2006.
 
 As
        of
        September 30, 2006, the Company had issued 808,430 ONSM common shares as
        a
        result of ten investors converting a total of 80,843 shares of Series A-10
        preferred shares, which included 1,298 Series A-10 shares issued for accrued
        dividends through the respective conversion dates. See Note 9 regarding
        significant conversions occurring after September 30, 2006.
 
 The
        above
        transactions are summarized as follows through September 30, 2006:
 
 Initial
                  number of Series A-10 shares issued
              
              
              454,650Plus:
                  A-10 shares issued for regular interest and dividends
              
              
              55,878Plus:
                  A-10 shares issued for conversion dividends
              
              
              1,298Less:
                  A-10 shares converted to common shares
              
              
              (80,843
              )Number
                  of Series A-10 shares outstanding
              
              
              430,983
 
 The
        placement agent fees and direct issue costs for the Series A-10 financing
        were
        approximately $172,000 plus five-year warrants to purchase approximately
        215,000
        shares of ONSM common stock for $1.50 per share.
 
 The
        estimated fair value of all warrants given in connection with the Series
        A-10
        plus the Series A-10’s beneficial conversion feature, is $2,755,951, which, in
        accordance with EITF 98-05 and EITF 00-27, was allocated to additional paid
        in
        capital and discount. The Company’s management calculated the discount primarily
        based on its estimate of the fair value of the warrants as a percentage of
        the
        face value of the convertible securities. The estimate was based on the closing
        price of the stock at the date of the agreement and the relationship to the
        conversion price of the instrument and the exercise price of the warrants.
        The
        discount, which totals $2,928,041 after inclusion of other direct costs
        associated with the financing, is being amortized as a dividend over the
        four-year term of the Series A-10. In addition, the unamortized portion of
        the
        discount related to converted securities is expensed as an additional dividend
        at the time of the conversion.
 
 *Other
        Preferred Stock Transactions*
 
 In
        May
        2003, the Company issued 140,000 shares of Series A-8 Convertible Preferred
        Stock (“Series A-8”) to a shareholder as compensation for restructuring an
        existing loan to the Company and loaning the Company additional funds. In
        addition, the shareholder converted his outstanding common stock in the Company
        into 92,750 shares of Series A-8. In December 2004, this shareholder converted
        all 232,750 shares of Series A-8 held by him into 139,650 shares of Series
        A-10
        Preferred Stock.
 
 On
        February 10, 2004, the Company sold 25,000 shares of its Series A-11 non-voting
        redeemable Convertible Preferred Stock, plus three-year warrants to purchase
        130,000 shares of its common stock, for $500,000. In December 2004, the Company
        redeemed all outstanding shares of Series A-11 for cash.
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        7: SEGMENT INFORMATION
 
 The
        Company's operations are currently comprised of two operating groups, Digital
        Asset Management and Webcasting. These groups are managed from the Company's
        Pompano Beach facility, with their primary operating activities at the San
        Francisco and Pompano Beach facilities, respectively. See Note 1 for details
        about the Company’s redefinition of its segments in fiscal 2005.
 
 All
        material balances related to Company sales, primary business activities,
        and
        location of property and equipment are within the United States.
 
 For
        the
        years ended September 30, 2006 and 2005 the Company provided webcasting services
        to one significant customer, Thomson/CCBN, under a contract that can be
        terminated upon a 30-day notification. Revenues from sales to Thomson/CCBN
        were
        approximately $331,000, or approximately 4%, and approximately $1,389,000,
        or
        approximately 17%, of total consolidated revenue for the years ended September
        30, 2006 and 2005, respectively. These revenues represented approximately
        9% and
        38% of Webcasting Group revenues for the same periods.
 
 For
        the
        years ended September 30, 2006 and 2005 the Company provided digital asset
        management services to another significant customer, America Online, Inc.,
        under
        a contract that can be terminated upon a 30-day notification. Revenues from
        sales to this customer were approximately $911,000, or approximately 11%,
        and
        approximately $1,184,000, or approximately 15% of total consolidated revenue
        for
        the years ended September 30, 2006 and 2005, respectively. These revenues
        represented approximately 20% and 26% of Digital Asset Management Group revenues
        for the same periods.
 
 For
        the
        year ended September 30, 2006 the Company provided digital asset management
        services to another significant customer, Discovery Education, Inc., under
        a
        contract that can be terminated upon a 30-day notification. Revenues from
        sales
        to this customer were approximately $641,000, or approximately 8% of total
        consolidated revenue for the year ended September 30, 2006. These revenues
        represented approximately 14% of Digital Asset Management Group revenues
        for the
        same period.
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        7:
        SEGMENT INFORMATION (Continued)
 
 Detailed
        below are the results of operations by segment for the years ended September
        30,
        2006 and 2005, and total assets by segment as of those dates.
   For
                  the years ended September 30,2006
              
              2005Revenue:Digital
                  Asset Management Group
              
              $
              4,631,360
              
              $
              4,477,402Webcasting
                  Group
              
              
              3,788,091
              
              
              3,678,992Total
                  consolidated revenue
              
              $
              8,419,451
              
              $
              8,156,394Segment
                  operating income:Digital
                  Asset Management Group
              
              $
              1,051,743
              
              $
              763,540Webcasting
                  Group
              
              
              145,559
              
              
              826,634Total
                  segment operating income
              
              
              1,197,302
              
              
              1,590,174Depreciation
                  and amortization
              
              
              (
                  2,121,161
              )
              
              (
                  1,152,633
              )Impairment
                  loss on goodwill
              
              
              -
              
              
              (
                  330,000
              )Corporate
                  and unallocated shared expenses
              
              
              (
                  4,933,140
              )
              
              (
                  5,714,949
              )Other
                  (expense) income, net
              
              
              (
                  609,214
              )
              
              (
                  4,030,480
              )Net
                  loss
              
              $
              (
                  6,466,213
              )
              $
              (
                  9,637,888
              )
  
 September
                  30,2006
              
              2005Total
                  assets:Digital
                  Asset Management Group
              
              $
              14,789,639
              
              $
              14,580,103Webcasting
                  Group
              
              
              1,408,488
              
              
              1,925,137Corporate
                  and unallocated
              
              
              968,085
              
              
              1,016,847Total
              
              $
              17,166,212
              
              $
              17,522,087
 
 
 Depreciation,
        amortization and impairment losses are not utilized by the Company’s primary
        decision makers for making decisions with regard to resource allocation or
        performance evaluation.
 
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        8:
        STOCK OPTIONS AND WARRANTS
 
 As
        of
        September 30, 2006, the Company had 15,212,431 issued and outstanding options
        and warrants, including 4,388,891 Plan Options; 2,431,390 Non-Plan Options
        to
        employees and directors; 2,254,239 Non-Plan Options to consultants; and
        6,137,911 warrants issued in connection with various financings and other
        transactions.
 
 On
        February 9, 1997, the Board of Directors and a majority of the Company's
        shareholders adopted the 1996 Stock Option Plan (the "Plan"). On April 11,
        2002,
        an amendment to the Plan, ratified by the shareholders, reserved an aggregate
        of
        733,334 Plan Options and added an equity compensation component. On December
        15,
        2004, a majority of the Company’s shareholders voted to increase the number of
        shares available for issuance under the plan to 3,500,000, including stock
        grants of up to 500,000 shares. On September 13, 2004, a majority of the
        Company’s shareholders voted to increase the number of shares available for
        issuance under the plan to 6,500,000, including stock grants of up to 2,000,000
        shares.
 
 As
        of
        September 30, 2006 the Company has outstanding options to management,
        employees and directors granted under the Plan. The initial term of these
        options were generally four to five years and they are fully
        vested as of September 30, 2006. All options were granted at a price equal
        to or greater than the fair market value at the date of grant. On December
        15,
        2004 a majority of the Company’s shareholders voted to approve the cancellation
        (subject to the option holder’s approval) of Plan Options to directors, senior
        management and employees covering 227,776 shares (plus 65,216 Non-Plan Options)
        with a weighted-average exercise price of $21.93, with such options to be
        re-issued six months and one day from the date of cancellation with an exercise
        price equal to the fair market value on the date of the reissue. This
        cancellation has not yet been implemented and 167,777 of the Plan Options
        subject to this cancellation and re-issue had expired as of January 10,
        2007.
  In
          December 2004 the Company issued four-year Plan options to purchase 50,000
          common shares to General Ronald Yates upon his initial appointment to the
          Company's Board of Directors, immediately exercisable at an exercise price
          of
          $1.57 per share, which was the fair market value on the date of grant.
          In
          December 2004, the Company's Board of Directors granted an aggregate
          of 300,000 four-year Plan options exercisable at an exercise price of $1.21
          per share, which was the fair market value on the date of grant, to two
          executives. The Board later accelerated the vesting of 150,000 of these
          options
          to the first executive, as discussed below, and the remaining 150,000 options
          expired unexercised as a result of termination of the second executive's
          employment.
 In
        July
        2005 the Company’s Board of Directors granted 2,634,224 five-year Plan options,
        exercisable at $1.12 per share, which was the fair market value on the date
        of
        grant. This included 1,500,000 fully vested options to Company directors
        and
        senior management, with the balance issued to other Company employees and
        vesting quarterly during the year ended September 30, 2006. At the same time,
        the Board accelerated the vesting of 150,000 four-year Plan options previously
        granted to a Company executive in December 2004 at an exercise price of $1.21
        per share, which was the fair market value on the date of grant. The options,
        which were to vest in installments of 50,000 options per year, beginning
        December 15, 2005, were declared fully vested. At the same time, the Company
        issued 26,759 Plan fully paid stock grants to Company executives.
 
 During
        July 2006, the Company issued four-year Plan options to purchase 50,000 common
        shares to Mr. Carl L. Silva upon his initial appointment to the Company’s Board
        of Directors, immediately exercisable at an exercise price of $0.88 per share
        (fair market value on the date of grant). In September 2006 the Company’s Board
        of Directors granted 1,500,000 five-year Plan options, exercisable at $0.71
        per
        share, which was the fair market value on the date of grant. These options
        were
        fully vested, with 700,000 issued to Company directors (other than Mr. Silva)
        and senior management and the balance issued to other Company
        employees.
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        8:
        STOCK OPTIONS AND WARRANTS (Continued)
 
 Detail
        of
        Plan Option activity for the years ended September 30, 2006 and 2005 is as
        follows:
 
 September
                  30, 2006
              
              September
                  30, 2005Number
                  of Shares
              
              Weighted
                  Average
                Exercise
                  Price
              
              Number
                  of Shares
              
              Weighted
                  Average
                Exercise
                  PriceBalance,
                  beginning of period
              
              
              2,940,895
              
              
              $   
                    1.89
              
              
              236,100
              
              
              $   
                    21.93Granted
                  during the period
              
              
              1,550,000
              
              
              0.71
              
              
              2,984,224
              
              
              1.14Expired
                  or forfeited during the period
              
              
              (
                  102,004
              )
              
              8.62
              
              
              (
                  279,429
              )
              
              2.66Balance,
                  end of the period
              
              
              4,388,891
              
              
              $   
                    1.28
              
              
              2,940,895
              
              
              $  
                       1.89Exercisable
                  at end of the period
              
              
              4,388,891
              
              
              $   
                    1.28
              
              
              1,806,671
              
              
              $   
                      2.37
 
 
 The
        Company’s 4,322,223 outstanding exercisable Plan Options at September 30, 2006
        not subject to the cancellation and re-grant discussed above have a remaining
        life of approximately 4.25 years and exercise prices ranging from $0.71 to
        $1.57
        per share. The Company’s 66,668 outstanding exercisable Plan Options subject to
        this cancellation and re-grant have a remaining life of less than 2 years
        and
        exercise prices ranging from $11.25 to $22.50 per share.
 
 As
        of
        September 30, 2006, the Company had 2,431,390 outstanding Non Plan options
        issued to employees and directors, which were issued during the year ended
        September 30, 2005. During that period, the Company issued immediately
        exercisable five-year options to certain executives, directors and other
        management for the purchase of 1,350,000 shares of our common stock at $1.57
        per
        share (fair market value at date of grant); five-year options to certain
        executives, fully-vested as of September 30, 2005, for the purchase of 800,000
        shares of our common stock at $2.50 per share (greater than the $1.57 fair
        market value at date of grant); and 281,390 options at an exercise price
        of
        $3.376 per share in conjunction with the Onstream Merger.
 
 As
        of
        September 30, 2006, the Company had 2,254,239 outstanding Non Plan options
        issued to consultants, of which (i) 1,055,000 were issued during the year
        ended
        September 30, 2006, 855,000 with an exercise price of $1.00 per share and
        200,000 with an exercise price of $1.05 per share, (ii) 929,240 were issued
        during the year ended September 30, 2005, 870,000 with exercise prices ranging
        from $1.10 to $3.00 per share, and
        59,240 issued at an exercise price of $3.376 per share in conjunction with
        the
        Onstream Merger and (iii) 269,999 were issued during the year ended September
        30, 2004, with exercise prices of $2.25 and $2.50 per share. These options
        granted to consultants have exercise prices from $1.00 to $3.38 per share
        and
        expire at various dates from June 2008 to September 2011. 268,750
        of the above options were not vested as of September 30, 2006, including
        125,000
        options issued during the year ended September 30, 2004 and which are not
        expected to vest prior to expiration due to termination of the underlying
        contract. See Note 5.
 
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        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        8:
        STOCK OPTIONS AND WARRANTS (Continued)
 
 As
        of
        September 30, 2006, the Company had outstanding vested warrants to purchase
        an
        aggregate of 6,137,911 shares of common stock, inclusive of warrants issued
        in
        connection with various financings. The warrants contain exercise prices
        ranging
        from $1.00 to $10.65 expiring from April 2007 to April 2011. During the year
        ended September 30, 2006 the Company granted 997,917 of these warrants -
        987,500
        five-year warrants at an exercise price of $1.50 per share issued in connection
        with the 8% Subordinated Convertible Debentures and which are not exercisable
        until September 2006 and 10,417 five-year warrants at an exercise price of
        $1.65
        per share as a result of the exercise of $1.00 warrants discussed below.
        During
        the year ended September 30, 2005 the Company granted 4,847,693 of these
        warrants - 2,936,250 five-year warrants at an exercise price of $1.65 per
        share
        in conjunction with the sale of 8% Convertible Debentures and Additional
        8%
        Convertible Debentures; 1,790,000 five-year warrants at an exercise price
        of
        $1.50 per share in conjunction with the sale of Series A-11; and 121,443
        warrants at an exercise price of $3.376 per share in conjunction with the
        Onstream Merger. In addition, 292,301 of these warrants were granted by the
        Company in connection with other financing activities in periods prior to
        the
        year ended September 30, 2005- 10,000 four-year warrants at an exercise price
        of
        $4.50 per share issued with the sale of Series A-9; 40,000 one-year warrants
        at
        an exercise price of $3.00 per share issued with the sale of Series A-9;
        130,000
        three-year warrants at an exercise price of $2.28 per share issued with the
        sale
        of Series A-11; 82,300 four-year warrants at an exercise price of $3.00 per
        share issued with the sale of common stock; and 30,001 warrants at exercise
        prices from $2.65 to $10.65 per share, issued with other transactions. See
        Notes
        4 and 6.
 
 In
        addition to the warrants listed above, the Additional 8% Convertible Debentures
        included one-year warrants to purchase 2,175,000 common shares of ONSM for
        $1.00
        per share. The one-year warrants were subject to the approval of a majority
        of
        the Company’s shareholders, which was obtained at the September 13, 2005
        shareholder meeting, and at which time the one-year term of those warrants
        began. The one-year warrants provided for the issuance of additional five
        year
        warrants, exercisable at $1.65 per share, to purchase 50% of the common shares
        of ONSM acquired upon the exercise of the one-year warrants. During
        April 2006, the Company issued a five-year warrant to purchase 10,417 common
        shares for $1.65 per share as the result of a single investor’s exercise of a
        warrant for 20,833 common shares at $1.00 per share. Effective September
        13,
        2006, the remaining $1.00 warrants expired without having been exercised.
        See
        Note 4.
  NOTE
        9:
        SUBSEQUENT EVENTS - FINANCING AND EQUITY TRANSACTIONS
 
 On
        October 27, 2006 the Company entered into a four-year promissory note in
        the
        aggregate principal amount of $1.0 million, which was funded in installments
        through December 2006. The note is unsecured and subordinate to all other
        liabilities of the Company. The note bears interest at a rate of 17.75% per
        annum, payable in cash quarterly in arrears or, at Company’s option, in
        Company’s unregistered common stock valued at $1.00 per share. If interest is
        paid in shares, it must be prepaid on a non-compounding, non-refundable basis
        for the entire remaining term of the loan. The Company elected to prepay
        all
        interest with the aggregate issuance of 694,495 unregistered common shares
        during November and December 2006.
 
 At
        any
        time after April 27, 2007, or earlier if agreed to by the Company, the lending
        entity, at its option, may begin converting the outstanding principal to
        the
        Company’s unregistered common stock at the rate of $1.00 per share through
        October 25, 2009, and at the rate of $2.00 per share thereafter. The Company
        allowed the note to be converted into 1.0 million unregistered common shares
        on
        January 10, 2007. The Company has granted the lending entity demand registration
        rights, effective six months from the date of the note, for any unregistered
        common shares issuable thereunder. Upon such demand, the Company will have
        60
        days to file a registration statement and shall use its best efforts to obtain
        promptly the effectiveness of such registration statement.
 F-46
  ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        9:
        SUBSEQUENT EVENTS - FINANCING AND EQUITY TRANSACTIONS (Continued)
 
 In
        connection with the above transaction, the Company has agreed to pay a finder’s
        fee to another individual not affiliated with the lending entity and not
        a
        director or officer of the Company, but who has greater than a 5% beneficial
        ownership in the Company. This finder’s fee is payable as 100,000 shares of the
        Company’s common stock, which the Company issued in November 2006, plus
        immediately exercisable four-year options to purchase 50,000 shares of the
        Company’s common stock at $1.00 per share, which was greater than the fair value
        of those shares at the option grant date. In November 2006, the Company entered
        into a three-year consulting contract with the principal and beneficial owner
        of
        the lending entity, for the provision of international business development
        and
        financial advice. The contract, which is cancellable upon thirty days notice
        after the first year, calls for the issuance of 60,000 restricted common
        shares
        in advance every six months.
 
 The
        Company’s Board of Directors declared a dividend payable on November 15, 2006 to
        Series A-10 shareholders of record as of November 10, 2006 of 17,239 Series
        A-10
        preferred shares, in lieu of a $172,394 cash payment.
 
 During
        November and December 2006 and through January 10, 2007, the Company issued
        an
        aggregate of 4,812,982 registered common shares as a result of conversions
        by
        several investors of 8% Senior and Subordinated Convertible Debentures and
        Series A-10 Preferred, as follows:
 
 (i)
            2,404,887
                ONSM common shares for the conversion of $2,369,855 of 8% Senior
                Convertible Debentures, plus accrued
                interest, 
 (ii)
            1,500,405
                ONSM common shares for the conversion of $1,475,000 of 8% Subordinated
                Convertible Debentures, plus accrued
                interest, 
 (iii)
            907,690
                ONSM common shares for the conversion of 90,769 shares of Series
                A-10
                Preferred, including accrued dividends. 
 The
        above
        debenture conversions will result in a one-time non-cash expense of
        approximately $1.5 million for the three months ended December 31, 2006 and
        another approximately $100,000 for the three months ended March 31, 2007,
        arising from the write-off of an unamortized debt discount.
 
 During
        December 2006 and through January 10, 2007, the Company received approximately
        $3.1 million from the exercise of previously issued warrants and options,
        resulting in its issuance of 2,076,479 registered common shares. These warrants
        and options had exercise prices ranging from $1.00 to $2.00 per
        share.
 
 The
        above
        debenture conversions as well as the warrant exercises will reduce the pool
        of
        derivatives that the Company is required to adjust to market value each quarter
        in accordance with EITF 00-19. However the impact on the December 31, 2006
        financial statements will depend on, among other things, the market price
        and
        calculated volatility of the Company’s shares at that date.
 
 During
        January 2007, the Company issued 20,971 common shares in lieu of the $34,599
        interest accrued and due through December 31, 2006 on the 8% Senior Convertible
        Debentures and the 8% Subordinated Convertible Debentures.
 
 Subsequent
        to September 30, 2006, $750,000 of notes payable included on the Company’s
        balance sheet at that date were renegotiated to include conversion rights
        at
        $1.00 and $1.22 per share. One of these lenders also has the right to lend
        another $1,050,000 with conversion rights at $1.00 per share, including the
        right to require prepaid interest in shares converted at that rate, of which
        $400,000 was received by the Company in December 2006 and $50,000 received
        in
        January 2007. See Note 4.
 
 F-47
 
 ONSTREAM
        MEDIA CORPORATION AND SUBSIDIARIES
 NOTES
        TO
        THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
        30, 2006
 
 
 NOTE
        9:
        SUBSEQUENT EVENTS - FINANCING AND EQUITY TRANSACTIONS (Continued)
 
 During
        the period from October 1, 2006 through January 10, 2007, the Company issued
        290,000 unregistered shares of common stock for consulting, financial advisory
        and legal services. The services are being provided over periods ranging
        up to
        one year, and will result in a professional fees expense of approximately
        $230,000 over the service period. None of these shares were issued to Company
        directors or officers.
 
 On
        November 8, 2006, the Company issued 59,615 unregistered shares of common
        stock
        to SAIC as payment for services previously capitalized by the Company at
        $62,000
        and included in accounts payable at September 30, 2006. The Company agreed
        to
        include these shares in the next registration statement filed by it. See
        Note
        5.
 
 F-48