UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





Form
10-K





(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, 2010





 ̈
            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


(Exact
name of registrant as specified 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)





Registrant's telephone number,
including area code 954-917-6655





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





Title of each class
                      
                      Name of each exchange on which registeredNone
                      
                      notapplicable





Securities registered under Section 12(g) of the Act:
              CommonStock(Title of class)





Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act      ̈  Yes    x  No





Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or 15(d) of
the Act      ̈  Yes    x  No





Note –
Checking the box above will not relieve any registrant required to file reports
pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under
those Sections.





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





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.05 of
this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit and post such
files).    Yes  ̈ No  ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.   ̈





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





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





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





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
last sold, or the averaged bid and asked price of such common equity, as of the
last business day of the registrant’s most recently completed second fiscal
quarter. The aggregate market value of the common equity held by non-affiliates
computed at the closing price of the registrant’s common stock on March 31, 2010
was approximately $13.8 million.





Note – If
a determination as to whether a particular person or entity is an affiliate
cannot be made without involving unreasonable effort and expense, the aggregate
market value of the common stock held by non-affiliates may be calculated on the
basis of assumptions reasonable under the circumstances, provided that the
assumptions are set forth in this Form.


Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date.  As of December 24, 2010,
8,941,353 shares of common stock were issued and outstanding.




DOCUMENTS
INCORPORATED BY REFERENCE





List
hereunder the following documents if incorporated by reference and the part of
the Form 10-K (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) or
(c) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).





Not
Applicable.





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





CERTAIN
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION





Certain
statements in this annual report on Form 10-K contain or may contain
forward-looking statements that are subject to known and unknown risks,
uncertainties and other factors which may cause actual results, performance or
achievements to be materially different from any future results, performance or
achievements expressed or implied by such forward-looking statements. These
forward-looking statements were based on various factors and were derived
utilizing numerous assumptions and other factors that could cause our actual
results to differ materially from those in the forward-looking statements. These
risks, uncertainties and other factors include, but are not limited to, our
ability to implement our strategic initiatives (including our ability to
successfully complete, produce, market and/or sell the DMSP and/or our ability
to eliminate cash flow deficits by increasing our sales), economic, political
and market conditions and fluctuations, government and industry regulation,
interest rate risk, U.S. and global competition, and other factors affecting our
operations and the fluctuation of our common stock price, and other factors
discussed elsewhere in this report and in other documents filed by us with the
Securities and Exchange Commission from time to time. Most of these factors are
difficult to predict accurately and are generally beyond our control. You should
consider the areas of risk described in connection with any forward-looking
statements that may be made herein. Readers are cautioned not to place undue
reliance on these forward-looking statements, which speak only as of September
30, 2010, unless otherwise stated. Readers should carefully review this Form
10-K in its entirety, including but not limited to our financial statements and
the notes thereto. Except for our ongoing obligations to disclose material
information under the Federal securities laws, we undertake no obligation to
release publicly any revisions to any forward-looking statements, to report
events or to report the occurrence of unanticipated events. Actual results could
differ materially from the forward-looking statements. In light of these risks
and uncertainties, there can be no assurance that the forward-looking
information contained in this report will, in fact, occur. For any
forward-looking statements contained in any document, we claim the protection of
the safe harbor for forward-looking statements contained in the Private
Securities Litigation Reform Act of 1995.





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





PART
I





ITEM
1.                                BUSINESS





Our
Business, Products and Services





We are a
leading online service provider of live and on-demand Internet video, corporate
audio and web communications and content management applications.  We
had approximately 96 full time employees as of September 30, 2010, with
operations organized in two main operating groups:





·
            Digital
      Media Services Group


·
            Audio
      and Web Conferencing Services
Group


2





Products
and services provided by each of the groups are:





Digital
Media Services Group





Our
Digital Media Services Group consists of our Webcasting division, our DMSP
(“Digital Media Services Platform”) division, our UGC (“User Generated Content”)
division and our Smart Encoding division.  This group represented
approximately 47.1% and 45.7% of our revenues for the years ended September 30,
2010 and 2009, respectively. These revenues are comprised primarily of fees for
hosting/storage, search/retrieval and distribution/streaming of digital assets
as well as encoding and production fees.





Our
Webcasting division, which operates primarily from 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.  This includes 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.
The Webcasting division also has a sales and production support office in New
York City as well as additional production and back-up webcasting facilities in
our San Francisco office. 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, 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 DMSP
division, which operates primarily from Colorado Springs, Colorado provides an
online, subscription based service that includes access to enabling technologies
and features for our clients to acquire, store, index, secure, manage,
distribute and transform these digital assets into saleable commodities. In
December 2004 we completed our acquisition of an entity formerly named Onstream
Media Corporation that we now identify as Acquired Onstream. 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 service was the initial
version of what became the DMSP, which is comprised of four separate products -
encoding, storage, search/retrieval and distribution. Although a limited version
of the DMSP was released in November 2005, the first complete version of the
DMSP, known as “Store and Stream”, was offered for sale to the general public
since October 2006.  In February 2009, we launched “Streaming
Publisher”, a second version of the DMSP with additional functionality.
Streaming Publisher is a stand-alone product based on a different architecture
than Store and Stream and is a primary building block of the recently launched
MarketPlace365 platform, which will enable the creation of on-line virtual
marketplaces and trade shows utilizing many of our other technologies such as
DMSP, webcasting, UGC and conferencing.





Our UGC
division, which also operates as Auction Video, provides a video ingestion and
flash encoder that can be used by our clients on a stand-alone basis or in
conjunction with the DMSP. In March 2007 we completed the acquisition of Auction
Video. The primary assets acquired included the video ingestion and flash
transcoder as well as related technology and patents pending.





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


3





Audio
and Web Conferencing Services Group





Our Audio
and Web Conferencing Services Group includes our Infinite Conferencing
(“Infinite”) division, which operates primarily from the New York City area and
provides “reservationless” and operator-assisted audio and web conferencing
services and our EDNet division, which operates primarily from San Francisco,
California and provides connectivity within the entertainment and advertising
industries through its managed network, which encompasses production and
post-production companies, advertisers, producers, directors, and
talent.





This
group represented approximately 52.9% and 54.3% of our revenues for the years
ended September 30, 2010 and 2009, respectively. These revenues are comprised
primarily of network access and usage fees as well as the sale and rental of
communication equipment.





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 and may be terminable earlier based on certain contractual
provisions.





We have
expanded our marketing efforts during the past year to include: targeted e-mail
campaigns, trade show participation, advanced search engine
optimization, pay-per-click, a public relations byline program and selected
trade magazine advertising. We intend to continue these actions during the
coming year.





No single
customer has represented more than 10% of our consolidated revenues during the
years ended September 30, 2010 or 2009.





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 ON24, IVT, WILink, Talkpoint, Wall
Street Transcripts, Netbriefings, PTEK Holdings, Shareholder.com, Thomson
Financial Group, ViaVid and others that offer live webcasts of quarterly
earnings conference calls. This list includes entities that are currently active
resellers of our services and not in significant competition with us, but could
compete with us under certain circumstances. 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.


4





While there is competition for the
provision of digital media services by our Digital Media Services Group, this is
a relatively new product and environment with few established professional
services providers. We believe that our approach of partnering with
complimentary technology providers such as SAIC, Autonomy/Virage Application
Services, Adobe Systems and Microsoft reduces the number of full-scale
competitors in our markets. We also believe that our strategic offering of
integrated webcasting, multi-screen encoding, intelligent syndication with broad
spectrum video indexing services, all as part of a unified and scalable digital
media platform (the DMSP) provides significant differentiation from our
competitors. However, companies that compete in some portion of the digital
media services market targeted by us include Ascent Media, Neulion, BrightCove,
Maven Networks (Yahoo), VitalStream (Internap), and thePlatform (Comcast). There
are video publishing platforms that compete with our DMSP, including those
offered by Move Networks, ExtendMedia, the Feedroom, Ooyala and
others.





Competition for audio and web
conferencing is primarily segregated between the low-cost, low-service offerings
such as FreeConference.Com and other more high-end providers such as Premiere
Global Services. Our Infinite division services a niche market for audio and web
conferencing services primarily for SMB (small to medium size) companies looking
for superior customer service at an affordable rate. This division's niche also
includes a growing demand for lead generation “webinars” (seminars presented via
the Internet), which it addresses by offering a dedicated account manager to
coordinate a customized solution for each event.




Competition for the audio and video
networking services provided by our EDNet division is based upon the ability to
provide equipment, connectivity and technical support for disparate
audio and video communications systems and to provide interoperable
compatibility for proprietary and 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 is small and will remain so. Our primary
video networking competitors are video and audio appliance dealers that source
encoding, decoding and transport hardware.  This division's advantage is
the provision of a total solution including system design, isochronous (a data
flow type used for streaming audio and video) connection and broadband
connection sourcing, and custom software connectivity applications that include
a comprehensive digital path for radio and 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, SohoNet,
Pathfire, Source Elements and Ascent Media.





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 was 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.


5


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 (including umbrella
coverage), professional liability and employment practices liability insurance.
These insurances 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. Although
we believe that the responsibility for compliance with those regulations
primarily falls on the local and long distance telephone service providers and
not us, the Federal Communications Commission (FCC) recently issued an order
that requires conference calling companies to remit Universal Service Fund (USF)
contribution payments on customer usage associated with conference calls. This
obligation requires Infinite to register as a reporting company with the FCC, as
well as to file both quarterly and annual reports regarding the revenues derived
from conference calling.





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.





As part
of our March 2007 acquisition of Auction Video, a pending United States patent
was assigned to us covering certain aspects of uploading live webcam images. A
parallel filing was done to protect these patent rights on an international
basis, via the filing of a “Patent Cooperation Treaty Request”. We are currently
pursuing the final approval of this patent application and in March 2008
retained the law firm of Hunton & Williams to assist in expediting the
patent approval process and to help protect rights related to our UGV (User
Generated Video) technology. In April 2008, we revised the original patent
application primarily for the purpose of splitting it into two separate
applications, which, while related, are being evaluated separately by the U.S.
Patent Office (“USPO”). With respect to the claims pending in the first of the
two applications, the USPO issued non-final rejections in August 2008, February
2009 and May 2009, as well as final rejections in January 2010 and June 2010.
Our responses to certain of these rejections included modifications to certain
claims made in the original patent application. In response to the latest
rejection we filed a Notice of Appeal with the USPO on November 22, 2010 and the
expected next step is our filing of an appeal brief with the USPO, which is due
on January 22, 2011, although extensions for this filing are available until
June 22, 2011 with the payment of additional fees. After our appeal brief
is filed, the USPO would be expected to file a response and following that, a
decision would be made by a three member panel, either based on the filings or a
hearing if requested by us. Regardless of the ultimate outcome of this matter,
our management has determined that a final rejection of these claims would not
have a material adverse effect on our financial position or results of
operations. The USPO has taken no formal action with regard to the second of the
two applications. Certain of the former owners of Auction Video, Inc. have an
interest in proceeds that we may receive under certain circumstances in
connection with these patents.





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.


6





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 24, 2010 we had
approximately 100 full time employees, of whom 56 were design, production
and technical personnel, 19 were sales and marketing personnel and 25 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.





ITEM
2.                                PROPERTIES





We lease:





·
            an
      approximately 16,500 square foot facility at 1291 SW 29th
      Street in Pompano Beach, Florida, which serves as our corporate
      headquarters and houses the majority of our webcasting production,
      marketing and distribution activities.  The monthly base rental
      is approximately $23,400 (including our share of property taxes and common
      area expenses). Our lease expired on September 15, 2010 and we are
      currently in negotiations to extend this lease for an additional three
      years, and have tentatively agreed to a starting monthly base rental of
      approximately $21,100 (including our share of property taxes and common
      area expenses), which would also be retroactive to September 15, 2009,
      plus two percent (2%) annual increases. The proposed extension would
      provide one two-year renewal option, with a three percent (3%) rent
      increase in year one.





·
            an
      approximately 4,700 square foot facility at 901 Battery Street, Suite 200
      in San Francisco, which serves as administrative headquarters for the
      Smart Encoding division of the Digital Media Services Group, as well as
      the EDNet division of the Audio and Web Conferencing Services Group, and
      houses the centralized network hub for electronically bridging affiliate
      studios. In addition, the facility operates as a backup to Florida for
      webcasting operations. Our lease expires on July 31, 2015 and provides for
      one five-year renewal option at 95% of fair market value and also provides
      for early cancellation at any time after August 1, 2011 at our option,
      with six months notice and a payment of no more than approximately
      $25,000.   The monthly base rental is approximately $8,900
      (including month-to-month parking) with annual increases up to
      5.1%.


7


·
            an
      approximately 6,800 square foot facility at 100 Morris Avenue in
      Springfield, New Jersey, which houses the Infinite Conferencing audio and
      web conferencing operations. Our lease expires on October 31, 2012 and
      provides one two-year renewal option, with no rent increase. The monthly
      base rental is approximately $10,800 with annual five percent (5%)
      increases.





·
            business
      offices located at 221 West Twenty-Sixth Street, New York City, New
      York.  These offices total approximately 1,000 square feet and
      serve primarily for webcasting sales activities and backup to
      Florida-based webcasting operations. Our lease expires January 31, 2013,
      although both we and the landlord have the right to terminate the lease
      without penalty, upon nine (9) months notice given any time after February
      1, 2011. The monthly base rental is approximately $12,000, with no
      increases.





·
            small
      limited purpose office space in Colorado Springs, Colorado, as well as
      equipment space at co-location or other equipment housing facilities in
      South Florida; Atlanta, Georgia; Jersey City, New Jersey; San Francisco,
      California and Colorado Springs,
Colorado.





ITEM
3.                                LEGAL
PROCEEDINGS





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





On
December 1, 2009, Narrowstep filed a complaint against us in the Court of
Chancery of the State of Delaware, alleging breach of contract, fraud and three
additional counts and seeking (i) $14 million in damages, (ii) reimbursement of
an unspecified amount for all of its costs associated with the negotiation and
drafting of the Merger Agreement, including but not limited to attorney and
consulting fees, (iii) the return of Narrowstep’s equipment alleged to be in our
possession, (iv) reimbursement of an unspecified amount for all of its attorneys
fees, costs and interest associated with this action and (v) any further relief
determined as fair by the court. After reviewing the complaint document, we
determined that Narrowstep had no basis in fact or in law for any claim and
accordingly, this matter was not reflected as a liability on our financial
statements. On December 30, 2010 Narrowstep counsel advised the Court in writing
that Narrowstep had reached an agreement in principle with us to dismiss their
lawsuit with prejudice, provided that both parties executed a mutual release.
Under this mutual release, which has been agreed to in principle by both parties
but is still being finalized, no further actions will be filed against each
other or affiliated parties in connection with this matter. This resolution of
this matter will not have a material adverse impact on our future financial
position or results of operations.





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




ITEM
4.                                REMOVED
AND RESERVED


8


PART
II





ITEM
      5.
            MARKET
      FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES





Our common stock is listed for trading
on The NASDAQ Capital Market, under the symbol "ONSM." The following table sets
forth the high and low closing sale prices for our common stock as reported on
The NASDAQ Capital Market for the period from October 1, 2008 through December
23, 2010. These prices do not include retail mark-ups, markdowns or commissions,
and may not necessarily represent actual transactions. A 1-for-6 reverse stock
split of the outstanding shares of our common stock was effective on April 5,
2010. All prices in the following table have been retroactively adjusted for the
effect of this reverse stock split.





High
                  
                  
                  LowFISCAL
      YEAR 2009First
      Quarter
                  
                  $
                  2.82
                  
                  
                  $
                  1.32Second
      Quarter
                  
                  $
                  1.92
                  
                  
                  $
                  0.84Third
      Quarter
                  
                  $
                  1.98
                  
                  
                  $
                  1.38Fourth
      Quarter
                  
                  $
                  3.54
                  
                  
                  $
                  1.62FISCAL
      YEAR 2010First
      Quarter
                  
                  $
                  2.64
                  
                  
                  $
                  1.62Second
      Quarter
                  
                  $
                  2.88
                  
                  
                  $
                  1.62Third
      Quarter
                  
                  $
                  2.20
                  
                  
                  $
                  1.03Fourth
      Quarter
                  
                  $
                  1.47
                  
                  
                  $
                  0.79FISCAL
      YEAR 2011First
      Quarter (to Dec 23)
                  
                  $
                  1.19
                  
                  
                  $
                  0.75





On
December 23, 2010, the last reported sale price of the common stock on The
NASDAQ Capital Market was $0.76 per share.   As of December 23,
2010 there were approximately 546 shareholders of record of the common
stock.





NASDAQ
Listing Issues





We have received letters from NASDAQ
with respect to our non-compliance with two requirements necessary to maintain
our current NASDAQ listing, as follows:


Share price requirement–On December 7,
2010, we received a letter from NASDAQ stating that we have 180 calendar days,
or until June 6, 2011, to regain compliance with Listing Rule 5550 (a) (2) (a)
(the “Bid Price Rule”), for which compliance 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 the Bid Price Rule was as a result
of the closing bid price for our common stock being below $1.00 per share for
the preceding thirty consecutive business days. We may be considered compliant
with the Bid Price Rule, subject to the NASDAQ staff’s discretion, if our common
stock closes at $1.00 per share or more for a minimum of ten consecutive
business days before the June 6, 2011 deadline. If we are not considered
compliant by June 6, 2011, but meet the continued listing requirement for market
value of publicly held shares and all other initial listing standards for The
NASDAQ Capital Market, and we provide written notice of our intention to cure
the deficiency during the second compliance period, including a reverse stock
split if necessary, we will be granted an additional 180 calendar day compliance
period. During the compliance period(s), our stock will continue to be listed
and eligible for trading on The NASDAQ Capital Market.


9





Minimum audit committee size
requirement –On June 24, 2010, we received a letter from NASDAQ stating
that we are currently not compliant with NASDAQ’s minimum audit committee size
requirement of three independent members, as set forth in Listing Rule 5605 (c)
(2) (a) (the “Audit Committee Rule”), for which compliance is necessary in order
to be eligible for continued listing on The NASDAQ Capital Market. Unless we
regain compliance with the Audit Committee Rule as of the earlier of our next
annual shareholders’ meeting or June 5, 2011, our common stock will be subject
to immediate delisting.





On June 14, 2010, we were notified that
Mr. Robert J. Wussler, who was then a director and a member of our audit
committee, had passed away on June 5, 2010. He has not at the present time been
replaced on the audit committee, which currently has two independent members. We
are in the process of evaluating independent candidates to fill the vacancy left
as a result of Mr. Wussler’s passing, both on the Board as well as the audit
committee. We will make that selection as soon as possible.


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. Dividends related to the Series A-13 Convertible
Preferred and the Series A-14 Convertible Preferred are cumulative and must
be fully paid by us prior to the payment of any dividend on our common
stock.
 
 Recent
Sales of Unregistered Securities
 
 During
the period from August 10, 2010 through September 30, 2010, we recorded the
issuance of 61,253 unregistered shares of common stock for financial consulting
and advisory and legal services. The services are being provided over a period
of three to eight months, and will result in a professional fees expense of
approximately $60,000 over the service period. None of these shares were issued
to our directors or officers.
 
 During
the period from October 1, 2010 through December 24, 2010, we recorded the
issuance of 72,113 unregistered shares of common stock for financial consulting
and advisory services. The services are being provided over a period of six to
twelve months and will result in a professional fees expense of approximately
$55,000 over the service period. None of these shares were issued to our
directors or officers.
 
 During
February 2010 we issued the unsecured subordinated convertible Wilmington Notes
for gross proceeds of $500,000, which notes had a remaining principal balance of
$344,000 as of September 30, 2010. This $344,000 balance, as well as all accrued
but unpaid interest, was satisfied by us on October 1, 2010 with cash payments
aggregating $238,756 plus the issuance of 137,901 unregistered common
shares.
 
 On
December 2, 2010, we issued 76,769 unregistered shares of common stock for
interest on $1,000,000 face value convertible debentures for the period from May
2010 through October 2010. The shares were in satisfaction of interest expense
of approximately $73,698 recognized over that period. None of these shares were
issued to our directors or officers, although 3,838 of these shares were issued
to CCJ Trust, which is a trust for the adult children of one of our directors,
who in turn disclaims beneficial ownership in CCJ Trust.




All of
the above securities were offered and sold without such offers and sales being
registered under the Securities Act of 1933, as amended (together with the rules
and regulations of the Securities and Exchange Commission (the "SEC")
promulgated thereunder, the "Securities Act"), in reliance on exemptions
therefrom as provided by Section 4(2) of the Securities Act of 1933, for
securities issued in private transactions. The recipients were accredited
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.


10




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, our 2007 Equity Incentive Plan, individual
compensation arrangements and any other compensation plans as of September 30,
2010.





PlanCategory
                                                        
                                                        Number of securities
                                                          to be issued upon
                                                          exercise of
                                                          outstanding options,
                                                          warrants and rights
                                                        
                                                        
                                                        Weighted average
                                                          exercise price of
                                                          outstanding
                                                          options, warrants
                                                          and rights
                                                        
                                                        
                                                        Number of securities
                                                          remaining available for
                                                          future issuance under
                                                          equity compensation
                                                          plans (excluding
                                                          securities reflected in
                                                          column (a))(a)
                                                        
                                                        
                                                        (b)
                                                        
                                                        
                                                        (c)1996
      Stock Option Plan (1)
                                                        
                                                        229,500
                                                        
                                                        
                                                        $
      6.47
                                                        
                                                        
                                                        None2007
      Equity Incentive Plan (2)
                                                        
                                                        941,343
                                                        
                                                        
                                                        $
      9.15
                                                        
                                                        
                                                        1,029,491Equity
      compensation plansapproved
      by shareholders (3)
                                                        
                                                        41,962
                                                        
                                                        
                                                        $
      20.26
                                                        
                                                        
                                                        NoneEquity
      compensation plans notapproved
      by shareholders (4)
                                                        
                                                        310,322
                                                        
                                                        
                                                        $
      8.14
                                                        
                                                        
                                                        445,000





1)
              On
      February 9, 1997, our Board of Directors and a majority of our
      shareholders adopted the 1996 Stock Option Plan (the "1996 Plan"), which,
      including the effect of subsequent amendments to the 1996 Plan, authorized
      up to 750,000 shares available for issuance as options and up to another
      333,333 shares available for stock grants. Since the provisions of the
      1996 Plan call for its termination 10 years from the date of its adoption,
      as of February 9, 2007 the 1996 Plan terminated and we may no longer issue
      additional options or stock grants under the 1996 Plan. However, the
      termination of the 1996 Plan did not affect the validity of any Plan
      Options previously granted
thereunder.





2)
              On
      September 18, 2007, our Board of Directors and a majority of our
      shareholders adopted the 2007 Equity Incentive Plan (the “2007 Plan”),
      which authorized the issuance of up to 1,000,000 shares of ONSM common
      stock pursuant to stock options, stock purchase rights, stock appreciation
      rights and/or stock awards for employees, directors and consultants. On
      March 25, 2010, our Board of Directors and a majority of our shareholders
      approved a 1,000,000 increase in the number of shares authorized for
      issuance under the 2007 Equity Incentive Plan (the “2007 Plan”), for total
      authorization of 2,000,000
shares.





3)
              On
      December 15, 2004, a majority of our shareholders voted to issue 270,047
      Non-Plan options to certain executives, directors and other management in
      connection with the Onstream Merger, of which (i) 84,375 were cancelled on
      August 11, 2009 in exchange for the issuance of an equivalent number of
      2007 Plan Options, (ii) 124,884 were cancelled on December 17, 2009 in
      exchange for the issuance of an equivalent number of 2007 Plan Options and
      (iii) 18,826 had expired as of September 30,
  2010.





4)
              During
      the fiscal years ended September 30, 2005 through 2010, we issued Non-Plan
      options to consultants in exchange for financial consulting and advisory
      services, 310,322 of which were still outstanding and fully vested as of
      September 30, 2010. These outstanding options are summarized
      below:


11





Issuance period
                  
                  Number
                      of shares
                  
                  Exercise
      price
                      per share
                  
                  Expiration
                      DateYear
      ended September 30, 2010
                  
                  
                  125,000
                  
                  $3.00
      - $6.00
                  
                  Aug
      2013 - July 2014Year
      ended September 30, 2009
                  
                  
                  25,000
                  
                  $3.00
                  
                  Aug
      2013 - Sept 2014Year
      ended September 30, 2008
                  
                  
                  41,667
                  
                  $10.38
      - $10.98
                  
                  Oct
      2011Year
      ended September 30, 2007
                  
                  
                  104,364
                  
                  $6.00
      - $14.88
                  
                  Oct
      2010 – Mar 2012Year
      ended September 30, 2006
                  
                  
                  14,291
                  
                  $6.30
                  
                  Mar
      2011Total
      common
      shares underlyingNon-Plan consultant optionsas
      of September 30, 2010
                  
                  
                  310,322


We have
entered into various agreements for financial consulting and advisory services
which, if not terminated as allowed by the terms of such agreements, will
require the issuance after September 30, 2010 of approximately 145,000
unregistered shares and 300,000 options to purchase common shares at an exercise
price of $1.50 per share. The options would include piggyback registration
rights as well as cashless exercise rights starting one year after issuance
until the options are registered.





ITEM
7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS
OF OPERATIONS





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 a
leading online service provider of live and on-demand Internet video, corporate
web communications and content management applications.  We had
approximately 100 full time employees as of December 24, 2010, with operations
organized in two main operating groups:





·
            Digital
      Media Services Group


·
            Web
      and Audio Conferencing Services
Group





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





Our
Webcasting division, which operates primarily from Pompano Beach, Florida and
has its main sales facility in New York City, provides an array of
corporate-oriented, web-based media services to the corporate market including
live audio and video webcasting and on-demand audio and video streaming for any
business, government or educational entity,  Our DMSP division, which
operates primarily from Colorado Springs, Colorado provides an online,
subscription based service that includes access to enabling technologies and
features for our clients to acquire, store, index, secure, manage, distribute
and transform these digital assets into saleable commodities. Our UGC division,
which also operates as Auction Video and operates primarily from Colorado
Springs, Colorado, provides a video ingestion and flash encoder that can be used
by our clients on a stand-alone basis or in conjunction with the DMSP. Our Smart
Encoding division, which operates primarily from San Francisco, California
provides both automated and manual encoding and editorial services for
processing digital media, using a set of coordinated technologies and processes
that allow the quick and efficient online search, retrieval and streaming of
this media, which can include photos, videos, audio, engineering specs,
architectural plans, web pages, and many other pieces of business
collateral.


12





Our Web
and Audio Conferencing Services Group includes our Infinite Conferencing
(“Infinite”) division, which operates primarily from the New York City area and
provides “reservationless” and operator-assisted audio and web conferencing
services and our EDNet division, which operates primarily from San Francisco,
California and provides connectivity within the entertainment and advertising
industries through its managed network, which encompasses production and
post-production companies, advertisers, producers, directors, and
talent.





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





Recent
Developments





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





On
September 17, 2010, we entered into a Purchase Agreement (the “Purchase
Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to
an initial purchase of 300,000 shares of our common stock and 420,000 shares of
our Series A-14 Preferred Stock (“Series A-14”), together with warrants to
purchase 540,000 of our common shares.  In accordance with the
Purchase Agreement, LPC also received 50,000 shares of our common stock as a
one-time commitment fee and a cash payment of $26,250 as a one-time structuring
fee. On September 24, 2010, we received net proceeds of $873,750 from LPC in
exchange for our issuance of the above shares and warrants. In accordance with
the Purchase Agreement, LPC also committed to purchase, at our sole discretion,
up to an additional 830,000 shares of our common stock in installments over the
term of the Purchase Agreement, generally at prevailing market prices, but
subject to the specific restrictions and conditions in the Purchase Agreement.
During the period from October 13, 2010 through January 5, 2011 LPC purchased an
additional 405,000 shares of our common stock under that Purchase Agreement for
net proceeds of approximately $336,000.
 
 From
January through May 2010 we borrowed an aggregate of $1.0 million from four
individual investors under the terms of unsecured subordinated convertible
notes. Although the remaining principal balance of these notes was $714,000 as
of September 30, 2010, $503,000 of this balance was satisfied by us on October
1, 2010 by the payment of cash and the issuance of common shares.  The
remaining outstanding principal balance of $211,000 as of September 30, 2010
will require future principal payments of $13,000 per month through April 2011
plus a balloon payment of $120,000 in May 2011, although it may be accelerated
by the holder under certain conditions.


On March
18, 2009, we terminated the Merger Agreement for the acquisition of Narrowstep,
which Merger Agreement we had first entered into on May 29, 2008. The Merger
Agreement could be terminated by either Onstream or Narrowstep at any time after
November 30, 2008 provided that the terminating party was not responsible for
the delay. On December 1, 2009, Narrowstep filed a complaint against us in the
Court of Chancery of the State of Delaware, alleging breach of contract, fraud
and three additional counts and seeking (i) $14 million in damages, (ii)
reimbursement of an unspecified amount for all of its costs associated with the
negotiation and drafting of the Merger Agreement, including but not limited to
attorney and consulting fees, (iii) the return of Narrowstep’s equipment alleged
to be in our possession, (iv) reimbursement of an unspecified amount for all of
its attorneys fees, costs and interest associated with this action and (v) any
further relief determined as fair by the court. After reviewing the complaint
document, we determined that Narrowstep had no basis in fact or in law for any
claim and accordingly, this matter was not been reflected as a liability on our
financial statements. On December 30, 2010 Narrowstep counsel advised the Court
in writing that Narrowstep had reached an agreement in principle with us to
dismiss their lawsuit with prejudice, provided that both parties executed a
mutual release. Under this mutual release, which has been agreed to in principle
by both parties but is still being finalized, no further actions will be filed
against each other or affiliated parties in connection with this matter. This
resolution of this matter will not have a material adverse impact on our future
financial position or results of operations.


13





Our
securities are listed on The NASDAQ Capital Market. We are currently not
compliant with NASDAQ’s minimum audit committee size requirement of three
independent members, as set forth in Listing Rule 5605 (c) (2) (a) (the “Rule”),
for which compliance is necessary in order to be eligible for continued listing
on The NASDAQ Capital Market. On June 24, 2010, we received a letter from NASDAQ
stating that unless we regain compliance with the Rule as of the earlier of our
next annual shareholders’ meeting or June 5, 2011, our common stock will be
subject to immediate delisting. Until that time, our shares will continue to be
listed on The NASDAQ Capital Market.





On June
14, 2010, we were notified that Mr. Robert J. Wussler, who was then a director
and a member of our audit committee, had passed away on June 5, 2010. He has not
at the present time been replaced on the audit committee, which currently has
two independent members. We are in the process of evaluating independent
candidates to fill the vacancy left as a result of Mr. Wussler’s passing, both
on the Board as well as the audit committee. We will make that selection as soon
as possible.




In
addition to the above, on December 7, 2010, we received a letter from NASDAQ
stating that we have 180 calendar days, or until June 6, 2011, to regain
compliance with Listing Rule 5550 (a) (2) (a) (the “Bid Price Rule”), for which
compliance 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 the Bid Price Rule was as a result of the closing bid price for our common
stock being below $1.00 per share for the preceding thirty consecutive business
days. We may be considered compliant with the Bid Price Rule, subject to the
NASDAQ staff’s discretion, if our common stock closes at $1.00 per share or more
for a minimum of ten consecutive business days before the June 6, 2011 deadline.
If we are not considered compliant by June 6, 2011, but meet the continued
listing requirement for market value of publicly held shares and all other
initial listing standards for The NASDAQ Capital Market, and we provide written
notice of our intention to cure the deficiency during the second compliance
period, including a reverse stock split if necessary, we will be granted an
additional 180 calendar day compliance period. During the compliance period(s),
our stock will continue to be listed and eligible for trading on The NASDAQ
Capital Market. Our closing share price was $0.76 per share on December 23,
2010.





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 price is reasonably
assured.


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


14


Our Audio
and Web Conferencing Services Group recognizes revenue from audio and web
conferencing as well as customer usage of digital telephone
connections.
 
 The
Infinite division generally charges for audio conferencing and web conferencing
services on a per-minute usage rate, although webconferencing services are also
available for a monthly subscription fee allowing a certain level of usage.
Audio conferencing and web conferencing revenue is recognized based on the
timing of the customer’s use of those services. The EDNet division primarily
generates revenue from customer usage of digital telephone connections
controlled by them. EDNet purchases digital phone lines from telephone companies
and sells access to the lines, as well as separate per-minute usage charges.
Network usage and bridging revenue is recognized based on the timing of the
customer’s usage of those services.


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





Results
of Operations





Our
consolidated net loss for the year ended September 30, 2010 was approximately
$9.3 million ($1.20 loss per share) as compared to a loss of approximately $11.8
million ($1.63 loss per share) for the prior fiscal year, a decrease in our loss
of approximately $2.6 million (22%). The decreased net loss was primarily due to
compensation expense and depreciation and amortization expense for the year
ended September 30, 2010 that were approximately $1.5 million lower and $1.3
million lower, respectively, than such expenses for the prior fiscal year. In
addition, the $4.7 million charge for impairment of goodwill and other
intangible assets in the current fiscal year was $800,000 lower than the $5.5
million charge for such item in the prior fiscal year. These items were
partially offset by an increase in interest expense of approximately $725,000,
or 111%, for the year ended September 30, 2010 as compared to the prior fiscal
year.


15




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





Years Ended
    September 30,2010
                    
                    
                    2009Revenue:DMSP
      and hosting
                    
                    
                    12.2
                    %
                    
                    
                    10.1
                    %Webcasting
                    
                    
                    34.4
                    
                    
                    
                    33.5Audio
      and web conferencing
                    
                    
                    40.9
                    
                    
                    
                    41.9Network
      usage
                    
                    
                    11.2
                    
                    
                    
                    11.8Other
                    
                    
                    1.3
                    
                    
                    
                    2.7Total
      revenue
                    
                    
                    100.0
                    %
                    
                    
                    100.0
                    %Cost
      of revenue:DMSP
      and hosting
                    
                    
                    5.4
                    %
                    
                    
                    3.3
                    %Webcasting
                    
                    
                    9.2
                    
                    
                    
                    9.9Audio
      and web conferencing
                    
                    
                    11.9
                    
                    
                    
                    11.4Network
      usage
                    
                    
                    4.8
                    
                    
                    
                    5.1Other
                    
                    
                    2.1
                    
                    
                    
                    2.8Total
      costs of revenue
                    
                    
                    33.4
                    %
                    
                    
                    32.5
                    %Gross
      margin
                    
                    
                    66.6
                    %
                    
                    
                    67.5
                    %Operating
      expenses:Compensation
                    
                    
                    49.6
                    %
                    
                    
                    57.9
                    %Professional
      fees
                    
                    
                    12.1
                    
                    
                    
                    7.5Other
      general and administrative
                    
                    
                    13.5
                    
                    
                    
                    14.4Write
      off deferred acquisition costs
                    
                    
                    -
                    
                    
                    
                    3.0Impairment
      loss on goodwill and other  intangible assets
                    
                    
                    28.2
                    
                    
                    
                    32.5Depreciation
      and amortization
                    
                    
                    11.5
                    
                    
                    
                    18.9Total
      operating expenses
                    
                    
                    114.9
                    %
                    
                    
                    134.2
                    %Loss
      from operations
                    
                    
                    (48.3
                    )%
                    
                    
                    (66.7
                    )%Other
      expense, net:Interest
      expense
                    
                    
                    (8.2
                    )%
                    
                    
                    (3.9
                    )%Other
      income, net
                    
                    
                    0.9
                    
                    
                    
                    0.6Total
      other expense, net
                    
                    
                    (7.3
                    )%
                    
                    
                    (3.3
                    )%Net
      loss
                    
                    
                    (55.6
                    )%
                    
                    
                    (70.0
                    )%


16




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 years ended
                    September 30,
                  
                  
                  Increase (Decrease)2010
                  
                  
                  2009
                  
                  
                  Amount
                  
                  
                  PercentTotal
      revenue
                  
                  $
                  16,694,106
                  
                  
                  $
                  16,926,953
                  
                  
                  $
                  (232,847
                  )
                  
                  
                  (1.4
                  )%Total
      costs of revenue
                  
                  
                  5,571,640
                  
                  
                  
                  5,493,533
                  
                  
                  
                  78,107
                  
                  
                  
                  1.4
                  %Gross
      margin
                  
                  
                  11,122,466
                  
                  
                  
                  11,433,420
                  
                  
                  
                  (310,954
                  )
                  
                  
                  (2.7
                  )%General
      and administrative expenses
                  
                  
                  12,554,774
                  
                  
                  
                  13,507,867
                  
                  
                  
                  (953,093
                  )
                  
                  
                  (7.1
                  )%Write
      off deferred acquisition costs
                  
                  
                  -
                  
                  
                  
                  504,738
                  
                  
                  
                  (504,738
                  )
                  
                  
                  (100.0
                  )%Impairment
      loss on goodwill and other intangible assets
                  
                  
                  4,700,000
                  
                  
                  
                  5,500,000
                  
                  
                  
                  (800,000
                  )
                  
                  
                  (14.5
                  )%Depreciation
      and amortization
                  
                  
                  1,923,460
                  
                  
                  
                  3,195,291
                  
                  
                  
                  (1,271,831
                  )
                  
                  
                  (39.8
                  )%Total
      operating expenses
                  
                  
                  19,178,234
                  
                  
                  
                  22,707,896
                  
                  
                  
                  (3,529,662
                  )
                  
                  
                  (15.5
                  )%Loss
      from operations
                  
                  
                  (8,055,768
                  )
                  
                  
                  (11,274,476
                  )
                  
                  
                  (3,218,708
                  )
                  
                  
                  (28.5
                  )%Other
      expense, net
                  
                  
                  (1,224,804
                  )
                  
                  
                  (556,309
                  )
                  
                  
                  668,495
                  
                  
                  
                  120.2
                  %Net
      loss
                  
                  $
                  (9,280,572
                  )
                  
                  $
                  (11,830,785
                  )
                  
                  $
                  (2,550,213
                  )
                  
                  
                  (21.6
                  )%





Revenues
and Gross Margin





Consolidated
operating revenue was approximately $16.7 million for the year ended September
30, 2010, a decrease of approximately $233,000 (1.4%) from the prior fiscal
year, due to decreased revenues of the Audio and Web Conferencing Services
Group.


Audio and
Web Conferencing Services Group revenues were approximately $8.8 million for the
year ended September 30, 2010, a decrease of approximately $354,000 (3.8%) from
the prior fiscal year. This decrease was primarily a result of decreased
Infinite division revenues arising from the loss of a major customer during the
fourth quarter of fiscal 2009, as well as decreased network usage service fees
from the EDNet division, which decrease we believe resulted from a reduction in
television and movie production activity in the current fiscal year in response
to a general economic slow-down.





The
number of minutes billed by the Infinite division was approximately 91.0 million
for the year ended September 30, 2010, as compared to approximately 98.1 million
minutes billed for the prior fiscal year. However, the average revenue per
minute was approximately 7.6 cents for the year ended September 30, 2010, as
compared to approximately 7.3 cents for the prior fiscal year. The average
revenue per minute statistic includes auxiliary services and fees that are not
billed to the customer on a per minute basis.





For some
time the Infinite division sales force has been focusing on entering into
agreements with organizations with resources to provide Infinite’s audio and web
conferencing services to certain targeted groups. This included agreements with
Proforma, a leading provider of graphic communications solutions, a reseller
agreement with Copper Conferencing, a leading, carrier-class conferencing
services provider for small and medium-sized businesses, a master agency
agreement with Presidio Networked Solutions, a systems integrator and a
collaboration with PeerPort to launch WebMeet Community, an integrated suite of
virtual collaboration services. In March 2010we announced the
expansion of Infinite’s alliance with BT Conferencing by providing a jointly
developed conferencing platform to Infinite’s reservationless client base.
Although these relationships and initiatives are important as a basis for
building future sales, in some cases there will be a lead time of a year or
longer before they are reflected in actual recorded sales. Furthermore, we
relatively recently reorganized the Infinite management and sales staff, which
included the hiring of a new divisional president in June 2009.


17





The
revenues of the Audio and Web Conferencing Services Group for the three months
ended September 30, 2010 were approximately $198,000 greater than those revenues
for the corresponding fiscal 2009 quarter, with this increase almost entirely
related to the Infinite division. We expect this trend to continue and
accordingly we expect the fiscal 2011 revenues of the Audio and Web Conferencing
Services Group (for the year as a whole) to exceed the fiscal 2010 amounts,
although this increase cannot be assured.





Digital
Media Services Group revenues were approximately $7.9 million for the year ended
September 30, 2010, an increase of approximately $121,000 (1.6%) from the prior
fiscal year. This increase was primarily due to an approximately $332,000
(19.4%) net increase in DMSP and hosting revenues over the prior fiscal year.
This increase in DMSP and hosting revenues included (i) an approximately
$254,000 increase in hosting and bandwidth charges to certain larger DMSP
customers serviced by our Smart Encoding division and (ii) an approximately
$78,000 increase in the DMSP division’s revenues from its “Store and Stream” and
“Streaming Publisher” products. This $332,000 increase was partially offset by
an approximately $238,000 (82.3%) decrease in Smart Encoding division revenues
for services other than hosting.





As of
September 30, 2010, we had 354 monthly recurring subscribers to the “Store and
Stream” and/or “Streaming Publisher” applications of the DMSP, which
applications were developed as a focused interface for small to medium business
(SMB) clients, as compared to 329 subscribers as of September 30, 2009.
Including large DMSP hosting customers supported by our Smart Encoding Division,
these customer counts were 364 and 345, respectively.





We expect
this DMSP customer base to continue to grow, especially as a result of the
launch of MP365 discussed below. In addition to the “Store and Stream” and
“Streaming Publisher” applications of the DMSP, we are continuing to work with
several entities assisting us in the deployment via the DMSP of enabling
technologies necessary to create social networks with integrated professional
and user generated multimedia content.





One of
the key components of our March 2007 acquisition of Auction Video was the video
ingestion and flash transcoder, already integrated into the DMSP as an integral
component of the services offered to social network providers and other User
Generated Video (UGV) applications. Auction Video’s technology may be used in
various applications such as online Yellow Pages listings, delivering video to
mobile phones, multi-level marketing and online newspaper classified
advertisements, and can also provide for direct input from webcams and other
imaging equipment. In addition, our Auction Video service was approved by eBay
to provide video hosting services for eBay users and PowerSellers (high volume
users of eBay). The Auction Video acquisition was another strategic step in
providing a complete range of enabling, turnkey technologies for our clients to
facilitate “video on the web” applications, which we believe will make the DMSP
a more competitive option as an increasing number of companies look to enhance
their web presence with digital rich media and social
applications.


18


In
addition to the beneficial effect of the Auction Video technology on DMSP
revenues, we believe that our ownership of that technology will provide us with
other revenue opportunities, including software sales and licensing fees,
although the timing and amount of these revenues cannot be assured. In March
2008 we retained the law firm of Hunton & Williams to assist in expediting
the patent approval process and helping protect our rights related to our patent
pending UGV technology. In April 2008, we revised the original patent
application primarily for the purpose of splitting it into two separate
applications, which, while related, are being evaluated separately by the U.S.
Patent Office (“USPO”). With respect to the claims pending in the first of the
two applications, the USPO issued non-final rejections in August 2008, February
2009 and May 2009, as well as final rejections in January 2010 and June 2010.
Our responses to certain of these rejections included modifications to certain
claims made in the original patent application. In response to the latest
rejection we filed a Notice of Appeal with the USPO on November 22, 2010 and the
expected next step is our filing of an appeal brief with the USPO, which is due
on January 22, 2011, although extensions for this filing are available until
June 22, 2011 with the payment of additional fees. After our appeal brief
is filed, the USPO would be expected to file a response and following that, a
decision would be made by a three member panel, either based on the filings or a
hearing if requested by us. Regardless of the ultimate outcome of this matter,
our management has determined that an adverse decision with respect to this
patent application would not have a material adverse effect on our financial
position or results of operations. The USPO has taken no formal action with
regard to the second of the two applications. Certain of the former owners of
Auction Video, Inc. have an interest in proceeds that we may receive under
certain circumstances in connection with these patents. As a result of this
technology plus other planned enhancements to the DMSP, the expected favorable
impact of the recently launched MP365 and our increased sales and marketing
focus on opportunities with social networks and other high-volume users of
digital rich media, we expect the fiscal 2011 DMSP and hosting revenues (for the
year as a whole) to exceed the corresponding fiscal 2010 amounts, although such
increase cannot be assured.





Webcasting
revenues increased by approximately $71,000 (1.2%) for the year ended September
30, 2010 as compared to the prior fiscal year. We have historically experienced
a seasonal decline in webcasting revenues during the fourth quarter, as compared
to the preceding third quarter. However, the 18.1% decline in webcasting
revenues for the fourth quarter of fiscal 2010, as compared to such revenues for
the third quarter of fiscal 2010, was less than the 24.6% decline in webcasting
revenues that we experienced during the fourth quarter of fiscal 2009, as
compared to such revenues for the third quarter of fiscal 2009.





The
number of webcasts produced, approximately 7,400 for the year ended September
30, 2010, was approximately equal to the number of webcasts for the prior fiscal
year and the average revenue per webcast event of approximately $786 for the
year ended September 30, 2010 was approximately equal to the prior fiscal year.
The number of webcasts reported, as well as the resulting calculation of the
average revenue per webcast event, does not include any webcast events
attributed with $100 or less revenue, based on our determination that excluding
such low-priced or even no-charge events increases the usefulness of this
statistic.





In
addition, we believe that the following factors will favorably impact our
webcasting revenues for fiscal 2011:





·
              Expanding
      government related business - In November 2007 we announced that we had
      been awarded a stake in a three-year Master Services Agreement (MSA) by
      the State of California to provide video and audio streaming services to
      the state and participating local governments. In August 2008 we announced
      that we had been awarded three new multi-year public sector webcasting
      services contracts with the United States Nuclear Regulatory Commission
      (NRC), CaliforniaStateDepartment of
      Technology Services (DTS), and California State Board of Equalization
      (BOE). In April 2009 we announced that, in addition to the extension of
      the NRC contract for the first full year after a successful initial test
      period, we were engaged to perform webcasting services for use by the U.S.
      Department of Interior, Minerals Management Service, via a strategic
      partner relationship.





In
November 2009, we announced that we were engaged to perform webcasting services
for the Department of the Treasury’s Internal Revenue Service (IRS) and to
provide webinar services for use by the U.S. Department of Housing and Urban
Development’s Federal Housing Administration (FHA) Philadelphia Homeownership
Center (HOC), via a strategic partner relationship. We also announced the
extension of the NRC contract, discussed above, for the second full
year.


19


We
recognized aggregate revenues for the above government-related contracts of
approximately $509,000 and $322,000 for the years ended September 30, 2010 and
2009, respectively, which represents a 58.1% increase. Our financial statements
for these periods include webcasting revenues from government related business
not included in these numbers, as these numbers only relate to the specific
government related contracts that we have publicly announced, as listed
above.





·
            New
      products and technology - iEncodeTM is a full-featured, turnkey, standalone
      webcasting solution, designed to operate inside a corporate LAN
      environment with multicast capabilities. Although we recorded some iEncode
      revenue during fiscal 2009 prior to the introduction of version 2 (V2) of
      iEncodeTM in June 2009, V2 was not available for delivery to our customers
      until December 2009 and we have continued to make some technical
      improvements after that date. Although iEncodeTM sales have been limited to
      date, we expect them to start to increase to more meaningful levels during
      fiscal 2011.





We have
relatively recently completed several feature enhancements to our proprietary
webcasting platform including a premium Flash webcasting service announced by us
in November 2010 for the Google AndroidTM smartphone platform.  In
addition to delivering webcasts to Android based mobile users, the new
Flash-based webcasting solution enhances our traditional online webcasting
service to existing clients as well as opens up a new market for us with
enterprise customers.


·
              BT
      reseller agreement - In October 2009, we announced an expansion of our
      business relationship with BT Conferencing, a division of BT Group plc,
      one of the world's leading providers of communications solutions and
      services, via the signing of a new webcasting, iEncode, and digital media
      services reseller agreement. Prior to this agreement, and continuing to
      the current time, we recognized significant webcasting revenues from a BT
      business group that had succeeded to our business relationship with
      another reseller, by virtue of BT’s acquisition of that reseller. Under
      the reseller agreement announced in October 2009, another business group
      within BT Conferencing will also be offering our webcasting, iEncode and
      digital media services to its new and existing clients worldwide. The
      implementation of this new agreement is in process and is expected to
      first impact our revenues in a meaningful way during fiscal
      2011.





·
              Organizational
      changes - In October 2010, weannounced Ari
      Kestin’s appointment as the Executive Vice President and General Manager
      of our Webcasting division. In his new role with the Webcasting division,
      Mr. Kestin will be responsible for all client-facing activities, sales and
      marketing, operations, partnerships, product and application development
      within the division. Mr. Kestin will also continue as President of the
      Infinite division, a position he has held since June
  2009.





As a
result of the above factors, we expect fiscal 2011 webcasting revenues (for the
year as a whole) to exceed the corresponding fiscal 2010 amounts, although such
increase cannot be assured.


20


During
fiscal 2009, we began the development of the MarketPlace365TM (MP365) platform,
which enables the creation of on-line virtual marketplaces, trade shows and
social communities, with the goal of generating business leads for our
customers, the MP365 site promoters. There are currently four active MP365
promoter sites – SUBWAY (a private marketplace for internal use by SUBWAY
vendors, franchisees and staff and the first site launched in July 2010), Home
Service Expo (a general public accessible marketplace providing services for
homeowners in the Dade, Broward and Palm Beach counties of Florida launched in
November 2010), Green Light Expo (a general public accessible global products
and services expo targeting all things green for lifestyle and business
applications launched in November 2010) and ProActive Capital Forum (general
public accessible and believed to be the first 24/7/365 financial tradeshow
concentrating on companies in the life-sciences and  technology areas
launched in November 2010). Fred DeLuca, co-founder and co-owner of SUBWAY and
active in the management of that company, is one of our major shareholders and
also controls Rockridge Capital Holdings, LLC, an entity to which we owe
approximately $1.5 million as of September 30, 2010 and which debt is
convertible into shares of our common stock under certain conditions. The
promoter of Green Light Expo’s MP365 site is also affiliated with
SUBWAY.


In
addition to the four active marketplaces, we have signed MP365 promoter
contracts for another 18 marketplaces, several of which we expect will
launch and become active in the coming weeks and months. In addition, we have
entered into several MP365 agent agreements, including the
following:





·
            In
      December 2009, we announced an agreement with the Tarsus Group plc
      (“Tarsus”) for them to market MP365 to Tarsus' more than 19,000 trade
      shows and 2,000 suppliers that are part of their Trade Show News Network
      (“TSNN”), a leading online resource for the trade show, exhibition and
      event industry.





·
            In
      February 2010, we announced an agreement with the Trade Show Exhibitors
      Association (“TSEA”) for them to market MP365 to TSEA’s members, vendors
      and sponsors.





·
            In
      April 2010, we announced an agreement with AMC Institute, to provide
      MP365, as well as our full suite of digital media and communications
      services, to the organization’s 150 association management company members
      who represent over 1,500 associations throughout the U.S., Canada, Europe
      and Asia.





·
            In
      May 2010, we announced an MP365 agent agreement with Conventions.net,
      which has thousands of industry suppliers in over 150 categories and plans
      to showcase the MP365 platform through its website and other marketing
      vehicles.





We will
charge each promoter a monthly fee based on the number of exhibitors within
their MP365 marketplace, as well as a share of the revenue from advertising in
their MP365 marketplace, but we also expect to recognize additional revenue
beyond these exhibitor and advertising fees since MP365 will integrate with and
utilize almost all of our other technologies including DMSP, webcasting, UGC and
conferencing. Special pricing and payment terms have been granted to SUBWAY and
may be granted to other MP365 promoters, particularly during the initial stages
of introducing the MP365 platform. Once we are past the initial introductory
stage and as the process of launching MP365 sites continues, we expect that
revenues from MP365 will begin to be a meaningful part of our overall operating
results. However, the attainment of any revenue from a MP365 marketplace or
promoter contract will be subject to various factors, including the
implementation of the MP365 product by the promoter/purchaser, including the
sales of booths to exhibitors and related advertising, which amount and timing
cannot be assured.





Due to
the anticipated increases in webcasting and DMSP and hosting revenues, as well
as our anticipation of meaningful revenues in fiscal 2011 from the recently
launched MP365 platform, all as discussed above, we expect the fiscal 2011
revenues of the Digital Media Services Group (for the year as a whole) to exceed
the corresponding fiscal 2010 amounts, although such increase cannot be
assured.


21




Consolidated
gross margin was approximately $11.1 million for the year ended September 30,
2010, a decrease of approximately $311,000 (2.7%) from the prior fiscal year.
This decrease was due to approximately $369,000 less gross margin from the Audio
and Web Conferencing Services Group, corresponding to the $354000 decrease in
Audio and Web Conferencing Services Group revenues as discussed above, as well
as decreased gross margin percentage on those revenues from 69.2% to 67.8%.
Primary reasons for this decreased gross margin percentage were (i) certain
costs related to providing webconferencing services that are generally fixed to
us and do not vary with utilization (ii) increased costs from purchasing
additional “overflow” operating capacity from third parties and (iii) decreases
in our per minute charges to certain customers deemed necessary in order to
respond to competition. The consolidated gross margin percentage was 66.6% for
the year ended September 30, 2010, versus 67.5% for the prior fiscal
year.


Based on
our expectation that the fiscal 2011 revenues of both the Audio and Web
Conferencing Services Group and the Digital Media Services Group (for the year
as a whole) to exceed the corresponding fiscal 2010 amounts, as discussed above,
we expect consolidated gross margin (in dollars) for fiscal year 2011 (for the
year as a whole) to exceed the corresponding fiscal 2010 amounts, although such
increase cannot be assured. However, it is possible that gross margin as a
percentage of the related revenue for fiscal year 2011 may be lower than such
percentage for fiscal year 2010, since (i) we expect continued price pressure in
fiscal 2011, as compared to fiscal 2010, arising from competition in all of our
major product lines and (ii) it is possible that the Infinite division’s cost of
sales, on a per-minute basis, may increase in fiscal 2011, as compared to fiscal
2010, in order for us to attract larger customers by increasing the reliability
of the subcontractors supporting our service offerings.





Operating
Expenses





Consolidated
operating expenses were approximately $19.2 million for the year ended September
30, 2010, a decrease of approximately $3.5 million (15.5%) from the prior fiscal
year, primarily because compensation expense and depreciation and amortization
expense each decreased by approximately $1.5 million and $1.3 million,
respectively, for the year ended September 30, 2010, as compared to those
expenses for the prior fiscal year. In addition, the $4.7 million charge for
impairment of goodwill and other intangible assets in the current fiscal year
was $800,000 lower than the $5.5 million charge for such item in the prior
fiscal year and we recorded an approximately $540,000 charge for the write off
of deferred acquisition costs for the year ended September 30, 2009 versus no
such expense in the current fiscal year. This write-off related to the
terminated Narrowstep acquisition, which is discussed in more detail in Item 3
of Part I of this 10-K.


The
decrease in compensation expense for the year ended September 30, 2010 of
approximately $1.5 million was 15.6% of that expense for the prior fiscal year.
Effective October 1, 2009, a significant portion of our workforce, including all
of management, took a 10% payroll reduction, which we expect will be maintained
until increased revenue levels result in positive cash flow (sufficient to cover
capital expenditures and debt service). This action, as well as payroll cost
reduction actions we took primarily during February and March 2009, continued in
2010 resulting in compensation expense reductions of approximately $1.3 million
for fiscal 2010, as compared to fiscal 2009, and are therefore the primary
reason for the decreased compensation expense during fiscal 2010.





The
decrease in depreciation and amortization expense for the year ended September
30, 2010 of approximately $1.3 million was 39.8% of that expense for the prior
fiscal year. This decrease is primarily due to (i) reduced depreciation expense
related to the DMSP as a result of certain DMSP components reaching the end of
the useful lives assigned to them for book depreciation purposes and (ii)
reduced amortization expense related to certain intangible assets as a result of
the impairment losses we recorded during the year ended September 30, 2010 and
the year ended September 30, 2009, which were recorded as a reduction of the
historical depreciable cost basis of those assets as of those
dates.





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


22





There is
a two step process for impairment testing of goodwill. The first step of this
test, used to identify potential impairment, compares the fair value of a
reporting unit with its carrying amount, including goodwill. The second step, if
necessary, measures the amount of the impairment. We performed impairment tests
on Infinite, EDNet and Acquired Onstream as of December 31, 2008. We assessed
the fair value of the net assets of these reporting units by considering the
projected cash flows and by analysis of comparable companies, including such
factors as the relationship of the comparable companies’ revenues to their
respective market values.  Based on these factors, we concluded that
there was no impairment of the assets of EDNet as of that date. Although the
first step of the two step testing process of the assets of Acquired Onstream
and Infinite preliminarily indicated that the fair value of those intangible
assets exceeded their recorded carrying value as of December 31, 2008, it was
noted that as a result of the then recent substantial volatility in the capital
markets, the price of our common stock and our market value had decreased
significantly and as of December 31, 2008, our market capitalization, after
appropriate adjustments for control premium and other considerations, was
determined to be less than our net book value (i.e., stockholders’ equity as
reflected in our financial statements). Based on this condition, and in
accordance with the provisions of the Intangibles – Goodwill and Other topic of
the ASC, we recorded a non-cash expense, for the impairment of our goodwill and
other intangible assets, of $5.5 million for the year ended September 30, 2009.
This $5.5 million adjustment was determined to relate to $1.1 million of
goodwill and intangible assets of Infinite, $100,000 of intangible assets of
Auction Video and $4.3 million of goodwill of Acquired
Onstream.




We also
performed impairment tests on Infinite, EDNet and Acquired Onstream as of
December 31, 2009, using the same methodologies discussed
above.  Based on these factors, we concluded that there was no
impairment of the assets of Acquired Onstream or EDNet as of that date. However,
we determined that Infinite’s goodwill and certain of its intangible assets were
impaired as of that date and based on that condition, and in accordance with the
provisions of the Intangibles – Goodwill and Other topic of the ASC, we recorded
a non-cash expense, for the impairment of our goodwill and other intangible
assets, of $3.1 million for the year ended September 30, 2010.




As the
result of the decline in the price of our common stock from $1.86 per share as
of March 31, 2010 to $1.03 as of June 30, 2010, it appeared that our market
value (after certain adjustments as discussed above) was probably less than our
net book value as of June 30, 2010. However, we concluded that the decline in
market value as of June 30, 2010 was not of sufficient duration nor was it
otherwise indicative of a triggering event that would require an interim
impairment review. However, this decline continued after June 30, 2010 and
resulted in a common stock price of $1.04 as of September 30, 2010 and $0.76 as
of December 23, 2010.  As a result, we determined that it was
appropriate for us to evaluate whether our goodwill and other intangible assets
were impaired as of September 30, 2010.





We
performed impairment tests on Infinite, EDNet and Acquired Onstream as of
September 30, 2010, using the same methodologies discussed
above.  Based on these factors, we concluded that there was no
impairment of the assets of Infinite or EDNet as of that date. However, we
determined that Acquired Onstream’s goodwill and certain of its intangible
assets were impaired as of that date and based on that condition, and as
discussed above, in accordance with the provisions of the Intangibles – Goodwill
and Other topic of the ASC, we recorded a non-cash expense, for the impairment
of our goodwill and other intangible assets, of $1.6 million, which combined
with the adjustment described above, resulted in a total impairment expense of
$4.7 million  for the year ended September 30, 2010.





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


23





Since we
do not expect continued material reductions in compensation expense or
depreciation and amortization expense in fiscal 2011 as compared to fiscal 2010,
we expect our consolidated operating expenses for fiscal year 2011 to be
approximately equal to the corresponding prior year amounts (excluding any
reduction arising from fiscal 2011 reductions in goodwill impairment charges as
compared to those costs in fiscal 2010), although this cannot be
assured.





Other
Expense





Other
expense of approximately $1.2 million for the year ended September 30, 2010
represented an approximately $669,000 (120.2%) increase as compared to the prior
fiscal year. This additional expense was primarily related to an increase in
interest expense of approximately $725,000, arising from a much higher level of
interest bearing debt, as well as increased effective interest rates, for the
year ended September 30, 2010 as compared to the year ended September 30,
2009.





As of
September 30, 2009, we had outstanding interest bearing debt with a total face
amount of approximately $3.8 million, versus approximately $2.9 million as of
September 30, 2008. The $3.8 million was primarily comprised of (i)
approximately $1.4 million in borrowings outstanding for working capital under a
line of credit arrangement (the “Line”), (ii) convertible debentures for
financing software and equipment purchases with a balance of $1.0 million and
bearing interest expense at 12% per annum and (iii) the Rockridge Note balance
of approximately $1.4 million, which did not exist until April 2009 and carries
an effective interest rate of approximately 28.0% per annum (after the September
2009 amendment).





In
addition to the above, we have received cash proceeds from interest-bearing
financing activities, net of repayments, of another approximately $933,000
during the year ended September 30, 2010. Approximately $714,000 of these cash
proceeds relate to additional borrowings aggregating $1.0 million ($250,000
under the Greenberg Note in January 2010, $500,000 under the Wilmington Notes in
February 2010 and $250,000 under the Lehmann Note in May 2010) less $286,000 of
principal payments against those notes. The effective interest rates on these
notes range from 50.7% to 83.9% per annum, with a weighted average rate of 73.9%
per annum.





In
addition to the increases in our outstanding debt as noted above, the Line was
amended in December 2009 and as a result the interest rate modified to be 13.5%
per annum, adjusted for future changes in the prime rate, plus a weekly
monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit. The
interest rate at the time of the amendment was 14.25% per annum (prime rate plus
11%) but there was no monitoring fee. Based on the outstanding balance of
approximately $1.6 million under the Line as of September 30, 2010, the amended
terms would represent increased interest expense, including the monitoring fee,
of approximately $40,000 per year.


As a
result of the January 2011 renegotiation of the terms of the $200,000 CCJ Note,
including related changes to Series A-13 Preferred also held by CCJ, the
effective interest rate on the CCJ Note increased from 47.4% per annum to
approximately 78.5% per annum – see the discussion of Liquidity and Capital
Resources below for details.
 
 Although
a significant portion of the remaining outstanding balance due on the borrowings
made during fiscal 2010 was repaid on October 1, 2010 using proceeds from
non-interest bearing equity financing, based on the remaining outstanding
interest-bearing portion of that debt, the increased interest rate on the Line
that was not effective for the entirety of fiscal 2010, the increased effective
interest rate on the CCJ Note from January 2011 and potential further borrowings
in fiscal 2011 in order to address our working capital deficit, we anticipate
our interest expense during fiscal 2011 to at least be equal to, or potentially
greater than, that expense for fiscal 2010.





Liquidity
and Capital Resources





Our
financial statements for the year ended September 30, 2010 reflect a net loss of
approximately $9.3 million and cash used in operations for that period of
approximately $197,000. Although we had cash of approximately $825,000 at
September 30, 2010, our working capital was a deficit of approximately $3.6
million at that date.


24





During
the year ended September 30, 2010, we obtained financing from four primary
sources – (i) the sale of our common and preferred stock under the terms of the
LPC Purchase Agreement, discussed in more detail below and which resulted in net
cash proceeds of approximately $824,000 during the period (ii) the unsecured
subordinated convertible Greenberg Note, Wilmington Notes and Lehmann Note,
under which we borrowed an aggregate of $714,000 (net of repayments) during the
period, (iii) the Line, collateralized by our accounts receivable, under which
we borrowed approximately $255,000 (net of repayments) during the period and
(iv) the Rockridge Note, collateralized by all our assets not pledged under the
Line, under which we borrowed approximately $170,000 (net of repayments) during
the period.





On
September 17, 2010, we entered into a Purchase Agreement (the “Purchase
Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to
an initial purchase of 300,000 shares of our common stock and 420,000 shares of
our Series A-14 Preferred Stock (“Series A-14”), together with warrants to
purchase 540,000 of our common shares.  In accordance with the
Purchase Agreement, LPC also received 50,000 shares of our common stock as a
one-time commitment fee and a cash payment of $26,250 as a one-time structuring
fee. On September 24, 2010, we received net proceeds of $873,750 from LPC in
exchange for our issuance of the above shares and warrants. After deducting
legal, accounting and other out-of-pocket costs incurred by us in connection
with this transaction, the net cash proceeds were $824,044.
 
 During
the period from October 13, 2010 through January 5, 2011 LPC purchased an
additional 405,000 shares of our common stock under that Purchase Agreement for
net proceeds of approximately $336,000.  LPC has also committed to
purchase, at our sole discretion, up to an additional 425,000 shares of our
common stock in installments over the remaining term of the Purchase Agreement,
generally at prevailing market prices, but subject to the specific restrictions
and conditions in the Purchase Agreement. There is no upper limit to the price
LPC may pay to purchase these additional shares. The purchase of our shares by
LPC will occur on dates determined solely by us and the purchase price of the
shares will be fixed on the purchase date and will be equal to the lesser of (i)
the lowest sale price of our common stock on the purchase date or (ii) the
average of the three (3) lowest closing sale prices of our common stock during
the twelve (12) consecutive business days prior to the date of a purchase by
LPC.  LPC shall not have the right or the obligation to purchase any
shares of our common stock from us at a price below $0.75 per
share.
 
 In
addition, we have agreed to use our best efforts to get, within 190 days from
the date of the Purchase Agreement, shareholder approval to sell up to an
additional 1,900,000 of our common shares to LPC, which upon such approval LPC
has agreed to purchase, at our sole discretion and subject to the same
restrictions and conditions in the Purchase Agreement.





The
Purchase Agreement has a term of 25 months but may be terminated by us at any
time after the first year at our discretion without any cost to us and may be
terminated by us at any time in the event LPC does not purchase shares as
directed by us in accordance with the terms of the Purchase Agreement. LPC may
terminate the Purchase Agreement upon certain events of default set forth
therein, including but not limited to the occurrence of a material adverse
effect, delisting of our common stock and the lack of immediate relisting on one
of the specified alternate markets and the lapse of the effectiveness of the
applicable registration statement for more than the specified number of days.
The Purchase Agreement restricts our use of variable priced financings for the
greater of one year or the term of the Purchase Agreement and, in the event of
future financings by us, allows LPC the right to participate under conditions
specified in the Purchase Agreement.





The
shares of common stock sold and issued under the Purchase Agreement and the
shares of common stock issuable upon conversion of Series A-14, were sold and
issued pursuant to a prospectus supplement filed by us on September 24, 2010
with the Securities and Exchange Commission in connection with a takedown of an
aggregate of 1.6 million shares from our Shelf Registration.  In
connection with the Purchase Agreement, we also entered into a Registration
Rights Agreement (the “Registration Rights Agreement”) with LPC, dated September
17, 2010, under which we agreed, among other things, to use our best efforts to
keep the registration statement effective until the maturity date as defined in
the Purchase Agreement and to indemnify LPC for certain liabilities in
connection with the sale of the securities.


25


From
January through May 2010 we issued the unsecured subordinated convertible
Greenberg Note, Wilmington Notes and Lehmann Note, for aggregate gross proceeds
of $1.0 million, as discussed above. The remaining principal balance of the
Greenberg and Wilmington Notes, representing $750,000 in original borrowing, was
$503,000 as of September 30, 2010. This $503,000 balance, as well as all accrued
but unpaid interest, was satisfied by us on October 1, 2010 with cash payments
aggregating $400,000 plus the issuance of 137,901 unregistered common
shares.  The effective rate of the Greenberg Note was initially
calculated to be approximately 50.7% per annum, assuming a one year loan term.
The effective rate of the Wilmington Notes was initially calculated to be
approximately 83.9% per annum, assuming a six month loan term and excluding the
finder’s fees payable by us to a third party in cash and equal to 7% of the
borrowed amount.





The
Lehmann Note, an unsecured subordinated convertible note under which we borrowed
$250,000 in May 2010, is repayable in principal installments of $13,000 per
month beginning July 3, 2010, with the final payment on May 3, 2011, including
remaining principal and all accrued but unpaid interest (at 10% per
annum).  The Lehmann Note is convertible into common stock at
Lehmann’s option based on our closing share price on the funding date of the
Lehmann Note, which was $2.04. $250,000 of the amount we borrowed under the
Wilmington Notes in February 2010 came from Lehmann.





The
Lehmann Note provides for (i) our issuance of 37,500 unregistered common shares
upon receipt of the funds and our issuance of 25,000 unregistered common shares
if the loan is still outstanding after 6 months and (ii) our prepayment of the
first six months of interest in the form of shares, based on our closing share
price on the funding date of the Lehmann Note. In the event the Lehmann Note is
prepaid after the first six months, the second tranche of 25,000 unregistered
common shares will be cancelled on a pro-rata basis, to the extent the second
six month time period has not elapsed at the time of such payoff.





The
effective rate of the Lehmann Note is approximately 77.0% per annum, assuming a
six month loan term and excluding the finder’s fees payable by us to a third
party in cash and equal to 7% of the borrowed amount.





We may
prepay the Lehmann Note at any time with ten days notice, provided that Lehmann
may convert the outstanding balance to common shares during such ten day period.
If we successfully conclude a financing of debt or equity in excess of
$1,000,000 during the term of the Lehmann Note, the proceeds of such financing
will be used to pay off the remaining balance of the Lehmann Note. Although the
aggregate gross proceeds from the sale of common and preferred shares under the
LPC Purchase Agreement exceeded $1,000,000 as of November 3, 2010, our position
is that the sale of shares in October, November and December 2010 were separate
financings from the initial sale of shares in September 2010 and since none of
those financings were in excess of $1,000,000, early repayment of the Lehmann
Note is not required. In the event of a default, uncured after the notice
provisions in the note, we will be obligated to pay Lehmann an additional 5%
interest per month (based on the outstanding loan balance and pro-rated on a
daily basis) until the default has been cured, payable in cash or unregistered
common shares.





The
maximum allowable borrowing amount under the Line is now $2.0 million, subject
to certain formulas with respect to the amount and aging of the underlying
receivables. The outstanding balance (approximately $1.6 million as of December
23, 2010) bears interest at 13.5% per annum, adjustable based on changes in
prime after December 28, 2009, plus a weekly monitoring fee of one twentieth of
a percent (0.05%) of the borrowing limit. The outstanding principal under the
Line may be repaid at any time, but no later than December 2011, which term may
be extended by us for an extra year, subject to compliance with all loan terms,
including no material adverse change, as well as concurrence of the
Lender.


26


During
fiscal 2009 we borrowed $1.5 million from Rockridge Capital Holdings, LLC
(“Rockridge”), an entity controlled by one of our largest shareholders, in
accordance with the terms of a Note and Stock Purchase Agreement that we entered
into with Rockridge dated April 14, 2009 and amended on September 14, 2009. We
received another $500,000 under the Note and Stock Purchase Agreement on October
20, 2009, resulting in cumulative allowable borrowings of $2.0 million. In
connection with this transaction, we issued a Note (the “Rockridge Note”), which
is secured by a first priority lien on all of our  assets, such lien
subordinated only to the extent higher priority liens on assets, primarily
accounts receivable and certain designated software and equipment, are held by
certain of our other lenders. We also entered into a Security Agreement with
Rockridge that contains certain covenants and other restrictions with respect to
the collateral.





The
Rockridge Note, which had an outstanding principal balance of approximately $1.5
million at September 30, 2010, is repayable in equal monthly installments of
$41,409 extending through August 14, 2013 (the “Maturity Date”), which
installments include principal (except for a $500,000 balloon payable at the
Maturity Date and which balloon payment is also convertible into restricted ONSM
common shares under certain circumstances) plus interest (at 12% per annum) on
the remaining unpaid balance. Upon notice from Rockridge at any time prior to
the Maturity Date, up to fifty percent (50%) of the outstanding principalamountof the Rockridge Note
(excluding the balloon payment subject to conversion per the previous sentence)
may be converted into a number of restricted shares of ONSM common stock. If we
sell all or substantially all of our assets, or at any time after September 4,
2011 and prior to the Maturity Date, the remaining outstanding principalamountof the Rockridge Note
may be converted by Rockridge into a number of restricted shares of ONSM common
stock. The above conversions are subject to a minimum of one month between
conversion notices (unless such conversion amount exceeds $25,000) and will use
a conversion price of eighty percent (80%) of the fair market value of the
average closing bid price for ONSM common stock for the twenty (20) days of
trading on The NASDAQ Capital Market (or such other exchange or market on which
ONSM common shares are trading) prior to such Rockridge notice, but such
conversion price will not be less than $2.40 per share.





The Note
and Stock Purchase Agreement also provides that Rockridge may receive an
origination fee, upon not less than sixty-one (61) days written notice to us, of
366,667 restricted shares of our common stock (the “Shares”). The value of those
Shares is subject to a limited guaranty of no more than an additional payment by
us of $75,000 which will be effective in the event the Shares are sold for an
average share price less than the minimum of $1.20 per share.





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





We are
currently obligated under convertible Equipment Notes with a face value of $1.0
million which are collateralized by specifically designated software and
equipment owned by us with a cost basis of approximately $1.5 million, as well
as a subordinated lien on certain other of our assets to the extent that the
designated software and equipment, or other software and equipment added to the
collateral at a later date, is not considered sufficient security for the loan.
Interest is payable every 6 months in cash or, at our option, in restricted ONSM
common shares, based on a conversion price equal to seventy-five percent (75%)
of the average ONSM closing price for the thirty (30) trading days prior to the
date the applicable payment is due. On November 11, 2009, we elected to issue
34,920 unregistered shares of our common stock to the Investors in lieu of
$60,493 cash interest on these Equipment Notes for the period from May 2009
through October 2009, which was recorded as interest expense of $67,040 on our
books, based on the fair value of those shares on the issuance date. On April
30, 2010, we elected to issue 44,369 unregistered common shares to the Investors
in lieu of $59,507 cash interest on these Equipment Notes for November 2009
through April 2010, which was recorded as interest expense of $92,288 on our
books, based on the fair value of those shares on the issuance date. On December
2, 2010, we elected to issue 76,769 unregistered shares of our common stock to
the Investors in lieu of $60,493 cash interest on these Equipment Notes for the
period from May 2010 through October 2010, which was recorded as interest
expense of $73,698 on our books, based on the fair value of those shares on the
issuance date.


27





The
Equipment Notes may be converted to restricted ONSM common shares at any time
prior to their maturity date, at the holder’s option, based on a conversion
price equal to seventy-five percent (75%) of the average ONSM closing price for
the thirty (30) trading days prior to the date of conversion, but in no event
may the conversion price be less than $4.80 per share. In the event the Notes
are converted prior to maturity (June 3, 2011), interest on the Equipment Notes
for the remaining unexpired loan period will be due and payable in additional
restricted ONSM common shares in accordance with the same formula for interest
as described above.





During
August 2009, CCJ Trust (“CCJ”) remitted $200,000 to us as a short term advance
bearing interest at 0.022% per day (equivalent to approximately 8% per annum)
until the date of repayment or unless the parties mutually agreed to another
financing transaction(s) prior to repayment. This advance was included in
accounts payable on our September 30, 2009 balance sheet. On December 29, 2009,
we entered into an agreement with CCJ whereby accrued interest through that date
of $5,808 was paid by us in cash and the $200,000 advance was converted to an
unsecured subordinated note payable at a rate of 8% interest per annum in equal
monthly installments of principal and interest for 48 months plus a $100,000
principal balloon at maturity (the “CCJ Note”) although none of those payments
were subsequently made by us. To resolve this payment default, the CCJ Note was
amended in January 2011 to prospectively increase the interest rate to 10% per
annum, payable quarterly, and to require two principal payments of $100,000 each
on December 31, 2011 and December 31, 2012, respectively. This amendment also
called for our cash payment of the previously accrued interest in the amount of
$16,263 on or before January 31, 2011. The remaining principal balance of this
note may be converted at any time into our common shares at the greater of (i)
the previous 30 day market value or (ii) $2.00 per share (which was $3.00 per
share prior to the January 2011 renegotiation).




In
conjunction with and in consideration of the December 2009 note transaction, the
35,000 shares of Series A-12 held by CCJ at that date were exchanged for 35,000
shares of Series A-13 plus four-year warrants for the purchase of 175,000 ONSM
common shares at $3.00 per share. In conjunction with and in consideration of
the January 2011 note amendment, it was agreed that certain terms of the 35,000
shares of Series A-13 held by CCJ at that date would be modified.
  The
effective interest rate of the CCJ Note prior to the January 2011 amendment was
approximately 47.4% per annum, including the Black-Scholes value of the warrants
plus the value of the increased number of common shares underlying the Series
A-13 shares versus the Series A-12 shares. The effective rate of 47.4% per annum
also included 11.2% per annum related to dividends that would have accrued to
CCJ as a result of the later mandatory conversion date of the Series A-13 shares
versus the mandatory conversion date of the Series A-12 shares. Following the
January 2011 amendment, the effective interest rate of the CCJ Note increased to
approximately 78.5% per annum, to reflect the value of the increased value of
common shares underlying the Series A-13 shares as a result of the modified
terms as well as the increase in the periodic cash interest rate from 8% to 10%
per annum. The effective rate of 78.5% per annum also includes 9.3% per annum
related to dividends that could accrue to CCJ as a result of the later mandatory
conversion date of the Series A-13 shares as a result of the modified
terms.
 
 Projected
capital expenditures for the twelve months ended September 30, 2011 total
approximately $1.3 million which includes software and hardware upgrades to the
DMSP, the webcasting system (including iEncode) and the audio and web
conferencing infrastructure, as well as costs of software development and
hardware costs in connection with the introduction and establishment of the
MarketPlace365 platform. This total includes at least $550,000 of projected
capital expenditures which we have determined may be financed, deferred past the
twelve month period or cancelled entirely, depending on our other cash flow
considerations. This total excludes approximately $270,000 reflected by us as
accounts payable at September 30, 2010, primarily representing amounts that are
presently the subject of litigation and which will not be reflected as capital
expenditures in our cash flow statement until paid.


28





We have
estimated that we would require an approximately 7-8% increase in our
consolidated revenues, as compared to our revenues for the twelve months ended
September 30, 2010, in order to adequately fund our anticipated operating cash
expenditures for the next twelve months (including cash interest expense and a
basic level of capital expenditures).  Due to seasonality, this
increase would be accomplished if we were to achieve average revenues over the
next four quarters equivalent to the revenues for the third quarter of fiscal
2010. We have estimated that, in addition to this revenue increase, we will also
require additional debt or equity financing of approximately $1.5 to $2.0
million (in addition to recent sales of common and preferred shares discussed
above) over the next twelve months to satisfy principal repayments due against
existing debt (other than debt repaid from the proceeds of recent sales of
common and preferred shares discussed below) as well as past due trade payables
that we believe are necessary to pay to continue our operations. However,
approximately $1.0 million of this $1.5 to $2.0 million would not be required
until June 2011.





If we
were to achieve revenue increases in excess of this 7-8%, or if any of our
lenders elected to convert a portion of the existing debt to equity as allowed
for under its terms, the required financing could be less than this $1.5 to $2.0
million. However, if we did not achieve these revenue increases, or if our
operating expenses, cash interest or capital expenditures were higher than
anticipated over the next twelve months, the required financing could be greater
than this $1.5 to $2.0 million.





We have
implemented and continue to implement specific actions, including hiring
additional sales personnel, developing new products and initiating new marketing
programs, geared towards achieving revenue increases. The costs associated with
these actions were contemplated in the above calculations.  However,
in the event we are unable to achieve the required revenue increases, we believe
that a combination of identified decreases in our current level of expenditures
that we would implement and the raising of additional capital in the form of
debt and/or equity that we believe we could obtain from identified sources would
be sufficient to allow us to operate for the next twelve months. We will closely
monitor our revenue and other business activity to determine if further cost
reductions, the raising of additional capital, or other activity is considered
necessary.





A
prospectus allowing us to offer and sell up to $6.6 million of our registered
common shares (“Shelf Registration”) was declared effective by the SEC on April
30, 2010. In connection with the LPC Purchase Agreement 1.6 million common
shares (including shares issuable upon conversion of preferred shares) were
included in a prospectus supplement filed by us on September 17, 2010 with the
SEC as a takedown under the Shelf Registration. However, there is no assurance
that we will sell additional shares to LPC under the Purchase Agreement or that
we will sell additional shares under the Shelf Registration, or if we do make
such sales what the timing or proceeds will be. In addition, we may incur fees
in connection with such sales. Furthermore, sales under the Shelf Registration
that exceed in aggregate twenty percent (20%) of our outstanding shares would be
subject to prior shareholder approval.





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


29





We have
incurred losses since our inception, and have an accumulated deficit of
approximately $123.4 million as of September 30, 2010. Our operations have been
financed primarily through the issuance of equity and debt.Cash required to fund our
continued operations will be affected by numerous known and unknown risks and
uncertainties including, but not limited to, our ability to successfully market
and sell the DMSP, iEncode and MarketPlace365 as well as our other existing
products and services, the degree to which competitive products and services are
introduced to the market, our ability to control and/or reduce expenses, our
need to invest in new equipment and/or technology, and our ability to service
and/or refinance our existing debt and accounts payable. We cannot assure that
our revenues will continue at their present levels, nor can we assure that they
will not decrease.





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. Other than working capital which may become available to us from
further borrowing or sales of equity (including but not limited to proceeds from
the LPC Purchase Agreement, Shelf Registration or Funding Letter, as discussed
above), we do not presently have any additional sources of working capital other
than cash on hand and cash, if any, generated from operations.As a
result of the uncertainty as to our available working capital over the upcoming
months, we may be required to delay or cancel certain of the projected capital
expenditures, some of the planned marketing expenditures, or other planned
expenses. In addition, it is likely 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.


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





Cash used
in operating activities was approximately $197,000 for the year ended September
30, 2010, as compared to approximately $322,000 provided by operations for the
prior fiscal year. The $197,000 reflects our net loss of approximately $9.3
million, reduced by approximately $9.1 million of non-cash expenses included in
that loss and reduced by approximately $14,000 arising from a net decrease in
non-cash working capital items during the period. The net decrease in non-cash
working capital items for the year ended September 30, 2010 is primarily due to
an approximately $715,000 increase in accounts payable, accrued liabilities and
amounts due to directors and officers, offset by an approximately $768,000
increase in accounts receivable. This compares to a net decrease in non-cash
working capital items of approximately $1.0 million for the corresponding period
of the prior fiscal year, primarily due to an approximately $940,000 increase in
accounts payable, accrued liabilities amounts due to directors and officers. The
primary non-cash expenses included in our loss for the year ended September 30,
2010 were $4.7 million arising from a charge for impairment of goodwill and
other intangible assets, approximately $1.9 million of depreciation and
amortization, approximately $816,000 of employee compensation expense arising
from the issuance of stock and options and approximately $796,000 of
amortization of deferred professional fee expenses paid for by issuing stock and
options. 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.


30





Cash used
in investing activities was approximately $1.3 million for the year ended
September 30, 2010 as compared to approximately $1.4 million for the prior
fiscal year. Current and prior period investing activities primarily related to
the acquisition of property and equipment.





Cash
provided by financing activities was approximately $1.8 million for the year
ended September 30, 2010 as compared to approximately $1.0 million for the prior
fiscal year. Current and prior year financing activities primarily related to
net proceeds from notes payable and convertible debentures, net of repayments.
The current year also included proceeds from the sale of common stock and A-14
preferred shares and the prior year also included proceeds from the sale of A-12
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.  Our most critical accounting
policies and estimates are described as follows.





Our prior
acquisitions of several businesses, including the Onstream Merger and the
Infinite Merger, have resulted in significant increases in goodwill and other
intangible assets. Goodwill and other unamortized intangible assets, which
include acquired customer lists, were approximately $13.7 million at September
30, 2010, representing approximately 66% of our total assets and approximately
117% of the book value of shareholder equity. In addition, property and
equipment as of September 30, 2010 includes approximately $2.0 million (net of
depreciation) related to the DMSP and other capitalized internal use software,
representing approximately 10% of our total assets and approximately 17% of the
book value of shareholder equity.





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




We follow
a two step process for impairment testing of goodwill. The first step of this
test, used to identify potential impairment and described above, compares the
fair value of a reporting unit with its carrying amount, including goodwill. The
second step, if necessary, measures the amount of the impairment, including a
comparison and reconciliation of the carrying value of all of our reporting
units to our market capitalization, after appropriate adjustments for control
premium and other considerations. If our market capitalization, after
appropriate adjustments for control premium and other considerations, is
determined to be less than our net book value (i.e., stockholders’ equity as
reflected in our financial statements), that condition might indicate an
impairment 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.


31




As the
result of a recent decline in the price of our common stock from $1.04 per share
as of September 30, 2010 to $0.76 per share as of December 23, 2010, it appears
that our market value (after certain adjustments as discussed above) may be less
than our net book value as of December 31, 2010. If the price of our common
stock and our market value were to remain at the same levels, or decline, such
condition could result in future non-cash impairment charges to our results of
operations related to our goodwill and other intangible assets arising either
from an interim impairment review as of December 31, 2010 or from our next
scheduled recurring annual impairment review, as of September 30, 2011. We will
closely monitor and evaluate all such factors as of December 31, 2010 and
subsequent periods, in order to determine whether to record future non-cash
impairment charges.


ITEM
8.                                FINANCIAL
STATEMENTS AND SUPPLEMENTARY DATA
 
 Our financial statements are contained
in pages F-1 through F-63, which appear at the end of this annual
report.


ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE





Effective January 1, 2010, Goldstein
Lewin & Co. (“Goldstein Lewin”), our independent certifying accountant and
the principal accountant engaged to audit our September 30, 2009 financial
statements, consummated a sale of its attest practice (the “Accounting Firm
Transaction”) to Mayer Hoffman McCann P.C. (“MHM”).  As a result, the
Audit Committee of our Board of Directors has engaged MHM to serve as our new
independent certifying accountant with respect to our September 30, 2010
financial statements.





The audit
report of Goldstein Lewin on our financial statements for the fiscal year ended
September 30, 2009 expressed an unqualified opinion.  Such audit
report did not contain an adverse opinion or disclaimer of opinion or
qualification.  During our two most recent fiscal years ending
September 30, 2009 and the period thereafter through the date of the Accounting
Firm Transaction, there were no disagreements with Goldstein Lewin on any matter
of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, which, if not resolved to the satisfaction of
Goldstein Lewin, would have caused such entity to make reference to such
disagreements in its reports.  During our two most recent fiscal years
ending September 30, 2009 and through the date of the Accounting Firm
Transaction, no “reportable events” (as described in Item 304(a)(1)(v) of
Regulation S-K) occurred that would be required by Item 304(a)(1)(v) to be
disclosed in this report.





During
our two most recent fiscal years ending September 30, 2009 and the period
thereafter through the date of the Accounting Firm Transaction, neither we, nor
anyone on our behalf, consulted MHM regarding:  (i) the application of
accounting principles to a specific completed or proposed transaction; (ii) the
type of audit opinion that might be rendered on our financial statements; or
(iii) any matter that was either the subject of a disagreement (as defined in
Rule 304(a)(1)(iv) of Regulation S-K promulgated under the Securities Act of
1933, as amended) or a reportable event (as defined in Rule 304(a)(1)(v) of
Regulation S-K).


32





ITEM
9A (T).    CONTROLS AND PROCEDURES





Management’s report on
disclosure 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, 2010, 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.


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.
 
 Management’s report on
internal control over financial reporting:
 
 We are responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control
over financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of external
financial statements in accordance with generally accepted accounting
principles. However, all internal control systems, no matter how well designed,
have inherent limitations. Therefore, even those systems determined to be
effective can provide only reasonable assurance with respect to financial
statement preparation and presentation. Because of inherent limitations,
internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.





As
required by Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of
1934, as of the end of the period covered by the annual report, being September
30, 2010, we have carried out an evaluation of the effectiveness of the design
and operation of our company's internal control over financial reporting. 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 and was based on the criteria set forth in
“Internal Control – Integrated Framework”, issued by the Committee of Sponsoring
Organizations of the Treadway Commission (‘COSO”). This evaluation included
review of the documentation of controls, evaluation of the design effectiveness
of controls and testing of the operating effectiveness of controls. Based upon
that evaluation, our company's President along with our company's Chief
Financial Officer concluded that our company's internal control over financial
reporting is 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.


ITEM 9B.
              OTHER
      INFORMATION


None.


33





PART
III





ITEM
      10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE


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


Name
              
              Age
              
              PositionRandy
      S. Selman
              
              54
              
              Chairman
      of the Board, President and Chief Executive OfficerAlan
      M. Saperstein
              
              51
              
              Director
      and Chief Operating OfficerRobert
      E. Tomlinson
              
              53
              
              Senior
      Vice President and Chief Financial OfficerClifford
      Friedland
              
              59
              
              Senior
      Vice President Business DevelopmentDavid
      Glassman
              
              59
              
              Senior
      Vice President and Chief Marketing OfficerCharles
      C. Johnston  (1)(2)(3)
              
              75
              
              DirectorCarl
      L. Silva (1)(2)(3)(4)
              
              47
              
              DirectorLeon
      Nowalsky (2)(3)
              
              49
              
              Director





(1)
              Member
      of the Audit Committee.
 (2)
              Member
      of the Compensation
Committee.


(3)
              Member
      of the Governance and Nominating
Committee.
 (4)
              Member
      of the Finance Committee.


Randy S. Selman.Mr. Selman has served as our Chairman of the Board, President and Chief
Executive Officer since our inception in May 1993 and, from September 1996
through June 1999 and from August 1, 2004 through December 15, 2004, has also
been 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 software development company. SKTC
developed and marketed 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.
 
 The primary experience, qualifications,
attributes and skills that led us to conclude that Mr. Selman should currently
serve as a director, in light of our business and structure, are as follows:
executive management, sales and software development industry experience with
SKTC and executive management and public and investor relations experience with
ONSM.





Alan M.
Saperstein.  Mr. Saperstein has served as our Executive Vice
President and a director since our inception in May 1993, and has also been our
Chief Operating Officer since December 2004. 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.
 
 The primary experience, qualifications,
attributes and skills that led us to conclude that Mr. Saperstein should
currently serve as a director, in light of our business and structure, are as
follows: video and film industry experience with NFL Films and executive
management and webcasting and digital media operations experience with
ONSM.


34


Robert E.
Tomlinson.On December 15, 2004 Mr. Tomlinson was appointed as 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.
 
 Clifford
Friedland. Mr. Friedland was appointed as a member of our Board of
Directors in December 2004.  He continued as a board member until his
resignation from the board in June 2010, although he continued as Senior Vice
President, Business Development. Mr. Friedland’s voluntary resignation was to
restore our board to the required majority of independent members, following the
death of another board member. He served as Chairman, CEO and co-founder of
Acquired Onstream from June 2001 until joining our company. 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.





David
Glassman. Mr.
Glassman has served as our Chief Marketing Officer since December 2004. 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, with a client list that 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., a fast food franchisor, from January 1981 until
December 1986.


35


Charles C.
Johnston. Mr. Johnston has been a member of our Board of Directors since
April 2003 and serves on our Audit (as Chairman), Compensation and 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 has been a member of the board of directors of AuthentiDate
Holding Company (Nasdaq National Market: ADAT), Internet Commerce Corporation
(Nasdaq National Market: ICCA), McData Corporation (Nasdaq National Market:
MCDT), Grumman
Corporation and Teleglobe Corporation. Mr. Johnston serves as a Trustee of
Worcester Polytechnic Institute, where he earned his Bachelor of Science
degree.
 
 The
primary experience, qualifications, attributes and skills that led us to
conclude that Mr. Johnston should currently serve as a director, in light of our
business and structure, are as follows: management and board experience at
public technology-oriented companies (ADAT, ICCA, MCDT, Grumman, Teleglobe) and
management experience in other technology-oriented firms (Ventex,
Inshore).


Carl
Silva.  Mr. Silva, who has been a member of our Board of
Directors since July 2006, serves on our Audit, Compensation (as Chairman),
Governance and Nominating and Finance Committees. Mr. Silva has over 25 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. Mr. Silva is currently
Chief Scientist and VP of Technology for Nexaira Wireless, Inc. (NXWI.OB), a
3G/4G Router company. Prior to this Mr. Silva was CEO of Conigen Business
Systems, Inc. (NASDAQ: CNGW), a managed service provider for small to mid-size
businesses for Voice over IP and high speed Internet. 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 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.





The
primary experience, qualifications, attributes and skills that led us to
conclude that Mr. Silva should currently serve as a director, in light of our
business and structure, are as follows: over 25 years of experience in the
telecommunications and high tech industry, most notably at Nexaira, Conigen and
SAIC.





Leon
Nowalsky.  Mr. Nowalsky was appointed a member of our Board of
Directors in December 2007 and serves on our Compensation and Governance and
Nominating (as Chairman) Committees. Mr. Nowalsky, a partner in the New
Orleans-based law firm of Nowalsky, Bronston & Gothard APLLC (NBG),
possesses over 20 years experience in the field of telecommunications law and
regulation. Mr. Nowalsky presently is a founder and board member of Thermo
Credit, LLC, a specialty finance company for the telecommunications industry and
J.C. Dupont, Inc., a Louisiana based oil and gas concern. Mr. Nowalsky has been
general counsel for Telemarketing Communications of America, Inc., (“TMC”), as
well as lead counsel in TMC’s mergers and acquisitions program, and following
TMC’s acquisition by a wholly owned subsidiary of Advanced Telecommunications
Corporation, Mr. Nowalsky served as ATC’s chief regulatory counsel as well as
interim general counsel.  In 1990, Mr. Nowalsky left ATC to set up a
private law practice specializing in telecommunications regulatory matters,
mergers and acquisitions and corporate law, which later expanded to become NBG.
Mr. Nowalsky has previously served as a director of the following companies:
Network Long Distance, Inc., a long distance company which was acquired by IXC
Communications; RFC Capital Corp., a specialty finance company dedicated
exclusively to the telecommunications industry which was purchased in 1999 by
TFC Financial Corp., a division of Textron (NYSE:TXT); and New South
Communications, a facilities-based competitive local exchange carrier which
merged to form NUVOX, which was subsequently acquired by Windstream; W2Com, LLC,
a video conferencing and distance learning provider which was acquired by Arel
Communications & Software, Ltd. (NASDAQ: ARLC).
 
 The primary experience, qualifications,
attributes and skills that led us to conclude that Mr. Nowalsky should currently
serve as a director, in light of our business and structure, are as follows:
over 20 years experience in the field of telecommunications law and regulation,
most notably at TMC and ATC, as well his currently active private law practice
specializing in telecommunications regulatory matters, mergers and acquisitions
and corporate law.


36


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.  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.
 
 Rule 5605(b)(1) of the NASDAQ Listing
Rules to which we are subject requires that a majority of the members of our
board of directors are independent as defined in Rule 5605((a)(2) of the NASDAQ
Listing Rules. Our independent directors are Messrs. Johnston, Silva and
Nowalsky.
 
 Expansion
of our Board of Directors


Our
bylaws provide that the number of directors shall be no less than two and no
more than nine. Our Board of Directors currently consists of five
directors.





Director
Compensation Table


The following table presents director
compensation (excluding directors who are Named Executive Officers) for the year
ended September 30, 2010:


CHANGE
      INPENSION
      VALUEFEES EARNED
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    
                                    NON-EQUITY
                                    
                                    
                                    AND NONQUALIFIEDOR
      PAID IN
                                    
                                    
                                    STOCK
                                    
                                    
                                    OPTION
                                    
                                    
                                    INCENTIVE PLAN
                                    
                                    
                                    DEFERRED
                                    
                                    
                                    ALL
      OTHER
                                    
                                    
                                    TOTALCASH
                                    
                                    
                                    AWARDS
                                    
                                    
                                    AWARDS
                                    
                                    
                                    COMPENSATION
                                    
                                    
                                    COMPENSATION
                                    
                                    
                                    COMPENSATION
                                    
                                    
                                    COMPENSATIONNAME
                                    
                                    ($)
      (1)
                                    
                                    
                                    ($)
                                    
                                    
                                    ($)
      (3)
                                    
                                    
                                    ($)
                                    
                                    
                                    EARNINGS
      ($)
                                    
                                    
                                    ($)
                                    
                                    
                                    ($)Robert
      J. Wussler (4)
                                    
                                    $
      10,208
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      29,972(2)
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      40,180Charles
      C. Johnston (4)
                                    
                                    $
      15,000
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      29,972(2)
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      44,972Carl
      L. Silva (4)
                                    
                                    $
      15,000
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      15,000Leon
      Nowalsky (4)
                                    
                                    $
      15,000
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    -0-
                                    
                                    
                                    $
      15,000





1)
              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. Mr. Wussler passed away on June 5, 2010 and
      his services as a director were paid for through that
  date.





2)
              In
      December 2004, and in connection with the Onstream Merger, Messrs. Wussler
      and Johnston each received immediately exercisable five-year Non-Plan
      options to purchase 16,667 shares of our common stock with an exercise
      price of $9.42 per share (fair market value on the date of issuance). On
      August 11, 2009, our Compensation Committee granted 13,352 fully vested
      five-year Plan Options (6,676 each) to Messrs. Wussler and Johnston in
      exchange for the cancellation of an equivalent number of these Non-Plan
      Options held by them and expiring in December 2009, with no change in the
      exercise price, which was in excess of the market value of an ONSM share
      as of August 11, 2009. As a result of this cancellation and the
      corresponding issuance, we recognized non-cash professional fee (director
      compensation) expense of approximately $12,760 ($6,380 each) for the year
      ended September 30, 2009, which represented the full valuation of the
      related options using the Black-Scholes model. On December 17, 2009, our
      Compensation Committee granted 19,982 fully vested five-year Plan Options
      (9,991 each) to Messrs. Wussler and Johnston in exchange for the
      cancellation of an equivalent number of these Non-Plan Options held by
      them and expiring in December 2009, with no change in the exercise price,
      which was in excess of the market value of an ONSM share as of the grant
      date. As a result of this cancellation and the corresponding issuance, we
      recognized non-cash professional fee (director compensation) expense of
      approximately $59,944 ($29,972 each) for the year ended September 30,
      2010, which represented the full valuation of the related options using
      the Black-Scholes model.


37




No other
options were issued to the directors who were not also Named Executive Officers
during the year ended September 30, 2010.


3)
                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, 2010 members of our Board of Directors
      (excluding those who are Named Executive Officers) held outstanding
      options to purchase an aggregate of 33,333 shares of our common stock at
      prices ranging from $4.26 to $9.42 per share. In addition to the 16,667
      options held by Mr. Johnston as discussed above, 16,666 options are still
      held as follows:
 
 Mr.
Johnston holds immediately exercisable five-year Plan options to purchase 8,333
shares of our common stock with an exercise price of $4.26 per share (above fair
market value on the date of issuance), issued to him in September
2006.
 
 Mr. Leon
Nowalsky holds immediately exercisable four-year Plan options to purchase 8,333
shares of our common stock with an exercise price of $6.00 per share (above fair
market value on the date of issuance), granted to him in December 2007 to upon
his initial appointment to our Board of Directors.





4)
              In
      addition to the allocation of a percentage of the Company Sale Price to
      the Executives, as discussed in Item 11 - Executive Compensation below, on
      August 11, 2009 our Compensation Committee determined that an additional
      two percent (2.0%) of the Company Sale Price would be allocated, on the
      same terms, to the then four outside members of our Board of Directors
      (0.5% each), as a supplement to provide appropriate compensation for
      ongoing services as a director and as a termination fee. On June 5, 2010,
      one of the four outside Directors passed away and we are still in the
      process of evaluating independent candidates to fill the resulting Board
      vacancy.





Board
of Directors Meetings and Committees





The Board
of Directors meets regularly (in-person and/or by telephone conference) during
the year to review matters affecting us and to act on matters requiring Board
approval and it also holds special meetings whenever circumstances require. In
addition, it may act by written consent. During the fiscal year ended September
30, 2010, there were nine meetings of the Board, and the Board took action
eleven times by written consent. The Board of Directors has four standing
committees as discussed below and may, from time to time, establish additional
committees.


38




Board
leadership structure and role in risk oversight





The
Board’s leadership structure combines the positions of chairman and CEO, which
we have determined to be appropriate, given our specific characteristics and
circumstances. In particular, our chairman and CEO is able to utilize the
in-depth focus and perspective as a company co-founder and his practical
experience gained during several years of running the company since its founding
to effectively and efficiently guide the Board. The Board has not designated a
lead independent director, since it has determined that our chairman closely
interacts with the other members of the Board, particularly the independent
directors, in fulfilling his responsibilities as chairman and CEO. Although it
is management’s responsibility to assess and manage the various risks we face,
it is the Board’s responsibility to oversee management in this effort. The Board
administers its risk oversight function by appropriate discussions with the CEO,
CFO and other members of management during meetings of the Board and at other
times.





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 Committee
Charter at least once every three years, we have included a copy of the Audit
Committee Charter as Appendix C to our proxy statement for our 2010 Annual
Meeting filed with the SEC on February 19, 2010.





The Audit
Committee is presently composed of Messrs. Johnston (chairman) and Silva. 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
and they are “audit committee financial experts” 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) four times and acted by written consent two
times in fiscal 2010.





We are
currently not compliant with NASDAQ’s minimum audit committee size requirement
of three independent members, as set forth in Listing Rule 5605 (c) (2) (a) (the
“Rule”), for which compliance is necessary in order to be eligible for continued
listing on the NASDAQ Capital Market. On June 24, 2010, we received a letter
from NASDAQ stating that unless we regain compliance with the Rule as of the
earlier of our next annual shareholders’ meeting or June 5, 2011, our common
stock will be subject to immediate delisting. Until that time, our shares will
continue to be listed on the NASDAQ Capital Market.





On June
14, 2010, we were notified that Mr. Robert J. Wussler, who was then a director
and a member of our audit committee, had passed away on June 5, 2010. He has not
at the present time been replaced on the audit committee, which currently has
two independent members. We are in the process of evaluating independent
candidates to fill the vacancy left as a result of Mr. Wussler’s passing, both
on the Board as well as the audit committee. We will make that selection as soon
as possible.





Compensation
Committee





The
Compensation Committee establishes and administers our executive and director
compensation practices and policies, including the review of the individual
elements of total compensation for executive officers and directors and
recommendation of adjustments to the Board of Directors.  In addition,
the Compensation Committee administers our 1996 Stock Option Plan and our 2007
Equity Incentive Plan and determines the number of performance shares and other
equity incentives awarded to executives and directors (as well as all other
employees) and the terms and conditions of which they are granted
and  recommends plans and plan amendments to the Board.  The
Compensation Committee is presently composed of Messrs. Silva (chairman),
Johnston and Nowalsky. The Compensation Committee met (in-person and/or by
telephone conference) one time in fiscal 2010.


39




The
Compensation Committee has the responsibility to review, recommend, and approve
all executive officer compensation arrangements. The Compensation Committee has
the specific responsibility and authority to (i) review and approve
corporate goals and objectives relevant to the compensation of our Chief
Executive Officer (“CEO”), (ii) evaluate the performance of our CEO in
light of those goals and objectives, and (iii) determine and approve the
compensation level of our CEO based upon that evaluation. The Compensation
Committee also has the responsibility to annually review the compensation of our
other executive officers and to determine whether such compensation is
reasonable under existing facts and circumstances. In making such
determinations, the Compensation Committee seeks to ensure that the compensation
of our executive officers aligns the executives’ interests with the interests of
our shareholders. The Compensation Committee must also review and approve all
forms of incentive compensation, including stock option grants, stock grants,
and other forms of incentive compensation granted to our executive officers. The
Compensation Committee takes into account the recommendations of our CEO in
reviewing and approving the overall compensation of the other executive
officers.





We
believe that the quality, skills, and dedication of our executive officers are
critical factors affecting our long-term value and success. Thus, one of our
primary executive compensation goals is to attract, motivate, and retain
qualified executive officers. We seek to accomplish this goal by rewarding past
performance, providing an incentive for future performance, and aligning our
executive officers’ long-term interests with those of our shareholders. Our
compensation program is specifically designed to reward our executive officers
for individual performance, years of experience, contributions to our financial
success, and creation of shareholder value. Our compensation philosophy is to
provide overall compensation levels that (i) attract and retain talented
executives and motivate those executives to achieve superior results,
(ii) align executives’ interests with our corporate strategies, our
business objectives, and the long-term interests of our shareholders, and
(iii) enhance executives’ incentives to increase our stock price and
maximize shareholder value. In addition, we strive to ensure that our
compensation, particularly salary compensation, is consistent with our constant
focus on controlling costs. Our primary strategy for building senior management
depth is to develop personnel from within our company to ensure that our
executive team as a whole remains dedicated to our customs, practices, and
culture, recognizing, however, that we may gain talent and new perspectives from
external sources.





Our
compensation program for executive officers generally consists of the following
five elements: (i) base salary, (ii) performance-based annual bonus (currently
equity based) determined primarily by reference to objective financial and
operating criteria, (iii) long-term equity incentives in the form of stock
options and other stock-based awards or grants, (iv) specified perquisites and
(v) benefits that are generally available to all of our
employees.




The
Compensation Committee has the responsibility to make and approve changes in the
total compensation of our executive officers, including the mix of compensation
elements. In making decisions regarding an executive’s total compensation, the
Compensation Committee considers whether the total compensation is (i) fair
and reasonable, (ii) internally appropriate based upon our culture and the
compensation of our other employees, and (iii) within a reasonable range of
the compensation afforded by other opportunities. The Compensation Committee
also bases its decisions regarding compensation upon its assessment of the
executive’s leadership, individual performance, years of experience, skill set,
level of commitment and responsibility required in the position, contributions
to our financial success, the creation of shareholder value, and current and
past compensation. In determining the mix of compensation elements, the
Compensation Committee considers the effect of each element in relation to total
compensation. Consistent with our desired culture of industry leading
performance and cost control, the Compensation Committee has attempted to keep
base salaries at moderate levels for companies within our market and total
capitalization and weight overall compensation toward incentive cash and
equity-based compensation. The Compensation Committee specifically considers
whether each particular element provides an appropriate incentive and reward for
performance that sustains and enhances long-term shareholder value. In
determining whether to increase or decrease an element of compensation, we rely
upon the Compensation Committee’s judgment concerning the contributions of each
executive and, with respect to executives other than the CEO, we consider the
recommendations of the CEO. We generally do not rely on rigid formulas (other
than performance measures under our annual cash bonus program) or short-term
changes in business performance when setting
compensation.


40




Pursuant
to the requirements of the Securities and Exchange Commission which requires
that we provide our shareholders with a copy of the Compensation Committee
Charter at least once every three years, we have included a copy of the
Committee Charter as Appendix D to our proxy statement for our 2010 Annual
Meeting filed with the SEC on February 19, 2010.





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 of Onstream and its
subsidiaries,




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




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




Mr.  Silva is currently the
sole member of the Finance Committee. The Finance Committee met in fiscal 2010
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.  An updated copy of our Corporate Governance and
Nominating Committee Principles was included as Appendix A to the proxy
statement for our 2008 and 2009 Annual Meeting of Stockholders filed with the
SEC on January 28, 2009.





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.




41




The
Governance and Nominating Committee has not yet had the occasion to, but will,
consider properly submitted proposed nominations by stockholders who are not one
of our directors, officers, or employees. These nominations will be evaluated on
the same basis as candidates proposed by any other person. A stockholder may
nominate a person for election as a director at an annual meeting of the
stockholders only if such stockholder gives written notice to our Corporate
Secretary as described in the applicable proxy statement for the previous year’s
annual meeting of stockholders. Each written notice must set forth, as to each
person whom the stockholder proposes to nominate for election as a director,
(i) all information relating to such person that is required to be
disclosed in solicitations of proxies for election of directors in an election
contest, or that is otherwise required, in each case pursuant to and in
accordance with Regulation 14A under the Securities Exchange Act of 1934, as
amended, and (ii) such person’s written consent to being named in the proxy
statement as a nominee and to serve as a director if elected. Each written
notice must also set forth, as to the stockholder making such nomination,
(i) the name and address of such stockholder, as they appear on our books,
(ii) the class and number of shares of our stock which are owned by such
stockholder, (iii) a representation that the stockholder is a holder of
record of our stock entitled to vote at such meeting and intends to appear in
person or by proxy at the meeting to propose such nomination, and (iv) a
representation whether the stockholder intends or is a part of a group which
intends (y) to deliver a proxy statement and/or form of proxy to holders of
at least the percentage of our outstanding capital stock required to elect the
nominee and/or (z) otherwise to solicit proxies from stockholders in
support of such nomination. We will evaluate the suitability of potential
candidates nominated by stockholders in the same manner as other candidates
identified to the Governance and Nominating Committee, including thespecific
minimum qualifications described below.





The
procedures for identifying candidates include a review of Onstream's current
directors, soliciting input from existing directors and executive officers, and
a review of submissions from stockholders, if any. Onstream’s management
believes that the Board should be composed of:





·
            directors
      chosen with a view to bringing to the Board a variety of experiences and
      backgrounds,




·
            directors
      who have high level managerial experience or are accustomed to dealing
      with complex problems,




·
            directors
      who will represent the balanced, best interests of the stockholders as a
      whole rather than special interest groups or constituencies, while also
      taking into consideration the overall composition and needs of the Board,
      and




·
            a
      majority of the Board's directors must be independent directors under the
      criteria for independence required by the Securities and Exchange
      Commission and the NASDAQ Stock
Market.




In
considering possible candidates for election as an outside director, the
Governance and Nominating Committee and other directors should be guided by the
foregoing general guidelines and by the following criteria:





·
            Each
      director should be an individual of the highest character and integrity,
      have experience at (or demonstrated understanding of)
      strategy/policy-setting and a reputation for working constructively with
      others.




·
            Each
      director should have sufficient time available to devote to our affairs in
      order to carry out the responsibilities of a
  director.




42




·
            Each
      director should be free of any conflict of interest, which would interfere
      with the proper performance of the responsibilities of a
      director.




·
            The
      Chief Executive Officer is expected to be a director. Other members of
      senior management may be considered, but Board membership is not necessary
      or a prerequisite to a higher management
  position.




The Governance and Nominating Committee
is presently composed of Messrs. Nowalsky (chairman), Johnston and Silva, who
are each "independent" as independence for nominating committee members is
defined within the NASDAQ Listing Rules. The Governance and Nominating Committee
met in fiscal 2010 in conjunction with meetings of the full Board of
Directors.


Code
of Business Conduct and 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
personnel shall be accorded full access to our President and to our Chief
Financial Officer, with respect to any matter that may arise relating to the
Code of Business Conduct and Ethics. Further, all of ourpersonnel are to be
accorded full access to our Board of Directors if any such matter involves an
alleged breach of the Code of Business Conduct and Ethics by our President or by
our 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 President or our
Chief Financial Officer.  If the incident involves an alleged breach
of the Code of Business Conduct and Ethics by our President or by our 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 policy to retaliate against any individual who reports in good faith
the violation or potential violation of our Code of Business Conduct and Ethics
by another.
 
 Our Code of Business Conduct and Ethics
is included as Exhibit 14.1 to this annual report. We will provide a copy of our
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.


43





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, 2010 and Forms 5 and amendments thereto
furnished to us with respect to the fiscal year ended September 30, 2010, 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,
2010, other than indicated below.





Randy
Selman, our CEO and Chairman of the Board and Alan Saperstein, our COO and one
of our directors, have not filed a Form 4 on a timely basis related to 44,958
options granted each of them on December 17, 2009 (as replacement for expiring
options – See Item 11 – Executive Compensation). Mr. Selman and Mr. Saperstein
have represented to us that they will file these forms as soon as
practicable.





Charles
Johnston, one of our directors, and Robert Wussler, a former director, have not
filed a Form 4 on a timely basis related to 9,991 options granted to each of
them on December 17, 2009 (as replacement for expiring options – See Item 10 –
Director Compensation table). Mr. Johnston has represented to us that he will
file this form as soon as practicable. Mr. Wussler passed away on June 5,
2010.




44




ITEM
11.            EXECUTIVE
COMPENSATION





Summary
Compensation Table


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
in total compensation during the most recent fiscal year (collectively, the
“Named Executive Officers”):





Total
compensation as presented in the following table includes cash and non-cash
elements. The most significant non-cash element is the value assigned to options
based on the Black-Scholes model, which options as discussed in footnotes 11, 12
and 13 below had strike prices that significantly exceeded the fair value of our
shares as of September 30, 2010 and 2009, respectively and thus at those dates
were what is commonly described as “under water”. See footnote 16 below for a
table that presents the cash and non-cash elements of compensation for the years
ended September 30, 2010 and 2009:





SUMMARY
COMPENSATION TABLE





STOCK
                                                              
                                                              
                                                              OPTION
                                                              
                                                              ALL
      OTHER
                                                              
                                                              TOTALNAME
      AND
                                                              
                                                              FISCAL
                                                              
                                                              
                                                              
                                                              BONUS
                                                              
                                                              
                                                              AWARDS
                                                              
                                                              
                                                              AWARDS
                                                              
                                                              COMPENSATION
                                                              
                                                              COMPENSATIONPRINCIPAL POSITION
                                                              
                                                              YEAR
                                                              
                                                              SALARY ($)
                                                              
                                                              ($)
                                                              
                                                              
                                                              ($)
                                                              
                                                              
                                                              ($)
                                                              
                                                              ($)
      (14)
                                                              
                                                              ($)(16)Randy
      S. Selman
                                                              
                                                              2010
                                                              
                                                              $
      271,751
                                                              (15)
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              $
      45,736(12)
                                                              
                                                              $
      55,760(1)
                                                              
                                                              $
      373,247President,
      Chief
                                                              
                                                              2009
                                                              
                                                              $
      287,687
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              $
      83,809(11)
                                                              
                                                              $
      55,421(2)
                                                              
                                                              $
      426,917Executive
      Officerand
      DirectorAlan
      Saperstein
                                                              
                                                              2010
                                                              
                                                              $
      247,047
                                                              (15)
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              $
      45,736(12)
                                                              
                                                              $
      59,660(3)
                                                              
                                                              $
      352,443Chief
      Operating
                                                              
                                                              2009
                                                              
                                                              $
      261,534
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              $
      83,809(11)
                                                              
                                                              $
      59,591(4)
                                                              
                                                              $
      404,934Officer
      and DirectorRobert
      Tomlinson
                                                              
                                                              2010
                                                              
                                                              $
      230,667
                                                              (15)
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              $
      61,601(5)
                                                              
                                                              $
      292,268Chief
      Financial
                                                              
                                                              2009
                                                              
                                                              $
      244,194
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              $
      28,162(13)
                                                              
                                                              $
      62,642(6)
                                                              
                                                              $
      334,998OfficerClifford
      Friedland
                                                              
                                                              2010
                                                              
                                                              $
      219,536
                                                              (15)
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              $
      61,552(7)
                                                              
                                                              $
      281,088Senior
      VP - Busi-
                                                              
                                                              2009
                                                              
                                                              $
      232,410
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              $
      62,934(8)
                                                              
                                                              $
      295,344ness
      DevelopmentDavid
      Glassman
                                                              
                                                              2010
                                                              
                                                              $
      219,536
                                                              (15)
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              $
      55,783(9)
                                                              
                                                              $
      275,319Senior
      VP -
                                                              
                                                              2009
                                                              
                                                              $
      232,410
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              
                                                              -0-
                                                              
                                                              $
      55,722(10)
                                                              
                                                              $
      288,132Marketing





(1)
              Includes
      $17,452 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $21,308 for retirement savings and 401(k)
      match.
  (2)
              Includes
      $16,826 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $21,595 for retirement savings and 401(k)
      match.
  (3)
              Includes
      $24,660 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $18,000 for retirement
    savings.
  (4)
              Includes
      $24,591 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $18,000 for retirement
    savings.
  (5)
              Includes
      $23,718 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $20,883 for retirement savings and 401(k)
      match.
 45


(6)
              Includes
      $24,591 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $21,051 for retirement savings and 401(k)
      match.
  (7)
              Includes
      $23,718 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $20,834 for retirement savings and
      401(k) match.
  (8)
              Includes
      $24,591 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $21,343 for retirement savings and
      401(k) match.
  (9)
              Includes
      $16,552 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $22,231 for retirement savings and 401(k)
      match.
  (10)
              Includes
      $16,826 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $21,896 for retirement savings and 401(k)
      match.


(11)
              On
      August 11, 2009, our Compensation Committee granted 133,334 fully vested
      five-year Plan Options (66,667 each) to Messrs. Selman and Saperstein in
      exchange for the cancellation of an equivalent number of fully vested Non
      Plan Options held by them and expiring in September 2009, with no change
      in the $15.00 exercise price, which was in excess of the market value of
      an ONSM share as of August 11, 2009. Furthermore, the quoted market value
      of an ONSM share was $2.46 per share as of September 30, 2009. As a result
      of this cancellation and the corresponding issuance, we recognized
      non-cash compensation expense of approximately $110,198 ($55,099 each) for
      the year ended September 30, 2009, which represented the full valuation of
      the related options using the Black-Scholes
  model.


On August
11, 2009, our Compensation Committee granted 60,084 fully vested five-year Plan
Options (30,042 each) to Messrs. Selman and Saperstein in exchange for the
cancellation of an equivalent number of fully vested Non Plan Options held by
them and expiring in December 2009, with no change in the $9.42 exercise price,
which was in excess of the market value of an ONSM share as of August 11, 2009.
Furthermore, the quoted market value of an ONSM share was $2.46 per share as of
September 30, 2009. As a result of this cancellation and the corresponding
issuance, we recognized non-cash compensation expense of approximately $57,420
($28,710 each) for the year ended September 30, 2009, which represented the full
valuation of the related options using the Black-Scholes
model.


(12)
              On
      December 17, 2009, our Compensation Committee granted 89,916 fully vested
      five-year Plan Options (44,958 each) to Messrs. Selman and Saperstein in
      exchange for the cancellation of an equivalent number of fully vested Non
      Plan Options held by them and expiring in December 2009, with no change in
      the $9.42 exercise price, which was in excess of the market value of an
      ONSM share as of the grant date. Furthermore, the quoted market value of
      an ONSM share was $1.04 per share as of September 30, 2010. As a result of
      this cancellation and the corresponding issuance, we recognized non-cash
      compensation expense of approximately $91,472 ($45,736 each) for the year
      ended September 30, 2010, which represented the full valuation of the
      related options using the Black-Scholes
model.
  (13)
              On
      August 11, 2009, our Compensation Committee granted 25,000 fully vested
      five-year Plan Options to Mr. Tomlinson as a replacement of an equivalent
      number of fully vested Plan Options held by him and expiring in July 2009,
      with no change in the $7.26 exercise price, which was in excess of the
      market value of an ONSM share as of August 11, 2009. Furthermore, the
      quoted market value of an ONSM share was $2.46 per share as of September
      30, 2009. As a result of this issuance, we recognized non-cash
      compensation expense of approximately $28,162 for the year ended September
      30, 2009, which represented the full valuation of the related options
      using the Black-Scholes model.
  (14)
              The
      Named Executive Officers did not receive non-equity incentive plan
      compensation or compensation from changes in pension value and
      nonqualified deferred compensation earnings during the periods covered by
      the above table.
 46


(15)
              Effective
      October 1, 2009, a significant portion of our workforce, including the
      Named Executive Officers, took a 10% payroll reduction, which we expect
      will be maintained until increased revenue levels result in positive cash
      flow (sufficient to cover capital expenditures and debt service). However,
      even though this 10% was deducted from the amounts paid to the Named
      Executive Officers, no adjustment was made to the provisions of their
      related employment agreements, as set forth below. With respect to the
      Named Executive Officers, this 10% reduction represented approximately
      $132,000 in aggregate compensation reduction as of and for the year ended
      September 30, 2010. This unpaid amount is not reflected as compensation in
      the table above nor was it accrued on our books as of or for the year
      ended September 30, 2010. We believe that the eventual resolution of this
      matter will not result in a material adverse effect on our financial
      position or results of operations.
  (16)
              Below
      is a table that presents the cash and non-cash elements of compensation
      for the years ended September 30, 2010 and
2009:


For the year ended September
30, 2010:


CashCompensation
                    
                    
                    Non-CashCompensationRandy
      S. Selman
                    
                    $
                    327,511
                    
                    
                    $
                    45,736Alan
      Saperstein
                    
                    $
                    306,707
                    
                    
                    $
                    45,736Robert
      Tomlinson
                    
                    $
                    292,268
                    
                    
                    $
                    -Clifford
      Friedland
                    
                    $
                    281,088
                    
                    
                    $
                    -David
      Glassman
                    
                    $
                    275,319
                    
                    
                    $
                    -





For the year ended September
30, 2009:


CashCompensation
                  
                  
                  Non-CashCompensationRandy
      S. Selman
                  
                  $
                  343,108
                  
                  
                  $
                  83,809Alan
      Saperstein
                  
                  $
                  321,125
                  
                  
                  $
                  83,809Robert
      Tomlinson
                  
                  $
                  306,836
                  
                  
                  $
                  28,162Clifford
      Friedland
                  
                  $
                  295,344
                  
                  
                  $
                  -David
      Glassman
                  
                  $
                  288,132
                  
                  
                  $
                  -





Employment
Agreements





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





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


47





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





As part
of the above employment agreements, the Executives were eligible for a
performance bonus, based on meeting revenue and cash flow objectives. In
connection with this bonus program, our Compensation Committee and Board of
Directors granted Plan Options to each of the Executives to purchase an
aggregate of 36,667 shares of ONSM common stock at an exercise price of $10.38
per share, the fair market value at the date of the grant, exercisable for a
period of four (4) years from the date of vesting.





The
performance objectives were met for the quarter ended December 31, 2007 but they
were not met for the remaining three quarters of fiscal 2008 nor were they met
for the fiscal year ended September 30, 2008. The performance objectives were
met for the quarter ended June 30, 2009 but they were not met for the remaining
three quarters of fiscal 2009 nor were they met for the fiscal year ended
September 30, 2009. Therefore, an aggregate of 4,583 options out of a potential
36,667 performance options vested for each Executive during fiscal year 2008 and
2009, with the remainder expiring. In the event the agreement is not renewed or
the Executive is terminated other than for cause, the Executive shall be
entitled to require us to register the vested options.





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





This
program was subject only to the approval by our shareholders of a sufficient
increase in the number of authorized 2007 Plan options, which occurred in the
March 25, 2010 shareholder meeting. However, the granting and pricing of the
above performance bonus options by the Board is still pending, subject to
further discussions between the Board and the Executives. Furthermore, although
the performance objectives were met for the third quarter of fiscal 2010, we
have not recognized any related compensation expense on our financial statements
as of September 30, 2010 since the amount is not yet determinable. However, we
do not expect this compensation amount, once determined, to be material to our
financial results.


48




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





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





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





The above
description is qualified in its entirety by the terms and conditions of the
employment agreements.




49




Outstanding
Equity Awards at Fiscal Year-End Table





The following table sets forth certain
information regarding stock options held as of September 30, 2010 by the Named
Executive Officers. There were no outstanding stock awards held by them as of
that date:





EQUITYINCENTIVEPLANAWARDS:NUMBER OFSECURITIESNUMBER OF SECURITIES
                                                                                    
                                                                                    
                                                                                    UNDERLYINGUNDERLYING UNEXERCISED
                                                                                    
                                                                                    
                                                                                    UNEXERCISED
                                                                                    
                                                                                    OPTIONOPTIONS (#)
                                                                                    
                                                                                    
                                                                                    UNEARNED
                                                                                    
                                                                                    EXERCISE
                                                                                    
                                                                                    OPTION EXPIRATIONNAME
                                                                                    
                                                                                    EXERCISABLE
                                                                                    
                                                                                    
                                                                                    UNEXERCISABLE
                                                                                    
                                                                                    
                                                                                    OPTIONS (#)
                                                                                    
                                                                                    PRICE ($)
                                                                                    
                                                                                    DATERandy
      Selman (5)
                                                                                    
                                                                                    
                                                                                    16,666
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    4.26
                                                                                    
                                                                                    9/29/201144,958
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    9.42
                                                                                    
                                                                                    12/17/201430,042
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    9.42
                                                                                    
                                                                                    8/11/201466,667
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    15.00
                                                                                    
                                                                                    8/11/201450,000
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    9/28/2012–
      9/28/201527,500
                                                                                    (2)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    12/31/2011–6/30/2013Alan
      Saperstein (5)
                                                                                    
                                                                                    
                                                                                    16,666
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    4.26
                                                                                    
                                                                                    9/29/201144,958
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    9.42
                                                                                    
                                                                                    12/17/201430,042
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    9.42
                                                                                    
                                                                                    8/11/201466,667
                                                                                    (3)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    15.00
                                                                                    
                                                                                    8/11/201450,000
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    9/28/2012–
      9/28/201527,500
                                                                                    (2)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    12/31/2011–6/30/2013Cliff
      Friedland (5)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    4.26
                                                                                    
                                                                                    9/29/201114,810
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    20.26
                                                                                    
                                                                                    7/1/201250,000
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    9/28/2012–
      9/28/201527,500
                                                                                    (2)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    12/31/2011–6/30/2013David
      Glassman (5)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    4.26
                                                                                    
                                                                                    9/29/201114,810
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    20.26
                                                                                    
                                                                                    7/1/201250,000
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    9/28/2012–
      9/28/201527,500
                                                                                    (2)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    12/31/2011–6/30/2013Robert
      Tomlinson (5)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    4.26
                                                                                    
                                                                                    9/29/201125,000
                                                                                    (4)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    7.26
                                                                                    
                                                                                    8/11/201450,000
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    16,667
                                                                                    (1)
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    9/28/2012–
      9/28/201527,500
                                                                                    (2)
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    
                                                                                    $
                                                                                    10.38
                                                                                    
                                                                                    12/31/2011–6/30/2013





(1)
              Vesting
      of these Plan options is based on years of service. These vesting
      conditions are discussed in detail under “Employment Agreements”
      above.
 (2)
              Vesting
      of these Plan options was based on achieving certain financial objectives.
      These vesting conditions are discussed in detail under “Employment
      Agreements” above.
 (3)
              These
      Plan options were issued in exchange for cancellation of an equivalent
      number of expiring Non-Plan options – see discussion in footnotes to
      Summary Compensation table above.
 (4)
              These
      Plan options were issued in exchange for an equivalent number of expiring
      Plan options – see discussion in footnotes to Summary Compensation table
      above.
 (5)
              The
      executive’s employment agreement provides that under certain
      circumstances, all options previously granted the executive will be
      cancelled, with all underlying shares (vested or unvested) issued to the
      executive, and we will pay all taxes for the executive. These conditions
      are discussed in detail under “Employment Agreements”
    above.


50




1996
Stock Option Plan and 2007 Equity Incentive Plan
 On February 9, 1997, our Board of
Directors and a majority of our shareholders adopted our 1996 Stock Option Plan
(the "1996 Plan").  Pursuant to an amendment to the 1996 Plan ratified
by our shareholders on September 13, 2005, we reserved an aggregate of 750,000
shares of common stock for issuance pursuant to options granted under the 1996
Plan ("Plan Options") and 333,333 shares for restricted stock grants (“Stock
Grants”) made under the 1996 Plan.  At September 30, 2010, there were
unexercised options to purchase 229,500 shares of our common stock outstanding
under the 1996 Plan.  Such options were issued to our directors,
employees and consultants at exercise prices ranging from $4.26 to $15.00 per
share. Since the provisions of the 1996 Plan call for its termination 10 years
from the date of its adoption, we may no longer issue additional options or
stock grants under the 1996 Plan. However, the termination of the 1996 Plan on
February 9, 2007 did not affect the validity of any Plan Options previously
granted thereunder.
 On September 18, 2007, our Board of
Directors and a majority of our shareholders adopted the 2007 Equity Incentive
Plan (the “2007 Plan”), which authorized the issuance of up to 1,000,000 shares
of ONSM common stock pursuant to stock options, stock purchase rights, stock
appreciation rights and/or stock awards for employees, directors and
consultants. The options and stock grants authorized for issuance under the 2007
Plan were in addition to those already issued under the 1996 Plan, although as
discussed above we may no longer issue additional options or stock grants under
the 1996 Plan. On March 25, 2010, our Board of Directors and a majority of our
shareholders approved a 1,000,000 increase in the number of shares authorized
for issuance under the 2007 Plan, for total authorization of 2,000,000 shares.
At September 30, 2010, there were unexercised options to purchase 941,343 shares
of our common stock outstanding under the 2007 Plan.  Such options
were issued to our directors, employees and consultants at exercise prices
ranging from $3.00 to $20.26 per share.


The
stated purpose of the 1996 Plan and the 2007 Plan (“the Plans”) is to increase
our employees', advisors', consultants' and non-employee directors' proprietary
interest in our 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 Plans are 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.
All other questions relating to the administration of the Plans, and the
interpretation of the provisions thereof, are to be resolved at the sole
discretion of our Board of Directors or the Committee.


Plan Options granted under the Plans
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 1996 Plan also allowed 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 1996 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.
 51


The term
of each Plan Option and the manner in which it may be exercised is determined by
our 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 Plans 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.
 
 The per
share purchase price of shares subject to Plan Options granted under the Plans
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 Plans.  Officers,
directors and employees of and consultants to us and our subsidiaries are
eligible to receive Non-Qualified Options under the Plans.  Only such
individuals 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 Plans at any time, except that
no amendment shall be made which (i) increases the total number of shares
subject to the Plans 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 dates of the
Plans.
 
 Unless
the 2007 Plan has been earlier suspended or terminated by the Board of
Directors, the 2007 Plan shall terminate 10 years from the date of the 2007
Plan’s adoption.  Any such termination of the 2007 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 Plans are therefore not
ascertainable. On December 23, 2010, the closing price of our common stock as
reported on The NASDAQ Capital Market was $0.76 per share.





ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS





The following table contains
information regarding beneficial ownership of our common stock as of December
10, 2010 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.




52


Unless otherwise indicated, the address
of each of the listed beneficial owners identified is c/o Onstream Media
Corporation, 1291 Southwest 29th 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 December 10, 2010 upon exercise of options,
warrants, convertible securities or other rights to receive our common shares.
Each beneficial owner's percentage of ownership is determined by assuming that
options, warrants, convertible securities or other rights to receive our common
shares 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 received from our transfer agent as of December 10, 2010.
At that date, approximately 83% of our outstanding shares were held by CEDE
& Co., which is accounted for as a single shareholder of record for multiple
beneficial owners. 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)
                    
                    
                    237,492
                    
                    
                    
                    2.6
                    %Alan
      M. Saperstein (2)
                    
                    
                    237,806
                    
                    
                    
                    2.6
                    %Clifford
      Friedland (3)
                    
                    
                    232,883
                    
                    
                    
                    2.6
                    %David
      Glassman (4)
                    
                    
                    232,855
                    
                    
                    
                    2.6
                    %Robert
      E. Tomlinson (5)
                    
                    
                    119,167
                    
                    
                    
                    1.3
                    %Charles
      C. Johnston (6)
                    
                    
                    103,973
                    
                    
                    
                    1.2
                    %Carl
      L. Silva
                    
                    
                    -
                    
                    
                    
                    0.0
                    %Leon
      Nowalsky (7)
                    
                    
                    8,333
                    
                    
                    
                    0.1
                    %All
      directors and officers as a group (eight persons) (8)
                    
                    
                    1,172,509
                    
                    
                    
                    12.0
                    %Austin
      Lewis (9)
                    
                    
                    949,133
                    
                    
                    
                    10.7
                    %





(1)           Includes
1,659 shares of our common stock presently outstanding, options to acquire
16,666 common shares at $4.26 per share, options to acquire 75,000 common shares
at $9.42 per share, options to acquire 77,500 common shares at $10.38 per share
and options to acquire 66,667 common shares at $15.00 per share.




(2)           Includes
1,973 shares of our common stock presently outstanding, options to acquire
16,666 common shares at $4.26 per share, options to acquire 75,000 common shares
at $9.42 per share, options to acquire 77,500 common shares at $10.38 per share
and options to acquire 66,667 common shares at $15.00 per share.




(3)           Includes
74,538 shares of our common stock presently outstanding, 24,684 shares of our
common stock held by Titan Trust, 24,684 shares of our common stock held by
Dorado Trust, options to acquire 16,667 common shares at $4.26 per share,
options to acquire 77,500 common shares at $10.38 per share and options to
acquire 14,810 common shares at $20.26 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.




(4)           Includes
74,510 shares of our common stock presently outstanding, 24,684 shares of our
common stock held by Titan Trust, 24,684 shares of our common stock held by
Dorado Trust, options to acquire 16,667 common shares at $4.26 per share,
options to acquire 77,500 common shares at $10.38 per share and options to
acquire 14,810 common shares at $20.26 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.




(5)           Includes
options to acquire 16,667 common shares at $4.26 per share, options to acquire
25,000 common shares at $7.26 per share and options to acquire 77,500 common
shares at $10.38 per share.




53




(6)           Includes
4,167 shares of our common stock presently outstanding, 73,203 shares of our
common stock held by J&C Resources, LLC, 1,603 shares of our common stock
held by Asset Factoring, Ltd., options to acquire 8,333 ONSM common shares at
$4.26 per share and options to acquire 16,667 ONSM common shares at $9.42 per
share.  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.




(7)           Includes
options to acquire 8,333 ONSM common shares at $6.00 per share.




(8)           See
footnotes (1) through (7) above.




(9)           Includes
944,758 shares of our common stock presently outstanding and warrants to acquire
4,375 common shares at $9.00 per share. These shares of common stock are as
reported on a Form 13G/A filed by Lewis Asset Management on January 5, 2009 and
attributing beneficial ownership of 777,508 shares to Lewis Opportunity Fund and
beneficial ownership of 167,250 shares to LAM Opportunity Fund, Ltd. Mr. Lewis
is the control person and beneficial owner of these entities and exercises sole
voting and dispositive powers over these shares.





Mr. Fred
Deluca has beneficial ownership of 437,311 shares as of December 10, 2010, which
includes the 420,645 shares of our common stock issuable upon conversion of a
portion of a note (the “Rockridge Note”) held by Rockridge Capital Holdings, LLC
(“Rockridge”) and options to acquire 16,666 ONSM common shares at $14.76 per
share. Mr. Deluca is the control person and beneficial owner of Rockridge and
exercises sole voting and dispositive powers over these shares. These 437,311
shares represent approximately 4.7% beneficial ownership, which is less than the
5% threshold for inclusion of Mr. Deluca in the beneficial ownership table
above. However, in connection with the transaction giving rise to the Rockridge
Note, Rockridge may also receive an origination fee upon not less than sixty-one
(61) days written notice to us, payable by our issuance of 366,667 restricted
ONSM common shares. Based on the 60 day threshold discussed above, these shares
are not considered to be beneficially owned by Rockridge or Mr. Deluca as of
December 10, 2010. However, if these 366,667 shares were added to the 437,311
which are considered beneficially owned by Mr. Deluca as of that date, the
combined total of 803,978 shares would represent 8.3% beneficial
ownership.





Upon
notice from Rockridge at any time and from time to time prior to the Maturity
Date up to $500,000 (representing the balloon payment of the outstanding
principal of the Rockridge Note) plus 50% of the remaining outstanding balance
of the Rockridge Note (excluding the balloon payment) may be converted into a
number of restricted shares of ONSM common stock. The conversion will use a
conversion price of eighty percent (80%) of the fair market value of the average
closing bid price for ONSM common stock for the twenty (20) days of trading on
The NASDAQ Capital Market (or such other exchange or market on which ONSM common
shares are trading) prior to such Rockridge notice, but such conversion price
will not be less than $2.40 per share.  We will not effect any
conversion of the Rockridge Note, to the extent Rockridge and Frederick DeLuca,
after giving effect to such conversion, would beneficially own in excess of 9.9%
of our outstanding common stock (the “Beneficial Ownership
Limitation”).  The Beneficial Ownership Limitation may be waived by
Rockridge upon not less than sixty-one (61) days prior written notice to us
unless such waiver would result in a violation of the NASDAQ shareholder
approval rules. The minimum conversion price of $2.40 per share would result in
the issuance of 420,645 common shares upon the conversion of the $500,000
balloon plus $509,548, which is 50% of the remaining outstanding balance of the
Rockridge Note as of December 10, 2010 (excluding the balloon
payment).




Lincoln Park Capital Fund, LLC (“LPC”)
has beneficial ownership of 420,000 shares of our common stock issuable upon
conversion of Series A-14 held by it. They also own warrants to acquire 540,000
ONSM common shares at $2.00 per share, although they are not exercisable until
March 24, 2011. These 960,000 shares from conversion of Series A-14 and exercise
of warrants, if available to LPC, would represent approximately 9.7% beneficial
ownership as of December 10, 2010. However, the number of shares of ONSM common
stock that can be issued upon the conversion of Series A-14 and/or the exercise
of the warrants is limited to the extent necessary to ensure that following the
conversion and/or exercise the total number of shares of ONSM common stock
beneficially owned by the holder does not exceed 4.999% of our issued and
outstanding common stock, although this percentage may be changed at the
holder’s option upon not less than 61 days advance notice to us and provided the
changed limitation does not exceed 9.99%. This 4.999% limitation is less than
the 5% threshold for inclusion of LPC in the beneficial ownership table
above.


54





Securities Authorized for Issuance
Under Equity Compensation Plans -See Item 5 - Market For Registrant’s
Common Equity, Related Stockholder Matters And Issuer Purchases Of Equity
Securities.





ITEM
      13.
            CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE





Certain
relationships and related transactions





In
November 2006, we entered into a three-year consulting contract with the
principal and beneficial owner of SBV Capital Corporation, for the provision of
international business development and financial advice. The contract, which was
cancellable upon thirty days notice after the first year, called for the
issuance of 10,000 restricted common shares in advance every six months. The
first two tranches under this contract (10,000 shares each) were issued in
January and May 2007. This contract was amended in July 2007 for some additional
short-term services, resulting in issuance of an additional 2,500 shares plus
$22,425 for cash reimbursement of related travel expenses. This contract was
amended again in October 2007, which resulted in the issuance of the remaining
40,000 restricted common shares, in exchange for the extension of the remaining
term of the contract from two years to three years.





In
December 2007, we entered into a line of credit arrangement (the “Line”) with a
financial institution (the “Lender”) under which we could borrow up to an
aggregate of $1.0 million for working capital, collateralized by our accounts
receivable and certain other related assets. In August 2008 the maximum
allowable borrowing amount under the Line was increased to $1.6 million and in
December 2009 this amount was again increased to $2.0 million. The outstanding
balance bears interest at 13.5% per annum, adjustable based on changes in prime
after December 28, 2009 (was prime plus 8% per annum through December 2, 2008
and prime plus 11% from that date through December 28, 2009), payable monthly in
arrears. Effective December 28, 2009, we also incur a weekly monitoring fee of
one twentieth of a percent (0.05%) of the borrowing limit, payable monthly in
arrears. We paid initial origination and commitment fees in December 2007
aggregating $20,015, an additional commitment fee in August 2008 of $6,000
related to the increase in the lending limit for the remainder of the year, a
commitment fee of $16,000 in December 2008 related to the continuation of the
increased Line for an additional year and a commitment fee of $20,000 in
December 2009 related to the continuation of the Line for an additional year as
well as an increase in the lending limit. An additional commitment fee of one
percent (1%) of the maximum allowable borrowing amount will be due for any
subsequent annual renewal after December 28, 2010. These origination and
commitment fees are recorded by us as debt discount and amortized as interest
expense over the remaining term of the loan. Mr. Leon Nowalsky, a member of our
Board of Directors, is also a founder and board member of the
Lender.





During
fiscal 2009 we received $1.5 million from Rockridge Capital Holdings, LLC
(“Rockridge”), an entity controlled by Mr. Fred Deluca, one of our largest
shareholders, in accordance with the terms of a Note and Stock Purchase
Agreement that we entered into with Rockridge dated April 14, 2009 and which was
amended on September 14, 2009. We also received another $500,000 under the Note
and Stock Purchase Agreement on October 20, 2009, resulting in cumulative
allowable borrowings of $2.0 million. This transaction is secured by a first
priority lien on all of our assets, such lien subordinated only to the extent
higher priority liens on assets, primarily accounts receivable and certain
designated software and equipment, are held by certain of our other lenders and
is repayable in equal monthly installments through August 14, 2013, which
installments include principal plus interest at 12% per annum. The outstanding
principalamount,
or portions thereof, are convertible into our common stock under certain
conditions (using a minimum conversion price of $2.40 per share) and the Note
and Stock Purchase Agreement also provides that Rockridge may receive an
origination fee of 366,667 restricted ONSM common shares.


55




On
December 29, 2009, we entered into an agreement with CCJ Trust (“CCJ”) whereby
accrued interest on a previous $200,000 cash advance through that date of $5,808
was paid by us in cash and the $200,000 advance was converted to an unsecured
subordinated note payable (the “CCJ Note”) at a rate of 8% interest per annum in
equal monthly installments of principal and interest for 48 months plus a
$100,000 principal balloon at maturity, although none of those payments were
subsequently made by us. CCJ is a trust for the adult children of Mr. Charles
Johnston, one of our directors, and he disclaims any beneficial ownership
interest in CCJ. To resolve the payment default, the CCJ Note was amended in
January 2011 to prospectively increase the interest rate to 10% per annum,
payable quarterly, and to require two principal payments of $100,000 each on
December 31, 2011 and December 31, 2012, respectively. This amendment also
called for our cash payment of the previously accrued interest in the amount of
$16,263 on or before January 31, 2011. The remaining principal balance of the
CCJ Note may be converted at any time into our common shares at the greater of
(i) the previous 30 day market value or (ii) $2.00 per share (which was $3.00
per share prior to the January 2011 renegotiation). In conjunction with and in
consideration of the December 2009 note transaction, the 35,000 shares of Series
A-12 held by CCJ at that date were exchanged for 35,000 shares of Series A-13
plus four-year warrants for the purchase of 29,167 ONSM common shares at $3.00
per share. In conjunction with and in consideration of January 2011 note
transaction entered into by us with CCJ, it was agreed that certain terms of the
35,000 shares of Series A-13 held by CCJ at that date would be modified as
follows -  the conversion rate to common shares, as well as the
minimum conversion rate for payment of dividends in common shares, will be $2.00
per share, the maturity date will be December 31, 2012 and dividends will be
paid quarterly, in cash or, at our option, in unregistered shares. In addition
it was agreed that $28,000 in A-13 dividends for calendar 2010 would be
immediately paid by issuance of 14,000 unregistered common shares, using the
minimum conversion rate of $2.00 per share.




During
December 2009, we received funding commitment letters executed by three (3)
entities agreeing to provide us, within twenty (20) days after our notice given
on or before December 31, 2010, aggregate cash funding of $750,000. The
funding under the commitment letters would be in exchange for our equity under
mutually agreeable terms to be negotiated at the time of funding, or in the
event such terms could not be reached, in the form of repayable debt. Terms of
the repayable debt would also be subject to negotiation at the time of funding,
provided that, among other things, the debt would be unsecured and subordinated
and the rate of return on such debt, including cash and equity consideration
given, would not be greater than (i) a cash coupon rate of fifteen percent (15%)
per annum and a (ii) total effective interest rate of thirty percent (30%) per
annum. As consideration for these commitment letters, the issuing entities
received an aggregate of 12,500 unregistered shares. One of these funding
commitment letters, for $250,000, was executed by Mr. Charles Johnston, one of
our directors, who received 4,167 of the 12,500 shares.





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





Review,
approval or ratification of transactions with related persons





Prior to
us entering into any related person transaction, our Board of Directors reviews
the terms of the proposed transaction to ensure that they are fair and
reasonable, on market terms and on an arms-length basis. Legal or other counsel
is consulted as appropriate.





If a
related party transaction involves compensation or is otherwise related to an
employment relationship with us, the related party transaction will be reviewed
by the Compensation Committee. Related party transactions are reported to the
Audit Committee for their review and approval of the related
disclosure.





With
respect to transactions in which a director or executive officer or immediate
family member may have a direct or indirect material interest, only
disinterested members of the Board of Directors, the Compensation Committee
and/or the Audit Committee may vote on whether to approve the
transaction.




56




Director
independence





Rule 5605(b)(1) of the NASDAQ Listing
Rules to which we are subject requires that a majority of the members of our
board of directors are independent as defined in Rule 5605(a)(2) of the NASDAQ
Listing Rules. Our independent directors are Messrs. Johnston, Silva and
Nowalsky.


ITEM
14.           PRINCIPAL
ACCOUNTING FEES AND SERVICES


Change
in Independent Accountants





Goldstein
Lewin & Co. (“Goldstein Lewin”) served as our independent certifying
accountants since July 2002. Effective January 1, 2010, Goldstein Lewin
consummated a sale of its attest practice to Mayer Hoffman McCann P.C.
(“MHM”).  As a result, the Audit Committee of our Board of Directors
engaged MHM to serve as our new independent certifying accountants.


Audit
Fees


The
aggregate audit fees billed to us by Goldstein Lewin and MHM for professional
services rendered during the fiscal year ended September 30, 2010 were $221,707,
$126,707 by Goldstein Lewin for the audit of our annual financial statements
included in our Annual Report on Form 10-K for the fiscal year ended September
30, 2009 and the balance by MHM for the review of our quarterly financial
statements included in our quarterly reports on Form 10-Q for the quarters ended
December 31, 2009, and March 31 and June 30, 2010.





The
aggregate audit fees billed to us by Goldstein Lewin for professional services
rendered during the fiscal year ended September 30, 2009 were $259,977, for the
audit of our annual financial statements included in our Annual Report on Form
10-KSB for the fiscal year ended September 30, 2008 and for the review of our
quarterly financial statements included in our quarterly reports on Form 10-Q
for the quarters ended December 31, 2008, and March 31 and June 30,
2009.





Audit
Related Fees





The
aggregate fees billed to us by Goldstein Lewin and MHM 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 $23,202 and
$6,903 for the fiscal years ended September 30, 2010 and 2009, respectively. The
fiscal 2010 amount is primarily for MHM’s services rendered in connection with
our Form S-3/Shelf Registration first filed with the SEC on March 5, 2010,
declared effective by the SEC on April 30, 2010 and subsequently amended with a
supplement to the prospectus filed on September 24, 2010. The fiscal 2009 amount
is primarily for Goldstein Lewin’s services rendered in connection with our
joint Proxy/Form S-4 first filed with the SEC on September 23, 2008, and
subsequently withdrawn by us.





Tax
Fees





The
aggregate tax fees billed to us by Goldstein Lewin were $5,500 and $13,590 for
the fiscal years ended September 30, 2010 and 2009, 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 or MHM for
services rendered for the fiscal years ended September 30, 2010 or
2009.




57




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 and MHM and believes that the provision of services for
activities unrelated to the audit is compatible with maintaining Goldstein
Lewin’s and MHM’s independence.


58




PART
IV


ITEM
15.           EXHIBITS,
FINANCIAL STATEMENT SCHEDULES


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





Number
              
              Description2.1
              
              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)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
              
              Infinite
      Conferencing Merger Agreement dated March 26, 2007 (22)2.6.1
              
              Narrowstep
      Merger Agreement dated May 29, 2008 (25)2.6.2
              
              First
      Amendment to Narrowstep Merger Agreement dated May 29, 2008
      (27)2.6.2
              
              Second
      Amendment to Narrowstep Merger Agreement dated May 29, 2008
      (28)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 (15)3.1.15
              
              Articles
      of Amendment dated December 30, 2004, with regard to corporate name change
      (14)3.1.16
              
              Articles
      of Amendment dated February 7, 2005 with regard to the designations for
      Series A-10 Convertible Preferred Stock (16)3.1.17
              
              Articles
      of Amendment dated January 7, 2009 with regard to the designations for
      Series A-12 Redeemable Convertible Preferred Stock (21)3.1.18
              
              Articles
      of Amendment dated December 23, 2009 with regard to the designations for
      Series A-13 Convertible Preferred Stock (28)3.1.19
              
              Articles
      of Amendment dated April 5, 2010 with regard to reverse stock split
      (29)3.1.20
              
              Articles
      of Amendment dated June 17, 2010 with regard to the number of authorized
      shares (30)3.1.21
              
              Articles
      of Amendment dated September 22, 2010 with regard to the designations for
      Series A-14 Convertible Preferred Stock (31)3.2
              
              By-laws
      (1)


59




4.1
                
                Specimen
      Common Stock Certificate (1)4.2
                
                Form
      of $1.50 Warrant for Subordinated Secured Convertible Notes
      (21)4.3
                
                Form
      of 12% Convertible Secured Note (23)4.4
                
                12%
      Convertible Secured Note - Rockridge (17)4.5
                
                Allonge
      to 12% Convertible Secured Note – Rockridge (27)4.6
                
                Form
      of Promissory Note – Thermo Credit (28)10.1
                
                Form
      of 1996 Stock Option Plan and Amendment thereto (1)(3)10.2
                
                Form
      of 2007 Equity Incentive Plan (21)10.3
                
                Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Randy S. Selman (28)10.4
                
                Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Alan Saperstein (28)10.5
                
                Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Clifford Friedland (28)10.6
                
                Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and David Glassman (28)10.7
                
                Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Robert Tomlinson (28)10.8
                
                Form
      of Subscription Agreement used for sale of $11.0 million common shares -
      March 2007 (19)10.9
                
                Form
      of Subscription Agreement for 12% Convertible Secured Notes
      (23)10.10
                
                Form
      of Security Agreement for 12% Convertible Secured Notes
    (23)10.11
                
                Note
      and Stock Purchase Agreement for 12% Convertible Secured Note - Rockridge
      (17)10.12
                
                Security
      Agreement for 12% Convertible Secured Note - Rockridge
  (17)10.13
                
                First
      Amendment to Note and Stock Purchase Agreement for 12% Convertible Secured
      Note - Rockridge (27)10.14
                
                Commercial
      Business Loan Agreement – Thermo Credit (28)10.15
                
                Amendment
      to Agreements – Thermo Credit (28)10.16
                
                Second
      Amendment to Commercial Business Loan Agreement – Thermo Credit
      (28)10.17
                
                Security
      Agreement – Thermo Credit (28)10.18
                
                Purchase
      Agreement, dated as of September 17, 2010, by and between the Company and
      Lincoln Park Capital Fund, LLC (31)10.19
                
                Registration
      Rights Agreement, dated as of September 17, 2010, by and between the
      Company and Lincoln Park Capital Fund, LLC (31)10.20
                
                Form
      of Warrant to be issued to Lincoln Park Capital Fund, LLC
    (31)14.1
                
                Code
      of Business Conduct and Ethics (12)14.2
                
                Corporate
      Governance and Nominating Committee Principles (27)14.3
                
                Audit
      Committee Charter (20)


60




14.4
                
                Compensation
      Committee Charter (20)21.1
                
                Subsidiaries
      of the registrant23.1
                
                Consent
      of Independent Registered Public Accounting Firm - MHM23.2
                
                Consent
      of Independent Registered Public Accounting Firm – Goldstein
      Lewin31.1
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Executive
    Officer31.2
                
                Rule
      13a-14(a)/15d-14(a) Certification of Chief Financial
    Officer32.1
                
                Section
      906 Certification of Chief Executive Officer32.2
                
                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 on
      January 4, 2005.
 (15)
              Incorporated
      by reference to the registrant’s current report on Form 8-K/A filed on
      January 4, 2005.
 (16)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed February
      11, 2005.
 (17)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed April
      20, 2009.
 (18)
              Incorporated
      by reference to the registrant's current report on Form 8-K/A filed April
      3, 2006.
 (19)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed March
      28, 2007.
 (20)
              Incorporated
      by reference to the registrant’s proxy statement for the 2010 Annual
      Meeting filed with the SEC on February 19,
2010.
 (21)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed January
      7, 2009.
 (22)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed June 2,
      2008.
 (23)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed June 6,
      2008.
 (24)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed August
      15, 2008.
 (25)
              Incorporated
      by reference to the registrant's current report on Form 8-K/A filed
      September 19, 2008.
 (26)
              Incorporated
      by reference to the registrant's Proxy Statement for the 2008 and 2009
      Annual Shareholders Meeting filed on January 28,
  2009.
 (27)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed
      September 18, 2009.
 (28)
              Incorporated
      by reference to the registrant’s Annual Report on Form 10-K for the year
      ended September 30, 2009.
  61
  (29)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed April 6,
      2010.
 (30)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed June 18,
      2010.
 (31)
              Incorporated
      by reference to the registrant's current report on Form 8-K filed
      September 23, 2010.


62


SIGNATURES


Pursuant to the requirements of Section
13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.


Onstream
      Media Corporation (Registrant)By:
                      /s/ Randy S. SelmanRandy
      S. SelmanPresident,
      Chief Executive OfficerDate:
      January 7, 2011By:
                      /s/ Robert E. TomlinsonRobert
      E. TomlinsonChief
      Financial OfficerDate:
      January 7,
2011





Pursuant
to the requirements of the Securities Exchange Act of 1934, 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
                                      
                                      DateBy: /s/ Randy S. Selman
                                      
                                      Director,
      President,
                                      
                                      January
      7, 2011Randy
      S. Selman
                                      
                                      Chief
      Executive OfficerBy: /s/ Robert E. Tomlinson
                                      
                                      Chief
      Financial Officer and
                                      
                                      January
      7, 2011Robert
      E. Tomlinson
                                      
                                      Principal
      Accounting OfficerBy: /s/ Alan Saperstein
                                      
                                      Director
      and Chief
                                      
                                      January
      7, 2011Alan
      Saperstein
                                      
                                      Operating
      OfficerBy: /s/ Charles C. Johnston
                                      
                                      Director
                                      
                                      January
      7, 2011Charles
      C. JohnstonBy: /s/ Carl Silva
                                      
                                      Director
                                      
                                      January
      7, 2011Carl
      SilvaBy: /s/ Leon Nowalsky
                                      
                                      Director
                                      
                                      January
      7, 2011Leon
      Nowalsky


63




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





To the
Shareholders of Onstream Media Corporation


Pompano
Beach, Florida





We have
audited the accompanying consolidated balance sheet of Onstream Media
Corporation and subsidiaries as of September 30, 2010 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year 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
audit.





We
conducted our audit 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 audit provides 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, 2010 and the results of their operations
and their cash flows for the year then ended in conformity with U.S. generally
accepted accounting principles.




/s/ Mayer
Hoffman McCann P.C.





MAYER
HOFFMAN MCCANN P.C.


Certified
Public Accountants


Boca
Raton, Florida


January
7, 2011




F-1




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





To the
Shareholders of Onstream Media Corporation


Pompano
Beach, Florida





We have
audited the accompanying consolidated balance sheet of Onstream Media
Corporation and subsidiaries as of September 30, 2009 and the related
consolidated statements of operations, stockholders' equity and cash flows for
the year 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
audit.





We
conducted our audit 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 audit provides 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, 2009 and the results of their operations
and their cash flows for the year then ended in conformity with generally
accepted accounting principles in the United States of America.





/s/
Goldstein Lewin & Co.





GOLDSTEIN
LEWIN & CO.


Certified
Public Accountants


Boca
Raton, Florida


December
29, 2009




F-2




ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





September 30,
              
              
              September 30,2010
              
              
              2009ASSETSCURRENT
      ASSETS:Cash
      and cash equivalents
              
              $
              825,408
              
              
              $
              541,206Accounts
      receivable, net of allowance for doubtful accounts of $363,973 and
      $241,298, respectively
              
              
              2,805,420
              
              
              
              2,189,252Prepaid
      expenses
              
              
              316,591
              
              
              
              356,963Inventories
      and other current assets
              
              
              125,000
              
              
              
              198,960Total
      current assets
              
              
              4,072,419
              
              
              
              3,286,381PROPERTY
      AND EQUIPMENT, net
              
              
              2,854,263
              
              
              
              3,083,096INTANGIBLE
      ASSETS, net
              
              
              1,284,524
              
              
              
              2,499,150GOODWILL,
      net
              
              
              12,396,948
              
              
              
              16,496,948OTHER
      NON-CURRENT ASSETS
              
              
              104,263
              
              
              
              118,398Total
      assets
              
              $
              20,712,417
              
              
              $
              25,483,973LIABILITIES AND STOCKHOLDERS’
      EQUITYCURRENT
      LIABILITIES:Accounts
      payable
              
              $
              2,553,366
              
              
              $
              2,384,344Accrued
      liabilities
              
              
              1,199,019
              
              
              
              1,199,843Amounts
      due to directors and officers
              
              
              242,065
              
              
              
              229,908Deferred
      revenue
              
              
              141,788
              
              
              
              163,198Notes
      and leases payable –  current portion, net of
      discount
              
              
              1,904,214
              
              
              
              1,615,891Convertible
      debentures, net of discount
              
              
              1,626,796
              
              
              
              -Series
      A-12 Convertible Preferred stock – redeemable portion, net
              
              
              -
              
              
              
              98,000Total
      current liabilities
              
              
              7,667,248
              
              
              
              5,691,184Notes
      and leases payable, net of current portion and discount
              
              
              120,100
              
              
              
              505,061Convertible
      debentures, net of discount
              
              
              815,629
              
              
              
              1,109,583Detachable
      warrants, associated with sale of common shares and Series A-14
      Preferred
              
              
              386,404
              
              
              
              -Total
      liabilities
              
              
              8,989,381
              
              
              
              7,305,828COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Series
      A-12 Redeemable Convertible Preferred stock, par value $.0001 per
      share,  authorized 100,000 shares, -0- and 70,000 issued and
      outstanding, respectively
              
              
              -
              
              
              
              7Series
      A-13 Convertible Preferred stock, par value $.0001 per share, authorized
      170,000 shares, 35,000 and -0- issued and outstanding,
      respectively
              
              
              3
              
              
              
              -Series
      A-14 Convertible Preferred stock, par value $.0001 per share, authorized
      420,000 shares, 420,000 and -0- issued and outstanding,
      respectively
              
              
              42
              
              
              
              -Common
      stock, par value $.0001 per share; authorized 75,000,000 shares, 8,384,570
      and 7,388,783 issued and outstanding, respectively
              
              
              838
              
              
              
              739Additional
      paid-in capital
              
              
              135,453,812
              
              
              
              132,299,589Unamortized
      discount
              
              
              (297,422
              )
              
              
              (12,000
              )Accumulated
      deficit
              
              
              (123,434,237
              )
              
              
              (114,110,190
              )Total
      stockholders’ equity
              
              
              11,723,036
              
              
              
              18,178,145Total
      liabilities and stockholders’ equity
              
              $
              20,712,417
              
              
              $
              25,483,973





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 30,2010
              
              
              2009REVENUE:DMSP
      and hosting
              
              $
              2,037,337
              
              
              $
              1,705,697Webcasting
              
              
              5,741,022
              
              
              
              5,670,364Audio
      and web conferencing
              
              
              6,831,900
              
              
              
              7,098,993Network
      usage
              
              
              1,876,116
              
              
              
              1,992,935Other
              
              
              207,731
              
              
              
              458,964Total
      revenue
              
              
              16,694,106
              
              
              
              16,926,953COSTS
      OF REVENUE:DMSP
      and hosting
              
              
              898,272
              
              
              
              557,652Webcasting
              
              
              1,541,171
              
              
              
              1,676,937Audio
      and web conferencing
              
              
              1,986,328
              
              
              
              1,928,103Network
      usage
              
              
              797,849
              
              
              
              863,621Other
              
              
              348,020
              
              
              
              467,220Total
      costs of revenue
              
              
              5,571,640
              
              
              
              5,493,533GROSS
      MARGIN
              
              
              11,122,466
              
              
              
              11,433,420OPERATING
      EXPENSES:General
      and administrative:Compensation
              
              
              8,276,677
              
              
              
              9,803,158Professional
      fees
              
              
              2,015,249
              
              
              
              1,268,608Other
      general and administrative
              
              
              2,262,848
              
              
              
              2,436,101Write
      off deferred acquisition costs
              
              
              -
              
              
              
              504,738Impairment
      loss on goodwill and other intangible assets
              
              
              4,700,000
              
              
              
              5,500,000Depreciation
      and amortization
              
              
              1,923,460
              
              
              
              3,195,291Total
      operating expenses
              
              
              19,178,234
              
              
              
              22,707,896Loss
      from operations
              
              
              (8,055,768
              )
              
              
              (11,274,476
              )OTHER
      EXPENSE, NET:Interest
      expense
              
              
              (1,376,176
              )
              
              
              (651,464
              )Other
      income, net
              
              
              151,372
              
              
              
              95,155Total
      other expense, net
              
              
              (1,224,804
              )
              
              
              (556,309
              )Net
      loss
              
              $
              (9,280,572
              )
              
              $
              (11,830,785
              )Loss
      per share – basic and diluted:Net
      loss per share
              
              $
              (1.20
              )
              
              $
              (1.63
              )Weighted
      average shares of common stock outstanding – basic and
    diluted
              
              
              7,726,575
              
              
              
              7,246,080





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


F-4


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


YEARS
ENDED SEPTEMBER 30, 2009 AND 2010





Series A- 10
                    Preferred Stock
                  
                  
                  Series A- 12
                    Preferred Stock
                  
                  
                  Common Stock *
                  
                  
                  Additional Paid-in
                      Capital
                  
                  
                  AccumulatedShares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Gross
                  
                  
                  Discount
                  
                  
                  Deficit
                  
                  
                  TotalBalance,
      September 30, 2008
                  
                  
                  74,841
                  
                  
                  $
                  8
                  
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  7,104,271
                  
                  
                  $
                  710
                  
                  
                  $
                  130,081,906
                  
                  
                  $
                  (20,292
                  )
                  
                  $
                  (102,194,640
                  )
                  
                  $
                  27,867,692Shares
      and options issued for consultant services
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  138,811
                  
                  
                  
                  14
                  
                  
                  
                  319,708
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  319,722Issuance
      of options for employee services
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,127,819
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,127,819Issuance
      of Series A-12 preferred
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  80,000
                  
                  
                  
                  8
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  199,998
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  200,006Redemption
      of Series A-12 preferred
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (10,000
                  )
                  
                  
                  (1
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (99,999
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (100,000
                  )Surrender
      of Series A-10 preferred for Series A-12 preferred
                  
                  
                  (60,000
                  )
                  
                  
                  (6
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (6
                  )Reclassification
      of  Series A-12  preferred (redeemable
      portion)  as a liability
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (100,000
                  )
                  
                  
                  16,000
                  
                  
                  
                  (14,000
                  )
                  
                  
                  (98,000
                  )Common
      shares/warrants  issued for interest and fees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  75,432
                  
                  
                  
                  8
                  
                  
                  
                  137,267
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  137,275Issuance
      of right to obtain common shares for financing fees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  531,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  531,000Dividends
      accrued or paid on Series A-10 preferred
                  
                  
                  2,994
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,326
                  
                  
                  
                  -
                  
                  
                  
                  37,895
                  
                  
                  
                  20,292
                  
                  
                  
                  (34,765
                  )
                  
                  
                  23,422Conversion
      of Series A-10 preferred to common shares
                  
                  
                  (17,835
                  )
                  
                  
                  (2
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  29,727
                  
                  
                  
                  3
                  
                  
                  
                  (1
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Dividends
      on Series A-12
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  39,216
                  
                  
                  
                  4
                  
                  
                  
                  63,996
                  
                  
                  
                  (28,000
                  )
                  
                  
                  (36,000
                  )
                  
                  
                  -Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (11,830,785
                  )
                  
                  
                  (11,830,785
                  )Balance,
      September 30, 2009
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  70,000
                  
                  
                  $
                  7
                  
                  
                  
                  7,388,783
                  
                  
                  $
                  739
                  
                  
                  $
                  132,299,589
                  
                  
                  $
                  (12,000
                  )
                  
                  $
                  (114,110,190
                  )
                  
                  $
                  18,178,145





(Continued)


F-5


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


YEARS
ENDED SEPTEMBER 30, 2009 AND 2010


(Continued)





Series A- 12
                    Preferred Stock
                  
                  
                  Series A- 13
                    Preferred Stock
                  
                  
                  Series A- 14
                    Preferred Stock
                  
                  
                  Common Stock *
                  
                  
                  Additional Paid-in
                    Capital
                  
                  
                  AccumulatedShares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Gross
                  
                  
                  Discount
                  
                  
                  Deficit
                  
                  
                  TotalBalance,
      September 30, 2009
                  
                  
                  70,000
                  
                  
                  $
                  7
                  
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  7,388,783
                  
                  
                  $
                  739
                  
                  
                  $
                  132,299,589
                  
                  
                  $
                  (12,000
                  )
                  
                  $
                  (114,110,190
                  )
                  
                  $
                  18,178,145Shares
      and options issued for consultant services
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  345,862
                  
                  
                  
                  34
                  
                  
                  
                  759,274
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  759,308Issuance
      of options for employee services
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  816,068
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  816,068Sale
      of common shares
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  350,000
                  
                  
                  
                  35
                  
                  
                  
                  373,538
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  373,573Sale
      of Series A-14 preferred
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  420,000
                  
                  
                  
                  42
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  749,069
                  
                  
                  
                  (298,639
                  )
                  
                  
                  -
                  
                  
                  
                  450,472Reclassification
      to liability of warrants associated with sale of common shares and Series
      A-14 preferred
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (386,404
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (386,404
                  )Surrender
      of Series A-12 for Series A-13 preferred
                  
                  
                  (35,000
                  )
                  
                  
                  (4
                  )
                  
                  
                  35,000
                  
                  
                  
                  3
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  108,500
                  
                  
                  
                  (6,747
                  )
                  
                  
                  -
                  
                  
                  
                  101,752Reclassification
      of  Series A-12  preferred (redeemable
      portion)  as equity
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  100,000
                  
                  
                  
                  (2,000
                  )
                  
                  
                  -
                  
                  
                  
                  98,000Issuance
      of common shares, or right to obtain common shares, for financing
      fees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  12,501
                  
                  
                  
                  1
                  
                  
                  
                  116,249
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  116,250Common
      shares/warrants issued for interest and fees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  229,091
                  
                  
                  
                  23
                  
                  
                  
                  517,932
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  517,955Conversion
      of Series A-12 preferred to common
                  
                  
                  (35,000
                  )
                  
                  
                  (3
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  58,333
                  
                  
                  
                  6
                  
                  
                  
                  (3
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Dividends
      on Series A-12
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  14,000
                  
                  
                  
                  (14,000
                  )
                  
                  
                  -Dividends
      on Series A-13
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  5,060
                  
                  
                  
                  (26,060
                  )
                  
                  
                  (21,000
                  )Dividends
      on Series A-14
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,904
                  
                  
                  
                  (3,415
                  )
                  
                  
                  (511
                  )Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (9,280,572
                  )
                  
                  
                  (9,280,572
                  )Balance,
      September 30, 2010
                  
                  
                  -
                  
                  
                  $
                  -
                  
                  
                  
                  35,000
                  
                  
                  $
                  3
                  
                  
                  
                  420,000
                  
                  
                  $
                  42
                  
                  
                  
                  8,384,570
                  
                  
                  $
                  838
                  
                  
                  $
                  135,453,812
                  
                  
                  $
                  (297,422
                  )
                  
                  $
                  (123,434,237
                  )
                  
                  $
                  11,723,036





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


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


F-6


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Years Ended
                  September 30,2010
              
              
              2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      loss
              
              $
              (9,280,572
              )
              
              $
              (11,830,785
              )Adjustments
      to reconcile net loss to net cash (used in) provided by operating
      activities:Depreciation
      and amortization
              
              
              1,923,460
              
              
              
              3,195,291Impairment
      loss on goodwill and other intangible assets
              
              
              4,700,000
              
              
              
              5,500,000Write
      off deferred acquisition costs
              
              
              -
              
              
              
              504,738Compensation
      expenses paid with equity
              
              
              816,068
              
              
              
              1,127,606Amortization
      of deferred professional fee expenses paid with equity
              
              
              795,746
              
              
              
              383,375Amortization
      of discount on convertible debentures
              
              
              450,887
              
              
              
              73,462Amortization
      of discount on notes payable
              
              
              232,343
              
              
              
              113,631Interest
      expense paid in common shares and options
              
              
              164,650
              
              
              
              98,858Bad
      debt expense
              
              
              122,675
              
              
              
              228,943Gain
      from settlements of obligations and sales of equipment
              
              
              (136,706
              )
              
              
              (85,009
              )Net
      cash (used in) operating activities, before changes in current assets and
      liabilities
              
              
              (211,449
              )
              
              
              (689,890
              )Changes
      in current assets and liabilities, net of effect of
      acquisitions:(Increase)
      decrease in accounts receivable
              
              
              (768,087
              )
              
              
              139,932Decrease
      (increase) in prepaid expenses
              
              
              14,747
              
              
              
              (9,947
              )Decrease
      (increase) in other current assets
              
              
              71,280
              
              
              
              (76,742
              )Decrease
      (increase) in inventories
              
              
              2,717
              
              
              
              (15,520
              )Increase
      in accounts payable and accrued liabilities
              
              
              714,938
              
              
              
              940,027(Decrease)
      increase in deferred revenue
              
              
              (21,410
              )
              
              
              34,483Net
      cash (used in) provided by operating activities
              
              
              (197,264
              )
              
              
              322,343CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisition
      of property and equipment
              
              
              (1,153,860
              )
              
              
              (1,225,447
              )Narrowstep
      acquisition costs (written off to expense in March 2009)
              
              
              (115,000
              )
              
              
              (187,614
              )Net
      cash (used in) investing activities
              
              
              (1,268,860
              )
              
              
              (1,413,061
              )





(Continued)


F-7


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





(Continued)




Years
      Ended
                September 30,2010
              
              
              2009CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from notes payable, net of expenses
              
              $
              927,875
              
              
              $
              1,553,194Proceeds
      from convertible debentures, net of expenses
              
              
              1,434,092
              
              
              
              375,000Proceeds
      from sale of common shares, net of expenses
              
              
              341,962
              
              
              
              -Proceeds
      from sale of A-12 preferred shares, net of expenses
              
              
              -
              
              
              
              100,000Proceeds
      from sale of A-13 preferred shares, net of expenses
              
              
              (6,747
              )
              
              
              -Proceeds
      from sale of A-14 preferred shares, net of expenses
              
              
              482,082
              
              
              
              -Repayment
      of notes and leases payable
              
              
              (1,142,938
              )
              
              
              -Repayment
      of convertible debentures
              
              
              (286,000
              )
              
              
              (1,070,762
              )Net
      cash provided by financing activities
              
              
              1,750,326
              
              
              
              957,432NET
      INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
              
              
              284,202
              
              
              
              (133,286
              )CASH
      AND CASH EQUIVALENTS, beginning of period
              
              
              541,206
              
              
              
              674,492CASH
      AND CASH EQUIVALENTS, end of period
              
              $
              825,408
              
              
              $
              541,206SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      payments for interest
              
              $
              676,408
              
              
              $
              351,776SUPPLEMENTAL
      SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Issuance
      of shares, warrants and options for consultant services
              
              $
              759,308
              
              
              $
              319,722Issuance
      of shares and options for employee services
              
              $
              816,068
              
              
              $
              1,127,819Issuance
      of A-10 preferred shares for A-10 dividends
              
              $
              -
              
              
              $
              29,938Issuance
      of common shares for A-12 dividends
              
              $
              -
              
              
              $
              64,000Issuance
      of common shares and warrants for interest
              
              $
              517,955
              
              
              $
              137,275Issuance
      of common shares, or right to obtain common shares, for financing
      fees
              
              $
              116,250
              
              
              $
              531,000Issuance
      of warrants in connection with the sale  of Common and
      preferred shares
              
              $
              386,404
              
              
              $
              -Issuance
      of common shares in connection with the sale  of common and
      preferred shares
              
              $
              54,500
              
              
              $
              -Issuance
      of common shares for A-10 preferred shares and dividends
              
              $
              -
              
              
              $
              186,318Issuance
      of A-12 preferred shares for A-10 preferred shares
              
              $
              -
              
              
              $
              600,000Issuance
      of A-13 preferred shares for A-12 preferred shares
              
              $
              350,000
              
              
              $
              -Issuance
      of common shares for A-12 preferred shares
              
              $
              350,000
              
              
              $
              -Conversion
      of short-term advance to convertible debenture
              
              $
              200,000
              
              
              $
              -Declaration
      of dividends payable on A-13 preferred shares
              
              $
              21,000
              
              
              $
              -Accrual
      of dividends payable on A-14 preferred shares
              
              $
              511
              
              
              $
              -Equipment
      obtained under capital lease
              
              $
              -
              
              
              $
              37,664





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, 2010





NOTE 1:
NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES





Nature of
Business





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





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


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





The DMSP
division, which operates primarily from facilities in Colorado Springs,
Colorado, provides an online, subscription based service that includes access to
enabling technologies and features for our clients to acquire, store, index,
secure, manage, distribute and transform these digital assets into saleable
commodities.The UGC division, which
operates primarily from facilities in Colorado Springs, Colorado and also
operates as Auction Video (see note 2), provides a video ingestion and flash
encoder that can be used by our clients on a stand-alone basis or in conjunction
with the DMSP.
 
 The Smart
Encoding division, which operates primarily from facilities in San Francisco,
California, provides both automated and manual encoding and editorial services
for processing digital media, using a set of coordinated technologies and
processes that allow the quick and efficient online search, retrieval, and
streaming of this media, which can include photos, videos, audio, engineering
specs, architectural plans, web pages, and many other pieces of business
collateral. This division also provides hosting, storage and streaming services
for digital media, which are provided via the DMSP.
 
 The Audio
and Web Conferencing Services Group consists of our Infinite Conferencing
(“Infinite”) division and our EDNet division. Our Infinite division, which
operates primarily from facilities in the New York City metropolitan area,
generates revenues from usage charges and fees for other services provided in
connection with “reservationless” and operator-assisted audio and web
conferencing services – see note 2.
 
 Our EDNet
division, which operates primarily from facilities in San Francisco, California,
provides connectivity (in the form of high quality audio, compressed video and
multimedia data communications) within the entertainment and advertising
industries through its managed network, which encompasses production and
post-production companies, advertisers, producers, directors, and talent. EDNet
also provides systems integration and engineering services, application-specific
technical advice, audio equipment, proprietary and off-the-shelf codecs,
teleconferencing equipment, and other innovative products to facilitate its
broadcast and production applications. EDNet generates revenues from network
usage, sale, rental and installation of equipment, and other related
fees.


F-9


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Liquidity





The
consolidated financial statements have been presented on the basis that we are
an ongoing concern, which contemplates the realization of assets and the
satisfaction of liabilities in the normal course of business. We have incurred
losses since our inception, and have an accumulated deficit of approximately
$123.4 million as of September 30, 2010. Our operations have been financed
primarily through the issuance of equity and debt. For the year ended September
30, 2010, we had a net loss of approximately $9.3 million, although cash used in
operations for that period was approximately $197,000. Although we had cash of
approximately $825,000 at September 30, 2010, our working capital was a deficit
of approximately $3.6 million at that date.





We have
estimated that we would require an approximately 7-8% increase in our
consolidated revenues, as compared to our revenues for the twelve months ended
September 30, 2010, in order to adequately fund our anticipated operating cash
expenditures for the next twelve months (including cash interest expense and a
basic level of capital expenditures).  Due to seasonality, this
increase would be accomplished if we were to achieve average revenues over the
next four quarters equivalent to the revenues for the third quarter of fiscal
2010. We have estimated that, in addition to this revenue increase, we will also
require additional debt or equity financing of approximately $1.5 to $2.0
million (in addition to recent sales of common and preferred shares discussed
below) over the next twelve months to satisfy principal repayments due against
existing debt (other than debt repaid from the proceeds of recent sales of
common and preferred shares discussed below) as well as past due trade payables
that we believe are necessary to pay to continue our operations. However,
approximately $1.0 million of this $1.5 to $2.0 million would not be required
until June 2011.





If we
were to achieve revenue increases in excess of this 7-8%, or if any of our
lenders elected to convert a portion of the existing debt to equity as allowed
for under its terms, the required financing could be less than this $1.5 to $2.0
million. However, if we did not achieve these revenue increases, or if our
operating expenses, cash interest or capital expenditures were higher than
anticipated over the next twelve months, the required financing could be greater
than this $1.5 to $2.0 million.





We have
implemented and continue to implement specific actions, including hiring
additional sales personnel, developing new products and initiating new marketing
programs, geared towards achieving revenue increases. The costs associated with
these actions were contemplated in the above calculations.  However,
in the event we are unable to achieve the required revenue increases, we believe
that a combination of identified decreases in our current level of expenditures
that we would implement and the raising of additional capital in the form of
debt and/or equity that we believe we could obtain from identified sources would
be sufficient to allow us to operate for the next twelve months. We will closely
monitor our revenue and other business activity to determine if and when further
cost reductions, the raising of additional capital, or other activity is
considered necessary.


F-10


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Liquidity
(continued)





A
prospectus allowing us to offer and sell up to $6.6 million of our registered
common shares (“Shelf Registration”) was declared effective by the SEC on April
30, 2010. On September 17, 2010, we entered into a Purchase Agreement (the
“Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC
agreed to purchase our common and preferred shares, and 1.6 million common
shares (including those issuable upon conversion of the preferred shares) were
included in a prospectus supplement filed by us with the SEC in connection with
a takedown under the Shelf Registration. On September 24, 2010, we received net
proceeds of $873,750 from LPC related to our issuance under that Purchase
Agreement of the equivalent of 770,000 common shares (when including those
common shares issuable upon conversion of the preferred shares). After deducting
legal, accounting and other out-of-pocket costs incurred by us in connection
with this transaction, the net cash proceeds were $824,044. During the period
from October 13, 2010 through January 5, 2011 LPC purchased an additional
405,000 shares of our common stock under that Purchase Agreement for net
proceeds of approximately $336,000.  LPC has also committed to
purchase, at our sole discretion, up to an additional 425,000 shares of our
common stock in installments over the remaining term of the Purchase Agreement,
generally at prevailing market prices, but subject to the specific restrictions
and conditions in the Purchase Agreement, including but not limited to a minimum
market price of $0.75 per share.





In
addition, we have agreed to use our best efforts to get, within 190 days from
the date of the Purchase Agreement, shareholder approval to sell up to an
additional 1,900,000 of our common shares to LPC, which upon such approval LPC
has agreed to purchase, at our sole discretion and subject to the same
restrictions and conditions in the Purchase Agreement.


There is
no assurance that we will sell additional shares to LPC under the Purchase
Agreement of that we will sell additional shares under the Shelf Registration,
or if we do make such sales what the timing or proceeds will be. In addition, we
may incur fees in connection with such sales. Furthermore, sales under the Shelf
Registration that exceed in aggregate twenty percent (20%) of our outstanding
shares would be subject to prior shareholder approval.





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


F-11


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Liquidity
(continued)





Our
continued existence is dependent upon our ability to raise capital and to market
and sell our services successfully. However, there are no assurances whatsoever
that we will be able to sell additional common shares or other forms of equity
under the LPC Purchase Agreement, the Shelf Registration or otherwise and/or
that we will be able to borrow further funds under the Funding Letter or
otherwise and/or that we will increase our revenues and/or control our expenses
to a level sufficient to provide positive cash flow. The financial statements do
not include any adjustments to reflect future effects on the recoverability and
classification of assets or amounts and classification of liabilities that may
result if we are unsuccessful.





Basis of
Consolidation





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





Reverse
stock split





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





Cash and
cash equivalents





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


Concentration
of Credit Risk





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





Bad Debt
Reserves





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


F-12


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Inventories





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





Fair
Value Measurements





The
carrying amounts of cash and cash equivalents, accounts receivable, accounts
payable, accrued liabilities and amounts due to directors and officers
approximate fair value due to the short maturity of the instruments. The
carrying amounts of the current portion of notes, debentures and leases payable
approximate fair value due to the short maturity of the instruments, as well as
the market value interest rates they carry.





Effective
October 1, 2008, we adopted the provisions of the Fair Values Measurements and
Disclosures topic of the Accounting Standards Codification (“ASC”), with respect
to our financial assets and liabilities, identified based on the definition of a
financial instrument contained in the Financial Instruments topic of the ASC.
This definition includes a contract that imposes a contractual obligation on us
to exchange other financial instruments with the other party to the contract on
potentially unfavorable terms. We have determined that the Lehmann Note, the
Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note and the
Equipment Notes discussed in note 4 and the redeemable portion of the Series
A-12 (preferred stock) discussed in note 6 are financial liabilities subject to
the accounting and disclosure requirements of the Fair Values Measurements and
Disclosures topic of the ASC. This is further discussed in “Effects of Recent
Accounting Pronouncements” below.





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





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





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





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


F-13


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Fair
Value Measurements (continued)





We have
determined that there are no Level 1 inputs for determining the fair value of
the Lehmann Note, the Wilmington Notes, the Greenberg Note, the Rockridge Note,
the CCJ Note, the Equipment Notes or the redeemable portion of the Series A-12.
However, we have determined that the fair value of the Lehmann Note, the
Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ Note, the
Equipment Notes and the redeemable portion of the Series A-12 may be determined
using Level 2 inputs, as follows: the fair market value interest rate paid by us
under our line of credit arrangement (the “Line”) as discussed in note 4 and the
value of conversion rights contained in those arrangements, based on the
relevant aspects of the same Black Scholes valuation model used by us to value
our options and warrants. We have also determined that the fair value of the
Lehmann Note, the Wilmington Notes, the Greenberg Note, the Rockridge Note, the
CCJ Note, the Equipment Notes and the redeemable portion of the Series A-12 may
be determined using Level 3 inputs, as follows: third party studies arriving at
recommended discount factors for valuing payments made in unregistered
restricted stock instead of cash.





Based on
the use of the inputs described above, we have determined that there was no
material difference between the carrying value and the fair value of the Lehmann
Note, the Wilmington Notes, the Greenberg Note, the Rockridge Note, the CCJ
Note, the Equipment Notes and the redeemable portion of the Series A-12 as of
October 1, 2008, September 30, 2009 or September 30, 2010 (to the extent each of
those liabilities were outstanding on each of those dates) and therefore no
adjustment with respect to fair value was made to our financial statements as of
those dates or for the years ended September 30, 2010 and 2009,
respectively.





In
accordance with the Financial Instruments topic of the ASC, we may elect to
report most financial instruments and certain other items at fair value on an
instrument-by-instrument basis with changes in fair value reported in earnings.
After the initial adoption, the election is made at the acquisition of an
eligible financial asset, financial liability, or firm commitment or when
certain specified reconsideration events occur. The fair value election may not
be revoked once an election is made. We have elected not to measure eligible
financial assets and liabilities at fair value.


F-14


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Property
and Equipment





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





Software


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





Goodwill
and other intangible assets





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





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





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


F-15


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Revenue
Recognition





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





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





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





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





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





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


F-16


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Revenue
Recognition (continued)





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





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





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





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





Comprehensive
Income or Loss





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


Advertising
and marketing


Advertising
and marketing costs, which are charged to operations as incurred and included in
Professional Fees and Other General and Administrative Operating Expenses, were
approximately $327,000 and $299,000 for the years ended September 30, 2010 and
2009, respectively.


F-17


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Income
Taxes





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


We have
approximately $93 million in Federal net operating loss carryforwards as of
September 30, 2010, approximately $8 million which expire in fiscal years 2011
through 2012 and approximately $85 million which expire in fiscal years
2018 through 2030.  Our utilization of approximately $20 million of
the net operating loss carryforwards, acquired from the 2001 acquisition of
EDNet and the 2002 acquisition of MOD and included in this $93 million
total, against future taxable income may be limited as a result of ownership
changes and other limitations.




Significant
judgment is required in determining our provision for income taxes, our deferred
tax assets and liabilities and any valuation allowance recorded against those
deferred tax assets. We had a deferred tax asset of approximately $34.8 million
as of September 30, 2010, primarily resulting from net operating loss
carryforwards. A full valuation allowance has been recorded related to the
deferred tax asset due to the uncertainty of realizing the benefits of certain
net operating loss carryforwards before they expire. Our management will
continue to assess the likelihood that the deferred tax asset will be realizable
and the valuation allowance will be adjusted accordingly.




Accordingly,
no income tax benefit was recorded in our consolidated statement of operations
as a result of the net tax losses for the years ended September 30, 2010 and
2009.  The primary differences between the net loss for book and the
net loss for tax purposes are the following items expensed for book purposes but
not deductible for tax purposes – amortization of certain loan discounts,
amortization and/or impairment adjustments of certain acquired intangible
assets, and expenses for stock options and shares issued in payment for
consultant and employee services but not exercised by the recipients, or in the
case of shares, not registered for or eligible for resale.




The
Income Taxes topic of the ASC prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return. However, as of September
30, 2010 or September 30, 2009, we have not taken, nor recognized the financial
statement impact of, any material tax positions, as defined above. Our policy is
to recognize, as non-operating expense, interest or penalties related to income
tax matters at the time such payments become probable, although we had not
recognized any such material items in our statement of operations for the years
ended September 30, 2010 and 2009. The tax year ending September 30, 2005 as
well as the tax years ending September 30, 2007 and thereafter remain subject to
examination by Federal and various state tax jurisdictions.




F-18


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Net Loss
Per Share





For the
years ended September 30, 2010 and 2009, net loss per share is based on the net
loss divided by the weighted average number of shares of common stock
outstanding – see discussion of reverse stock split above.  Since the
effect of common stock equivalents was anti-dilutive, all such equivalents were
excluded from the calculation of weighted average shares outstanding. The total
outstanding options and warrants, which have been excluded from the calculation
of weighted average shares outstanding, were 2,216,605 and 2,424,085 at
September 30, 2010 and 2009, respectively.


In
addition, the potential dilutive effects of the following convertible securities
outstanding at September 30, 2010 have been excluded from the calculation of
weighted average shares outstanding: (i) 35,000 shares of Series A-13 which
could potentially convert into 116,667 shares of ONSM common stock, (ii) 420,000
shares of Series A-14 which could potentially convert into 420,000 shares of
ONSM common stock (iii) $1,000,000 of convertible notes which in aggregate could
potentially convert into up to 208,333 shares of our common stock (excluding
interest), (iv) 366,667 restricted shares of our common stock for the
origination fee in connection with the Rockridge Note, issuable upon not less
than sixty-one (61) days written notice to us, (v) the $1,016,922 convertible
portion of the Rockridge Note which could have potentially converted into up to
423,718 shares of our common stock, (vi) the $200,000 CCJ Note, which could
potentially convert into up to 66,667 shares of our common stock, (vii) the
$159,000 remaining outstanding balance of the Greenberg Note, which could have
potentially converted into up to 66,250 shares of our common stock, (viii) the
$344,000 remaining outstanding balance of the Wilmington Notes, which could have
potentially converted into up to 123,339 shares of our common stock and (ix) the
$211,000 outstanding balance of the Lehmann Note, which could have potentially
converted into up to 103,431 shares of our common stock.





Furthermore,
if we were to sell all or substantially all of our assets prior to the repayment
of the Rockridge Note, the remaining outstanding principalamountof the Rockridge Note
could be converted into restricted shares of our common stock, which would have
been 215,383 shares as of September 30, 2010 (in addition to the 423,718 shares
noted above).





The
potential dilutive effects of the following convertible securities outstanding
at September 30, 2009 have been excluded from the calculation of weighted
average shares outstanding: (i) 70,000 shares of Series A-12 which could have
potentially converted into 116,667 shares of our common stock, (ii) $1,000,000
of convertible notes which in aggregate could have potentially converted into up
to 208,333 shares of our common stock (excluding interest), (iii) 325,000
restricted ONSM common shares for the origination fee in connection with the
Rockridge Note, issuable upon not less than sixty-one (61) days written notice
to us and (iv) the then $375,000 convertible portion of the Rockridge Note which
could have potentially converted into a minimum of 156,250 shares of ONSM common
stock.


F-19


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Compensation
and related expenses





Compensation
costs for employees considered to be direct labor are included as part of
webcasting and smart encoding costs of revenue. Certain compensation costs for
employees involved in development of software for internal use, as discussed
under Software above, are capitalized. Accrued liabilities and amounts due to
directors and officers includes, in aggregate, approximately $581,000 and
$661,000 as of September 30, 2010 and 2009, respectively, related to salaries,
commissions, taxes, vacation and other benefits earned but not paid as of those
dates.


Equity
Compensation to Employees and Consultants





We have a
stock based compensation plan (the “2007 Plan”) for our employees. The
Compensation – Stock Compensation topic of the ASC requires all companies to
measure compensation cost for all share-based payments, including employee stock
options, at fair value, which we adopted as of October 1, 2006 (the required
date) and first applied during the year ended September 30, 2007, using the
modified-prospective-transition method. Under this method, compensation cost
recognized for the years ended September 30, 2010 and 2009 includes compensation
cost for all share-based payments granted subsequent to September 30, 2006,
calculated using the Black-Scholes model, based on the estimated grant-date fair
value and allocated over the applicable vesting and/or service period. As of
October 1, 2006, there were no outstanding share-based payments granted prior to
that date, but not yet vested. For 2007 Plan options that were granted and thus
valued under the Black-Scholes model during the year ended September 30, 2010,
the expected volatility rate was 88%, the risk-free interest rate was 2.5% and
the expected term was 5 years. For Plan options that were granted (or extended)
and thus valued under the Black-Scholes model during the year ended September
30, 2009, the expected volatility rate was 88 to 96%, the risk-free interest
rate was 1.1 to 2.5% and the expected term was 4 to 5 years.





We have
granted Non-Plan Options to consultants and other third parties. These options
have been accounted for under the Equity topic (Equity-Based Payments to
Non-Employees subtopic) of the ASC, under which the fair value of the options at
the time of their issuance, calculated using the Black-Scholes model, is
reflected as a prepaid expense in our consolidated balance sheet at that time
and expensed as professional fees during the time the services contemplated by
the options are provided to us. For Non-Plan options that were granted and thus
valued under the Black-Scholes model during the year ended September 30, 2010,
the expected volatility rate was 91 to 104%, the risk-free interest rate was 1.6
to 2.6% and the expected term was 4 to 5 years. For Non-Plan options that were
granted and thus valued under the Black-Scholes model during the year ended
September 30, 2009, the expected volatility rate was 99%, the risk-free interest
rate was 2.11% and the expected term was 4 years.





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


F-20


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Employee
401(k) plan


Our
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.  We match employees’ contributions to
the Plan, up to the first 8% of eligible compensation, at a 25%
rate.  Our matching contribution was approximately $49,000 and $52,000
for the years ended September 30, 2010 and 2009, respectively. We expensed
approximately $47,000 and $52,000 in those fiscal years, respectively, with the
remaining amount of $2,000 in fiscal 2010 satisfied by amounts previously funded
by us and expensed but forfeited by terminated employees. Our contributions to
the Plan vest over five years, based on the employee’s initial date of service
and without regard to the date of the contribution. Therefore, the unvested
portion of our previous contributions was not material as of September 30,
2010.





Accounting
Estimates





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


Certain
prior year amounts have been reclassified to conform to the current year
presentation, including classifications between accounts payable, accrued
liabilities and amounts due to directors and officers. Also see discussion of
reverse stock split above.





Effects
of Recent Accounting Pronouncements





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


F-21


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Effects
of Recent Accounting Pronouncements (continued)





The
Business Combinations topic of the ASC establishes principles and requirements
for how an acquirer recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed, and any noncontrolling
interest in an acquiree, including the recognition and measurement of goodwill
acquired in a business combination.  Certain provisions of this
guidance were first effective for our fiscal year beginning October 1, 2009. Had
these provisions been in effect prior to that date, the $504,738 currently
reflected as a write off of those costs for the year ended September 30, 2009
would have been replaced by an expense of $86,680, the amount of such costs
incurred during that period. There would have been no change for the year ended
September 30, 2010.





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





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





ASC Topic
415, Derivatives and Hedging, outlines a two-step approach to evaluate an
instrument’s contingent exercise provisions, if any, and to evaluate the
instrument’s settlement provisions when determining whether an equity-linked
financial instrument (or embedded feature) is indexed to an entity’s own stock,
which would in turn determine whether the instrument was treated as a liability
to be recorded on the balance sheet at fair value and then adjusted to market in
subsequent accounting periods. These provisions were first effective for fiscal
years beginning after December 15, 2008 and accordingly were first applied
by us for our fiscal year beginning October 1, 2009. There were no outstanding
instruments that this accounting would apply to as of the beginning of the
fiscal year of adoption, and therefore there was no cumulative-effect adjustment
recorded to the opening balance of retained earnings related to this issue.
However, it was determined that this pronouncement did apply to warrants issued
by us in September 2010 – see note 8.


F-22


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





In
October 2009, the Financial Accounting Standards Board (“FASB”) issued ASC
update number 2009-14 -Software (Topic 985): Certain Revenue Arrangements That
Include Software Elements (“Update 2009-14”) and ASC update number 2009-13 -
Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements
(“Update 2009-13”). As summarized in Update 2009-14, ASC Topic 985 has been
amended to remove from the scope of industry specific revenue accounting
guidance for software and software related transactions, tangible products
containing software components and non-software components that function
together to deliver the product’s essential functionality. As summarized in
Update 2009-13, ASC Topic 605 has been amended (1) to provide updated
guidance on whether multiple deliverables exist, how the deliverables in an
arrangement should be separated, and the consideration allocated; (2) to
require an entity to allocate revenue in an arrangement using estimated selling
prices of deliverables if a vendor does not have vendor-specific objective
evidence (“VSOE”) or third-party evidence of selling price; and (3) to
eliminate the use of the residual method and require an entity to allocate
revenue using the relative selling price method. These requirements will be
effective for our fiscal year ended September 30, 2011 with early adoption
permitted. Adoption may either be on a prospective basis or by retrospective
application. We are currently assessing the impact of these requirements and at
this time we are unable to quantify their impact on our financial statements or
to determine the timing and/or method of their adoption.





In
January 2010, the FASB issued ASC update number 2010-06 - Fair Value
Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value
Measurements (“Update 2010-06”). Update 2010-06 requires new and revised
disclosures for recurring or non-recurring fair value measurements, specifically
related to significant transfers into and out of Levels 1 and 2, and for
purchases, sales, issuances, and settlements in the rollforward of activity for
Level 3 fair value measurements. Update 2010-06 also clarifies existing
disclosures related to the level of disaggregation and the inputs and valuation
techniques used for fair value measurements. The new disclosures and
clarifications of existing disclosures about fair value measurements were
effective January 1, 2010. However, the disclosures about purchases, sales,
issuances, and settlements in the rollforward of activity for Level 3 fair value
measurements are not effective until our fiscal year ended September 30, 2012.
Our adoption of Update 2010-06 did not, and is not expected to, have a material
impact on our financial position, results of operations or cash
flows.





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


F-23


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS





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





September 30, 2010
              
              
              September 30, 2009Gross
                Carrying
                Amount
              
              
              Accumulated
                Amortization
              
              
              Net Book
                Value
              
              
              Gross
                Carrying
                Amount
              
              
              Accumulated
                Amortization
              
              
              Net Book
                ValueGoodwill:Infinite
      Conferencing
              
              $
              8,600,887
              
              
              $
              -
              
              
              $
              8,600,887
              
              
              $
              11,100,887
              
              
              $
              -
              
              
              $
              11,100,887Acquired
      Onstream
              
              
              2,521,401
              
              
              
              -
              
              
              
              2,521,401
              
              
              
              4,121,401
              
              
              
              -
              
              
              
              4,121,401EDNet
              
              
              1,271,444
              
              
              
              -
              
              
              
              1,271,444
              
              
              
              1,271,444
              
              
              
              -
              
              
              
              1,271,444Auction
      Video
              
              
              3,216
              
              
              
              -
              
              
              
              3,216
              
              
              
              3,216
              
              
              
              -
              
              
              
              3,216Total
      goodwill
              
              
              12,396,948
              
              
              
              -
              
              
              
              12,396,948
              
              
              
              16,496,948
              
              
              
              -
              
              
              
              16,496,948Acquisition-related
      intangible assets (items listed are those remaining on our books as of
      September 30, 2010):Infinite
      Conferencing - customer lists, trademarks and URLs
              
              
              3,181,197
              
              
              
              (
      2,021,321
              )
              
              
              1,159,876
              
              
              
              4,383,604
              
              
              
              ( 2,061,105
              )
              
              
              2,322,499Auction
      Video – patent pending
              
              
              321,815
              
              
              
              (
      197,167
              )
              
              
              124,648
              
              
              
              1,110,671
              
              
              
              (934,020
              )
              
              
              176,651Total
      intangible assets
              
              
              3,503,012
              
              
              
              (
      2,218,488
              )
              
              
              1,284,524
              
              
              
              5,494,275
              
              
              
              (2,995,125
              )
              
              
              2,499,150Total
      goodwill and other acquisition-related intangible assets
              
              $
              15,899,960
              
              
              $
              (2,218,488
              )
              
              $
              13,681,472
              
              
              $
              21,991,223
              
              
              $
              (2,995,125
              )
              
              $
              18,996,098





Infinite Conferencing –
April 27, 2007





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


F-24


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Infinite Conferencing –
April 27, 2007 (continued)





The fair
value of certain intangible assets (internally developed software, customer
lists, trademarks, URLs (internet domain names), favorable contractual terms and
employment and non-compete agreements) acquired as part of the Infinite Merger
was determined by our management at the time of the merger. This fair value was
primarily based on the discounted projected cash flows related to these assets
for the next three to six years immediately following the merger on a
stand-alone basis without regard to the Infinite Merger, as projected by our
management and Infinite’s management. The discount rate utilized considered
equity risk factors (including small stock risk) as well as risks associated
with profitability and working capital, competition, and intellectual property.
The projections were adjusted for charges related to fixed assets, working
capital and workforce retraining. We have been and are amortizing these assets
over useful lives ranging from 3 to 6 years - as of September 30, 2010 the
assets with a useful life of three years (favorable contractual terms and
employment and non-compete agreements) had been fully amortized and removed from
our balance sheet.





The
approximately $18.2 million purchase price exceeded the fair values we assigned
to Infinite’s tangible and intangible assets (net of liabilities at fair value)
by approximately $12.0 million, which we recorded as goodwill as of the purchase
date. As discussed in “Testing for Impairment” below, this initially recorded
goodwill was determined to be impaired as of December 31, 2008 and a $900,000
adjustment was made to reduce its carrying value to approximately $11.1 million
as of that date.  A similar adjustment of $200,000 was made as of that
date to reduce the carrying value of certain intangible assets acquired as part
of the Infinite Merger. These adjustments, totaling $1.1 million, were included
in the aggregate $5.5 million charge for impairment of goodwill and other
intangible assets as reflected in our results of operations for year ended
September 30, 2009. Furthermore, the Infinite goodwill was determined to be
further impaired as of December 31, 2009 and a $2.5 million adjustment was made
to reduce the carrying value of that goodwill to approximately $8.6 million as
of that date. A similar adjustment of $600,000 was made as of that date to
reduce the carrying value of certain intangible assets acquired as part of the
Infinite Merger. These adjustments, totaling $3.1 million, were reflected in our
results of operations for the year ended September 30, 2010, as a charge for
impairment of goodwill and other intangible assets.


Auction Video – March 27,
2007





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


F-25


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Auction Video – March 27,
2007 (continued)





We
allocated the Auction Video purchase price to the identifiable tangible and
intangible assets acquired, based on a determination of their reasonable fair
value as of the date of the acquisition. The technology and patent pending
related to the video ingestion and flash transcoder, the Auction Video customer
lists and the consulting and non-compete agreements entered into with the former
executives and owners of Auction Video were valued in aggregate at $1,150,000
and have been and are being amortized over various lives between two to five
years commencing April 2007 -  as of September 30, 2010 the assets
with a useful life of two or three years (customer lists and the consulting and
non-compete agreements) had been fully amortized and removed from our balance
sheet.





$600,000
was assigned as the value of the video ingestion and flash transcoder, which was
already integrated into our DMSP as of the date of the acquisition and was added
to that asset’s carrying cost for financial statement purposes, with
depreciation over a three-year life commencing April 2007 – see note 3. Future
cost savings for Auction Video services to be provided to our customers existing
prior to the acquisition were valued at $250,000 and were amortized to cost of
sales over a two-year period commencing April 2007.




Subsequent
to the Auction Video acquisition, we began pursuing the final approval of the
patent pending application and in March 2008 retained the law firm of Hunton
& Williams to assist in expediting the patent approval process and to help
protect rights related to our UGV (User Generated Video) technology. In April
2008, we revised the original patent application primarily for the purpose of
splitting it into two separate applications, which, while related, were being
evaluated separately by the U.S. Patent Office (“USPO”). With respect to the
claims pending in the first of the two applications, the USPO issued non-final
rejections in August 2008, February 2009 and May 2009, as well as final
rejections in January 2010 and June 2010. Our responses to certain of these
rejections included modifications to certain claims made in the original patent
application. In response to the latest rejection we filed a Notice of Appeal
with the USPO on November 22, 2010 and the expected next step is our filing of
an appeal brief with the USPO, which is due on January 22, 2011, although
extensions for this filing are available until June 22, 2011 with the payment of
additional fees. After our appeal brief is filed, the USPO would be
expected to file a response and following that, a decision would be made by a
three member panel, either based on the filings or a hearing if requested by us.
Regardless of the ultimate outcome of this matter, our management has determined
that an adverse decision with respect to this patent application would not have
a material adverse effect on our financial position or results of operations.
The USPO has taken no formal action with regard to the second of the two
applications. Certain of the former owners of Auction Video, Inc. have an
interest in proceeds that we may receive under certain circumstances in
connection with these patents.




On
December 5, 2008 we entered into an agreement whereby one of the former owners
of Auction Video Japan, Inc. agreed to shut down the Japan office of Auction
Video as well as assume all of our outstanding assets and liabilities connected
with that operation, in exchange for non-exclusive rights to sell our products
in Japan and be compensated on a commission-only basis. As a result, we
recognized other income of approximately $45,000 for the year ended September
30, 2009, which is the difference between the assumed liabilities of
approximately $84,000 and the assumed assets of approximately $39,000. It is the
opinion of our management that any further developments with respect to this
shut down or the above agreement will not have a material adverse effect on our
financial position or results of operations.


F-26


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Auction Video – March 27,
2007 (continued)





As
discussed in “Testing for Impairment” below, the carrying value of the initially
recorded identifiable intangible assets acquired as part of the Auction Video
Acquisition were determined to be impaired as of December 31, 2008 and an
adjustment was made to reduce the net carrying value of those intangible assets
by $100,000.  This $100,000 adjustment was included in the aggregate
$5.5 million charge for impairment of goodwill and other intangible assets as
reflected in our results of operations for the year ended September 30,
2009.





Acquired Onstream – December
23, 2004





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





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





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





The
approximately $10.0 million purchase price we paid for 100% of Acquired Onstream
exceeded the fair values we assigned to Acquired Onstream’s tangible and
intangible assets (net of liabilities at fair value) by approximately $8.4
million, which we recorded as goodwill as of the purchase date. As discussed in
“Testing for Impairment” below, this initially recorded goodwill was determined
to be impaired as of December 31, 2008 and a $4.3 million adjustment was made to
reduce the carrying value of that goodwill to approximately $4.1 million as of
that date.  This adjustment was included in the aggregate $5.5 million
charge for impairment of goodwill and other intangible assets as reflected in
our results of operations for the year ended September 30,
2009.


F-27


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Testing for
Impairment


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





There is
a two step process for impairment testing of goodwill. The first step of this
test, used to identify potential impairment, compares the fair value of a
reporting unit with its carrying amount, including goodwill. The second step, if
necessary, measures the amount of the impairment. We performed impairment tests
on Infinite, EDNet and Acquired Onstream as of December 31, 2008. We assessed
the fair value of the net assets of these reporting units by considering the
projected cash flows and by analysis of comparable companies, including such
factors as the relationship of the comparable companies’ revenues to their
respective market values.  Based on these factors, we concluded that
there was no impairment of the assets of EDNet as of that date. Although the
first step of the two step testing process of the assets of Acquired Onstream
and Infinite preliminarily indicated that the fair value of those intangible
assets exceeded their recorded carrying value as of December 31, 2008, it was
noted that as a result of the then recent substantial volatility in the capital
markets, the price of our common stock and our market value had decreased
significantly and as of December 31, 2008, our market capitalization, after
appropriate adjustments for control premium and other considerations, was
determined to be less than our net book value (i.e., stockholders’ equity as
reflected in our financial statements). Based on this condition, and in
accordance with the provisions of the Intangibles – Goodwill and Other topic of
the ASC, we recorded a non-cash expense, for the impairment of our goodwill and
other intangible assets, of $5.5 million for the year ended September 30, 2009.
As discussed above, this $5.5 million adjustment was determined to relate to
$1.1 million of goodwill and intangible assets of Infinite, $100,000 of
intangible assets of Auction Video and $4.3 million of goodwill of Acquired
Onstream.


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





As the
result of the decline in the price of our common stock from $1.86 per share as
of March 31, 2010 to $1.03 as of June 30, 2010, it appeared that our market
value (after certain adjustments as discussed above) was probably less than our
net book value as of June 30, 2010. However, we have concluded that the decline
in market value as of June 30, 2010 was not of sufficient duration nor was it
otherwise indicative of a triggering event that would require an interim
impairment review. However, this decline continued after June 30, 2010 and
resulted in a common stock price of $1.04 as of September 30, 2010 and $0.76 as
of December 23, 2010.  As a result, we determined that it was
appropriate for us to evaluate whether our goodwill and other intangible assets
were impaired as of September 30, 2010.


F-28


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





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





Testing for
Impairment (continued)


We
performed impairment tests on Infinite, EDNet and Acquired Onstream as of
September 30, 2010, using the same methodologies discussed
above.  Based on these factors, we concluded that there was no
impairment of the assets of Infinite or EDNet as of that date. However, we
determined that Acquired Onstream’s goodwill and certain of its intangible
assets were impaired as of that date and based on that condition, and as
discussed above, in accordance with the provisions of the Intangibles – Goodwill
and Other topic of the ASC, we recorded a non-cash expense, for the impairment
of our goodwill and other intangible assets, of $1.6 million, which combined
with the adjustment described above, resulted in a total impairment expense of
$4.7 million  for the year ended September 30, 2010.





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


F-29


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
3:  PROPERTY AND EQUIPMENT





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


September 30, 2010
              
              
              September 30, 2009Historical
                  Cost
              
              
              Accumulated
                  Depreciation
                  and
                  Amortization
              
              
              Net Book
                  Value
              
              
              Historical
                  Cost
              
              
              Accumulated
                  Depreciation
                  and
                  Amortization
              
              
              Net Book
                  Value
              
              
              Useful
                  Lives
                  (Yrs)Equipment
      and software
              
              $
              10,367,283
              
              
              $
              (9,596,497
              )
              
              $
              770,786
              
              
              $
              10,442,539
              
              
              $
              ( 9,079,681
              )
              
              $
              1,362,858
              
              
              
              1-5DMSP
              
              
              5,890,134
              
              
              
              (5,113,292
              )
              
              
              776,842
              
              
              
              5,719,979
              
              
              
              ( 4,791,517
              )
              
              
              928,462
              
              
              
              3-5Other
      capitalized internal use software
              
              
              1,840,136
              
              
              
              (599,753
              )
              
              
              1,240,383
              
              
              
              1,215,401
              
              
              
              ( 448,218
              )
              
              
              767,183
              
              
              
              3-5Travel
      video library
              
              
              1,368,112
              
              
              
              (1,368,112
              )
              
              
              -
              
              
              
              1,368,112
              
              
              
              ( 1,368,112
              )
              
              
              -
              
              
              
              N/AFurniture,
      fixtures and leasehold improvements
              
              
              540,669
              
              
              
              (474,417
              )
              
              
              66,252
              
              
              
              475,857
              
              
              
              (451,264
              )
              
              
              24,593
              
              
              
              2-7Totals
              
              $
              20,006,334
              
              
              $
              (17,152,071
              )
              
              $
              2,854,263
              
              
              $
              19,221,888
              
              
              $
              (16,138,792
              )
              
              $
              3,083,096





Depreciation
and amortization expense for property and equipment was approximately $1,298,000
and $2,227,000 for the years ended September 30, 2010 and 2009,
respectively.
 
 During
the year ended September 30, 2010, we disposed of equipment having a historical
cost and net book value of approximately $284,000 and zero, respectively. The
proceeds from these disposals, as well as the gain or loss recognized, were
immaterial.


As part
of the Onstream Merger (see note 2), we became obligated under a contract with
SAIC, under which SAIC would build a platform that eventually, albeit after
further extensive design and re-engineering by us, led to the DMSP. This
platform was the primary asset included in our purchase of Acquired Onstream,
and was recorded at an initial amount of approximately $2.7 million. The SAIC
contract terminated by mutual agreement of the parties on June 30, 2008.
Although cancellation of the contract releases SAIC to offer what is identified
as the “Onstream Media Solution” directly or indirectly to third parties, we do
not expect this right to result in a material adverse impact on future DMSP
sales.





The
DMSP is comprised of four separate “products”- transcoding, storage,
search/retrieval and distribution. A limited version of the DMSP, with three of
the four products, was first placed in service in November 2005. “Store and
Stream” was the first version of the DMSP sold to the general public, starting
in October 2006.


F-30


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
3:  PROPERTY AND EQUIPMENT (Continued)





On March
27, 2007 we completed the acquisition of Auction Video – see note 2. The assets
acquired included a video ingestion and flash transcoder, which was already
integrated into the DMSP as of that date. Based on our determination of the fair
value of the transcoder at that date, $600,000 was added to the DMSP’s carrying
cost, which additional cost was depreciated over a three-year life commencing
April 2007.





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





In
connection with the development of “Streaming Publisher”, a second version of
the DMSP with additional functionality, we have capitalized as part of the DMSP
approximately $774,000 of employee compensation, payments to contract
programmers and related costs as of September 30, 2010, including $314,000
capitalized during the year ended September 30, 2010, $274,000 during the year
ended September 30, 2009 and $186,000 during the year ended September 30, 2008.
As of September 30, 2010, approximately $680,000 of these Streaming Publisher
costs had been placed in service and are being depreciated primarily over five
years. The remainder of the costs not in service relate primarily to new
versions and/or releases of the DMSP under development. Streaming Publisher is a
stand-alone product based on a different architecture than Store and Stream and
is a primary building block of the MP365 platform, discussed below.





Other
capitalized internal use software as of September 30, 2010 includes
approximately $583,000 of employee compensation and payments to contract
programmers for the development of the MP365 platform, which will enable the
creation of on-line virtual marketplaces and trade shows utilizing many of our
other technologies such as DMSP, webcasting, UGC and conferencing. Approximately
$435,000 was capitalized during the year ended September 30, 2010 and $148,000
during the year ended September 30, 2009. This excludes related costs for the
development of Streaming Publisher, as discussed above. $297,000 of these MP365
costs were first placed in service as of August 1, 2010. The remainder of the
costs not in service relate primarily to new versions and/or releases of MP365
under development.





Other
capitalized internal use software as of September 30, 2010 includes
approximately $681,000 of employee compensation and other costs for the
development of iEncode software, which runs on a self-administered, webcasting
appliance that can be used anywhere to produce a live video webcast.
Approximately $180,000 was capitalized during the year ended September 30, 2010,
$288,000 during the year ended September 30, 2009 and $213,000 during the year
ended September 30, 2008. As of September 30, 2010, $592,000 of these iEncode
costs had been placed in service and are being depreciated over a five-year
life. The remainder of the costs not in service relate primarily to new versions
and/or releases of iEncode under development.


F-31


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT





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





Convertible
Debentures





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





September 30,
                  2010
              
              
              September 30,
                  2009Equipment
      Notes
              
              $
              1,000,000
              
              
              $
              1,000,000CCJ
      Note
              
              
              200,000
              
              
              
              -Greenberg
      Note
              
              
              159,000
              
              
              
              -Wilmington
      Notes
              
              
              344,000
              
              
              
              -Lehmann
      Note
              
              
              211,000
              
              
              
              -Rockridge
      Note (excluding portion classified under notes payable)
              
              
              1,016,922
              
              
              
              375,000Total
      convertible debentures
              
              
              2,930,922
              
              
              
              1,375,000Less:
      discount on convertible debentures
              
              
              (488,497
              )
              
              
              (265,417
              )Convertible
      debentures, net of discount
              
              
              2,442,425
              
              
              
              1,109,583Less:
      current portion, net of discount
              
              
              (1,626,796
              )
              
              
              -Convertible
      debentures, net of current portion
              
              $
              815,629
              
              
              $
              1,109,583





Equipment
Notes





During
the period from June 3, 2008 through July 8, 2008 we received an aggregate of
$1.0 million from seven accredited individuals and other entities (the
“Investors”), under a software and equipment financing arrangement. This
included $50,000 received from CCJ Trust (“CCJ”). CCJ is a trust for the adult
children of Mr. Charles Johnston, one of our directors, and he disclaims any
beneficial ownership interest in CCJ.





We issued
notes to those Investors (the “Equipment Notes”), which are collateralized by
specifically designated software and equipment owned by us with a cost basis of
approximately $1.5 million, as well as a subordinated lien on certain other of
our assets to the extent that the designated software and equipment, or other
software and equipment added to the collateral at a later date, is not
considered sufficient security for the loan. Under this arrangement, the
Investors received 1,667 restricted ONSM common shares for each $100,000 lent to
us, and also receive interest at 12% per annum. Interest is payable every 6
months in cash or, at our option, in restricted ONSM common shares, based on a
conversion price equal to seventy-five percent (75%) of the average ONSM closing
price for the thirty (30) trading days prior to the date the applicable payment
is due.


F-32


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





Equipment
Notes (continued)





In lieu
of cash payments for interest previously due on these Equipment Notes, we
elected to issue the following unregistered common shares to the Investors,
which were recorded based on the fair value of those shares on the issuance
date. The next interest due date, after October 31, 2010 which is reflected in
the following table, is April 30, 2011.





Share issuance date
                    
                    Number of unregistered
                      common shares
                    
                    Interest period
                    
                    Interest if
                      paid in cash
                    
                    
                    Fair value of
                      shares at issuanceNovember
      11, 2008
                    
                    26,333
                    
                    June
      - October 2008
                    
                    $
                    48,740
                    
                    
                    $
                    69,520May
      21, 2009
                    
                    49,098
                    
                    Nov
      2008 - April 2009
                    
                    $
                    60,000
                    
                    
                    $
                    67,756November
      11, 2009
                    
                    34,920
                    
                    May
      - October 2009
                    
                    $
                    60,493
                    
                    
                    $
                    67,040April
      30, 2010
                    
                    44,369
                    
                    Nov
      2009 - April 2010
                    
                    $
                    59,507
                    
                    
                    $
                    92,288December
      2, 2010
                    
                    76,769
                    
                    May
      - October 2010
                    
                    $
                    60,493
                    
                    
                    $
                    73,698





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





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





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





Fees were
paid to placement agents and finders for their services in connection with the
Equipment Notes in aggregate of 16,875 restricted ONSM common shares and $31,500
paid in cash. These 16,875 shares, plus the 16,667 shares issued to the
investors (as discussed above) had a fair market value of approximately
$186,513. The value of these 33,542 shares, plus the $31,500 cash fees and
$9,160 paid for legal fees and other issuance costs related to the Equipment
Notes, were reflected as a $227,173 discount against the Equipment Notes and are
being amortized as interest expense over the three year term of the Equipment
Notes. The effective interest rate of the Equipment Notes is approximately 19.5%
per annum, excluding the potential effect of a premium to market prices if
payment of interest is made in common shares instead of cash. The unamortized
portion of this discount was $57,144 and $130,607 at September 30, 2010 and
2009, respectively.


F-33


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





Equipment
Notes (continued)





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





CCJ
Note





During
August 2009, CCJ Trust (“CCJ”) remitted $200,000 to us as a short term advance
bearing interest at 0.022% per day (equivalent to approximately 8% per annum)
until the date of repayment or unless the parties mutually agreed to another
financing transaction(s) prior to repayment. This advance was included in
accounts payable on our September 30, 2009 balance sheet.




On
December 29, 2009, we entered into an agreement with CCJ whereby accrued
interest on the above advance through that date of $5,808 was paid by us in cash
and the $200,000 advance was converted to an unsecured subordinated note payable
(the “CCJ Note”) at a rate of 8% interest per annum in equal monthly
installments of principal and interest for 48 months plus a $100,000 principal
balloon at maturity, although none of those payments were subsequently made by
us. To resolve this payment default, the CCJ Note was amended in January 2011 to
prospectively increase the interest rate to 10% per annum, payable quarterly,
and to require two principal payments of $100,000 each on December 31, 2011 and
December 31, 2012, respectively. This amendment also called for our cash payment
of the previously accrued interest in the amount of $16,263 on or before January
31, 2011. The remaining principal balance of the CCJ Note may be converted at
any time into our common shares at the greater of (i) the previous 30 day market
value or (ii) $2.00 per share (which was $3.00 per share prior to the January
2011 renegotiation).




In
conjunction with and in consideration of the December 2009 note transaction, the
35,000 shares of Series A-12 held by CCJ at that date were exchanged for 35,000
shares of Series A-13 plus four-year warrants for the purchase of 29,167 ONSM
common shares at $3.00 per share. In conjunction with and in consideration of
the January 2011 note amendment, it was agreed that certain terms
of  the 35,000 shares of Series A-13 held by CCJ at that date would be
modified – see note 6.




F-34


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





CCJ
Note (continued)





The
effective interest rate of the CCJ Note prior to the January 2011 amendment was
approximately 47.4% per annum, including the Black-Scholes value of the warrants
of $32,518 plus the $108,500 value of the increased number of common shares
underlying the Series A-13 shares versus the Series A-12 shares (see note 6),
which total of $141,018 we recorded as a debt discount. The effective rate of
47.4% per annum also included 11.2% per annum related to dividends that would
have accrued to CCJ as a result of the later mandatory conversion date of the
Series A-13 shares versus the mandatory conversion date of the Series A-12
shares (see note 6). Following the January 2011 amendment, the effective
interest rate of the CCJ Note increased to approximately 78.5% per annum, to
reflect the value of the increased value of common shares underlying the Series
A-13 shares as a result of the modified terms as well as the increase in the
periodic cash interest rate from 8% to 10% per annum. The effective rate of
78.5% per annum also includes 9.3% per annum related to dividends that could
accrue to CCJ as a result of the later mandatory conversion date of the Series
A-13 shares as a result of the modified terms.




The
unamortized portion of the debt discount, which will be amortized as interest
expense over the remaining term of the CCJ Note, was $114,577 at September 30,
2010.





Greenberg
Note





On
January 13, 2010 we borrowed $250,000 from Greenberg Capital (“Greenberg”) under
the terms of an unsecured subordinated convertible note (the “Greenberg Note”),
which was repayable in principal installments of $13,000 per month beginning
March 1, 2010. Although the note called for a final balloon payment on December
31, 2010, including remaining principal and all accrued but unpaid interest (at
10% per annum), it also provided that if we successfully concluded a subsequent
financing of debt or equity in excess of $500,000 during the note term, the
proceeds of such financing would be used to pay off any remaining balance.
Accordingly, following the sale of common and preferred shares under the LPC
Purchase Agreement (see note 6), we repaid the principal balance due under the
Greenberg Note on October 1, 2010.





The
Greenberg Note provided for (i) our issuance of 20,833 unregistered common
shares upon receipt of the funds and our issuance of 20,833 unregistered common
shares if the loan was still outstanding after 6 months (ii) our payment of
$2,500 in legal fees incurred by Greenberg and (iii) the option to prepay up to
$12,500 of interest in the form of shares, based on the weighted average share
price for the five days prior, which we exercised by the issuance of 6,945
unregistered common shares. The second installment of 20,383 unregistered common
shares, per item (i) above, was issued in July 2010.


Furthermore,
certain principals of Greenberg Capital are also principals in Triumph Small Cap
Fund, which provided us with one of the Letters for $250,000, and required us to
release Triumph Small Cap Fund from their commitment under that Letter as a
condition of a February 2010 modification to the Greenberg Note. This
modification also included Greenberg Capital’s agreement to allow up to $500,000
of subsequent subordinated financing to be issued on a pari passu basis with the
Greenberg Note, which was applied to the Wilmington Notes as discussed
below.


F-35


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





Greenberg
Note (continued)





The
effective rate of the Greenberg Note was initially calculated to be
approximately 50.7% per annum, assuming a one year loan term. The value of the
27,778 shares initially issued to Greenberg for fees and prepaid interest and
the value of the 4,167 common shares issued to Triumph Small Cap Fund in
consideration for the Letter, plus the $2,500 paid for legal fees, were
reflected as a $60,999 discount against the Greenberg Note and were amortized as
interest expense primarily over the initial six month term of the Greenberg
Note. The value of the 20,383 shares issued to Greenberg for fees in July 2010
was reflected as a $19,583 discount against the Greenberg Note and was being
amortized as interest expense through September 30, 2010 over the second six
month term of the Greenberg Note. The unamortized portion of the debt discount
was $9,911 at September 30, 2010, which was written off to interest expense upon
the repayment of the loan on October 1, 2010.





The
Greenberg Note was convertible into common stock at Greenberg’s option at a
price equal to 85% of the weighted average share price for the five days prior
to conversion, such conversion price to be no less than $2.40 per
share.





Wilmington
Notes





During
February 2010 we borrowed an aggregate of $500,000 from three entities (the
“Wilmington Investors”) under the terms of unsecured subordinated convertible
notes (the “Wilmington Notes”), which were issued on a pari passu basis with the
Greenberg Note and were repayable in aggregate principal installments of $26,000
per month beginning April 18, 2010. Although the note called for a final balloon
payment on February 18, 2011, including remaining principal and all accrued but
unpaid interest (at 10% per annum), it also provided that if we successfully
concluded a subsequent financing of debt or equity in excess of $750,000 during
the note term, the proceeds of such financing would be used to pay off any
remaining balance. Accordingly, following the sale of common and preferred
shares under the LPC Purchase Agreement (see note 6), we repaid the principal
balance due under the Wilmington Notes on October 1, 2010 by a cash payment of
$238,756 plus the issuance of 137,901 common shares, which cash and shares also
included the settlement of all cash and non-cash interest and fees otherwise
due.





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


F-36





ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





Wilmington
Notes (continued)





The
effective rate of the Wilmington Notes was initially calculated to be
approximately 83.9% per annum, assuming a six month loan term and excluding the
finder’s fees payable by us to a third party in cash and equal to 7% of the
borrowed amount. The value of the 58,049 shares initially issued to the
Wilmington Investors for fees and prepaid interest plus the finder’s fees of
$35,000 and the $2,500 obligation for legal fees, were reflected as a $199,443
discount against the Wilmington Notes and were amortized as interest expense
primarily over the initial six month term of the Wilmington Notes. The
unamortized portion of the debt discount was zero at September 30,
2010.





The
Wilmington Notes were convertible into common stock at the option of each
individual Wilmington Investor, based on our closing share price on the funding
date of the Wilmington Notes, which was $2.76 with respect to $375,000 of the
funding and $2.88 with respect to the balance.





Lehmann
Note





On May 3,
2010 we closed on the borrowing of $250,000 from an individual (“Lehmann”) under
the terms of an unsecured subordinated convertible note (the “Lehmann Note”),
which is repayable in principal installments of $13,000 per month beginning July
3, 2010, with the final payment on May 3, 2011, including remaining principal
and all accrued but unpaid interest (at 10% per annum).  The Lehmann
Note is convertible into common stock at Lehmann’s option based on our closing
share price on the funding date of the Lehmann Note, which was $2.04. $250,000
of the amount we borrowed under the Wilmington Notes in February 2010 (and which
was fully repaid as of October 1, 2010) came from Lehmann.





The
Lehmann Note provides for (i) our issuance of 37,500 unregistered common shares
upon receipt of the funds and our issuance of 25,000 unregistered common shares
if the loan is still outstanding after 6 months and (ii) our prepayment of the
first six months of interest in the form of shares, based on our closing share
price on the funding date of the Lehmann Note. In the event the Lehmann Note is
prepaid after the first six months, the second tranche of 25,000 unregistered
common shares will be cancelled on a pro-rata basis, to the extent the second
six month time period has not elapsed at the time of such payoff.





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


F-37


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Convertible
Debentures (continued)





Lehmann
Note (continued)





We may
prepay the Lehmann Note at any time with ten days notice, provided that Lehmann
may convert the outstanding balance to common shares during such ten day period.
If we successfully conclude a financing of debt or equity in excess of
$1,000,000 during the term of the Lehmann Note, the proceeds of such financing
will be used to pay off the remaining balance of the Lehmann Note. Although the
aggregate gross proceeds from the sale of common and preferred shares under the
LPC Purchase Agreement exceeded $1,000,000 as of November 3, 2010, our position
is that the sale of shares in October, November and December 2010 were separate
financings from the initial sale of shares in September 2010 and since none of
those financings were in excess of $1,000,000, early repayment of the Lehmann
Note is not required.





In the
event of a default, uncured after the notice provisions in the note, we will be
obligated to pay Lehmann an additional 5% interest per month (based on the
outstanding loan balance and pro-rated on a daily basis) until the default has
been cured, payable in cash or unregistered common shares.





Rockridge
Note





A portion
of the Rockridge Note ($1,016,922 face value, which is $736,699 net, after
deducting the applicable discount) is also convertible into ONSM common shares,
as discussed below, and classified under the non-current portion of Convertible
Debentures, net of discount, on our September 30, 2010 balance sheet. This
convertible portion was $375,000 ($240,190 net of discount) as of September 30,
2009.





Notes and Leases
Payable





Notes and
leases payable consist of the following as of September 30, 2010 and 2009,
respectively:





September 30,
                  2010
              
              
              September 30,
                  2009Line
      of Credit Arrangement
              
              $
              1,637,150
              
              
              $
              1,382,015Rockridge
      Note (excluding portion classified under convertible
      debentures)
              
              
              516,921
              
              
              
              989,187Capitalized
      equipment leases
              
              
              27,328
              
              
              
              142,924Total
      notes and leases payable
              
              
              2,181,399
              
              
              
              2,514,126Less:
      discount on notes payable
              
              
              (143,085
              )
              
              
              (393,174
              )Less:
      consideration for funding commitment letters
              
              
              (14,000
              )
              
              
              -Notes
      and leases payable, net of discount
              
              
              2,024,314
              
              
              
              2,120,952Less:
      current portion, net of discount
              
              
              (1,904,214
              )
              
              
              (1,615,891
              )Long
      term notes and leases payable, net of current portion
              
              $
              120,100
              
              
              $
              505,061


F-38


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Notes and Leases
Payable (continued)





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





The
outstanding balance bears interest at 13.5% per annum, adjustable based on
changes in prime after December 28, 2009 (was prime plus 8% per annum through
December 2, 2008 and prime plus 11% from that date through December 28, 2009),
payable monthly in arrears. Effective December 28, 2009, we also incur a weekly
monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit,
payable monthly in arrears.
 
 We paid
initial origination and commitment fees in December 2007 aggregating $20,015, an
additional commitment fee in August 2008 of $6,000 related to the increase in
the lending limit for the remainder of the year, a commitment fee of $16,000 in
December 2008 related to the continuation of the increased Line for an
additional year and a commitment fee of $20,000 in December 2009 related to the
continuation of the Line for an additional year as well as an increase in the
lending limit. An additional commitment fee of one percent (1%) of the maximum
allowable borrowing amount will be due for any subsequent annual renewal after
December 28, 2010. These origination and commitment fees (plus other fees paid
to Lender) are recorded by us as debt discount and amortized as interest expense
over the remaining term of the loan. The unamortized portion of this discount
was zero and $37,082 as of September 30, 2010 and 2009,
respectively.
 
 The
outstanding principal balance due under the Line may be repaid by us at any
time, but no later than December 28, 2011, which may be extended by us for an
extra year, subject to compliance with all loan terms, including no material
adverse change, as well as concurrence of the Lender. We will incur a charge
equal to two percent (2%) of the borrowing limit if we terminate the Line before
June 28, 2011 and a charge equal to one percent (1%) of the borrowing limit if
we terminate the Line after that date but before December 28, 2011. The
outstanding principal is due on demand in the event a payment default is uncured
five (5) days after written notice.
 
 The Line
is also subject to us maintaining an adequate level of receivables, based on
certain formulas, as well as our compliance with a quarterly debt service
coverage covenant. We are in compliance with this covenant as of September 30,
2010. The Lender must approve any additional debt incurred by us, other than
debt incurred in the ordinary course of business (which includes equipment
financing). Accordingly the Lender has approved the $1.0 million Equipment Notes
we issued in June and July 2008, the $200,000 CCJ Note we issued in December
2009, the $250,000 Greenberg Note we issued in January 2010, the $500,000
Wilmington Notes we issued in February 2010 and the $250,000 Lehmann Note we
issued in May 2010, all as discussed above, and the $2.0 million Rockridge Note
we issued in April 2009 and amended in September 2009, as discussed
below.
 
 Mr. Leon
Nowalsky, a member of our Board of Directors, is also a founder and board member
of the Lender.


F-39


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Notes and Leases
Payable (continued)





Rockridge
Note





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





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





The
Rockridge Note, after giving effect to all borrowings under the Amendment and
the Allonge, is repayable in equal monthly installments of $41,409 extending
through August 14, 2013 (the “Maturity Date”), which installments include
principal (except for a $500,000 balloon payable on the Maturity Date) plus
interest (at 12% per annum) on the remaining unpaid balance. Monthly payments of
$45,202 were made from November 14, 2009 through October 14, 2010, at which time
the payment schedule was corrected to (i) omit the November 2010 payment and
(ii) start with the new payment amount on December 14, 2010.





The
Rockridge Agreement, as amended, also provides that Rockridge may receive an
origination fee upon not less than sixty-one (61) days written notice to us,
payable by our issuance of 366,667 restricted shares of our common stock (the
“Shares”). The Rockridge Agreement provides that on the Maturity Date we shall
pay Rockridge up to a maximum of $75,000, based on the sum of (i) the cash
difference between the per share value of $1.20 (the “Minimum Per Share Value”)
and the average sale price for all previously sold Shares (whether such
number is positive or negative) multiplied by the number of sold
Shares and (ii) for the Shares which were not previously sold by Rockridge, the
cash difference between the Minimum Per Share Value and the market value of the
Shares at the Maturity Date (whether such number is positive or negative)
multiplied by the number of unsold Shares, up to a maximum shortfall amount of
$75,000 in the aggregate for items (i) and (ii). The closing ONSM share price
was $0.76 per share on December 23, 2010.





Legal
fees totaling $55,337 were paid or accrued by us in connection with the
Rockridge Agreement. The 366,667 origination fee Shares discussed above are
considered earned by Rockridge and had a fair market value of approximately
$626,000 at the date of the Rockridge Agreement or the Amendment, as applicable.
The value of these Shares plus the legal fees paid or accrued were reflected as
a $681,337 discount against the Rockridge Note (as well as a corresponding
increase in additional paid-in capital for the value of the Shares), which is
being amortized as interest expense over the term of the Rockridge Note. The
unamortized portion of this discount was $423,308 and $490,902 as of September
30, 2010 and 2009, respectively.


F-40


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Notes and Leases
Payable (continued)





Rockridge
Note (continued)





The
effective interest rate of the Rockridge Note was approximately 44.3% per annum,
until the September 2009 amendment, when it was reduced to approximately 28.0%
per annum. These rates exclude the potential effect of a premium to market
prices if the balloon payment is satisfied in common shares instead of cash as
well as the potential effect of any appreciation in the value of the Shares at
the time of issuance beyond their value at the date of the Rockridge Agreement
or the Amendment, as applicable.





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





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





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


F-41


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE 4:
DEBT (Continued)





Notes and Leases
Payable (continued)





Capitalized
Equipment Leases
 
 During
July 2007, we entered into a capital lease for audio conferencing equipment,
with an outstanding principal balance of zero and $109,151 as of September 30,
2010 and 2009, respectively. During January 2009, we entered into a capital
lease for telephone equipment, which had an outstanding principal balance of
$27,328 and $33,773 as of September 30, 2010 and 2009, respectively. The balance
is payable in equal monthly payments of $828 through January 2014, which
includes interest at approximately 11% per annum.





Funding
Commitment Letters





During
December 2009, we received funding commitment letters (“Letters”) executed by
certain entities agreeing to provide us funding within twenty days after our
notice given on or before December 31, 2010. Funding under the Letters would be
in exchange for our equity under mutually agreeable terms to be negotiated at
the time of funding, or in the event such terms could not be reached, in the
form of repayable debt subject to certain defined parameters. The value of
shares issued as consideration for the Letters is reflected on our balance sheet
as a reduction of the carrying value of notes payable, pending inclusion as part
of the discount for any financing received in connection with the Letters and
amortization as interest expense over the term of that financing. However, we do
not expect to obtain financing under the Letters before they expire, and
accordingly the $14,000 balance of this item on our balance sheet as of
September 30, 2010 will be written off as interest expense as of December 31,
2010.





NOTE
5:  COMMITMENTS AND CONTINGENCIES





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





On
December 1, 2009, Narrowstep filed a complaint against us in the Court of
Chancery of the State of Delaware, alleging breach of contract, fraud and three
additional counts and is seeking (i) $14 million in damages, (ii) reimbursement
of an unspecified amount for all of its costs associated with the negotiation
and drafting of the Merger Agreement, including but not limited to attorney and
consulting fees, (iii) the return of Narrowstep’s equipment alleged to be in our
possession, (iv) reimbursement of an unspecified amount for all of its attorneys
fees, costs and interest associated with this action and (v) any further relief
determined as fair by the court. After reviewing the complaint document, we have
determined that Narrowstep had no basis in fact or in law for any claim and
accordingly, this matter was not been reflected as a liability on our financial
statements. On December 30, 2010 Narrowstep counsel advised the Court in writing
that Narrowstep had reached an agreement in principle with us to dismiss their
lawsuit with prejudice, provided that both parties executed a mutual release.
Under this mutual release, which has been agreed to in principle by both parties
but is still being finalized, no further actions will be filed against each
other or affiliated parties in connection with this matter. This resolution of
this matter will not have a material adverse impact on our future financial
position or results of operations.


F-42


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES





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





NASDAQ listing issues
- The terms of the 8% Senior Convertible Debentures and the 8% Subordinated
Convertible Debentures (and the related warrants), which we issued from December
2004 through April 2006, as well as common shares we issued during March and
April 2007, contain penalty clauses if our common stock is not traded on NASDAQ
or a similar national exchange, which is detailed under Registration Payment
Arrangements below. Our access to funding under the LPC Purchase Agreement
requires our common stock to be traded on NASDAQ or a similar national exchange.
We have received letters from NASDAQ with respect to our non-compliance with two
requirements necessary to maintain our current NASDAQ listing, as
follows:


Share price requirement–On December 7,
2010, we received a letter from NASDAQ stating that we have 180 calendar days,
or until June 6, 2011, to regain compliance with Listing Rule 5550 (a) (2) (a)
(the “Bid Price Rule”), for which compliance 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 the Bid Price Rule was as a result
of the closing bid price for our common stock being below $1.00 per share for
the preceding thirty consecutive business days. We may be considered compliant
with the Bid Price Rule, subject to the NASDAQ staff’s discretion, if our common
stock closes at $1.00 per share or more for a minimum of ten consecutive
business days before the June 6, 2011 deadline. If we are not considered
compliant by June 6, 2011, but meet the continued listing requirement for market
value of publicly held shares and all other initial listing standards for The
NASDAQ Capital Market, and we provide written notice of our intention to cure
the deficiency during the second compliance period, including a reverse stock
split if necessary, we will be granted an additional 180 calendar day compliance
period. During the compliance period(s), our stock will continue to be listed
and eligible for trading on The NASDAQ Capital Market. Our closing share price
was $0.76 per share on December 23, 2010.





Minimum audit committee size
requirement –On June 24, 2010, we received a letter from NASDAQ stating
that we are currently not compliant with NASDAQ’s minimum audit committee size
requirement of three independent members, as set forth in Listing Rule 5605 (c)
(2) (a) (the “Audit Committee Rule”), for which compliance is necessary in order
to be eligible for continued listing on The NASDAQ Capital Market. Unless we
regain compliance with the Audit Committee Rule as of the earlier of our next
annual shareholders’ meeting or June 5, 2011, our common stock will be subject
to immediate delisting.





On June
14, 2010, we were notified that Mr. Robert J. Wussler, who was then a director
and a member of our audit committee, had passed away on June 5, 2010. He has not
at the present time been replaced on the audit committee, which currently has
two independent members. We are in the process of evaluating independent
candidates to fill the vacancy left as a result of Mr. Wussler’s passing, both
on the Board as well as the audit committee. We will make that selection as soon
as possible.


F-43


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 
 Registration payment
arrangements – The 8% Senior Convertible Debentures, including the
Additional 8% Convertible Debentures (AIR),  provide cash penalties of
1% of the original purchase price for each month that our common shares are not
listed on the NASDAQ Capital Market for a period of 3 trading days (which need
not be consecutive). Regardless of the above, we believe that the applicability
of this provision would be limited by equity and/or by statute to a certain
timeframe after the original security purchase - all of these debentures were
converted to common shares on or before March 31, 2007.
 
 We
included the 8% Subordinated Convertible Debentures and the related $9.00
warrants on a registration statement declared effective by the SEC on July 26,
2006. We are only required to expend commercially reasonable efforts to keep the
registration statement continuously effective. However, in the event the
registration statement or the ability to sell shares thereunder lapses for any
reason for 30 or more consecutive days in any 12 month period or more than twice
in any 12 month period, the purchasers of the 8% Subordinated Convertible
Debentures may require us to redeem any shares obtained from the conversion of
those notes and still held, for 115% of the market value for the previous five
days. The same penalty provisions apply if our common stock is not listed or
quoted, or is suspended from trading on an eligible market for a period of 20 or
more trading days (which need not be consecutive). Since there is no established
mechanism for reporting to us changes in the ownership of these shares
after  they are originally issued, we are unable to quantify how many
of these shares are still held by the original recipient and thus subject to the
above provisions. Regardless of the above, we believe that the applicability of
these provisions would be limited by equity and/or by statute to a certain
timeframe after the original security purchase. All of these debentures were
converted to common shares on or before March 31, 2007 and the related $9.00
warrants have all expired.


During
March and April 2007, we sold 814,815 restricted common shares for total gross
proceeds of approximately $11.0 million. These shares were included in a
registration statement declared effective by the SEC on June 15,
2007.  We are required to maintain the effectiveness of this
registration statement until the earlier of the date that (i) all of the shares
have been sold, (ii) all the shares have been transferred to persons who may
trade such shares without restriction (including our delivery of a new
certificate or other evidence of ownership for such securities not bearing a
restrictive legend) or (iii) all of the shares may be sold at any time, without
volume or manner of sale limitations pursuant to Rule 144(k) or any similar
provision (in the opinion of our counsel). In the event such effectiveness is
not maintained or trading in the shares is suspended or if the shares are
delisted for more than five (5) consecutive trading days then we are liable for
a compensatory payment (pro rated on a daily basis) of one and one-half percent
(1.5%) per month until the situation is cured, such payment based on the
purchase price of the shares still held and provided that such payments may not
exceed ten percent (10%) of the initial purchase price of the shares with
respect to any one purchaser. Regardless of the above, we believe that the
applicability of these provisions would be limited by equity and/or by statute
to a certain timeframe after the original security purchase.
 
 We have
concluded that the arrangements discussed in the preceding three paragraphs are
registration payment arrangements, as that term is defined in the Derivatives
and Hedging topic (Contracts in Entity’s own Equity subtopic) of the ASC. Based
on our satisfactory recent history of maintaining the effectiveness of our
registration statements and our NASDAQ listing, as well as stockholders’ equity
in excess of the NASDAQ listing standards as of September 30, 2010, we have
concluded that material payments under these registration payment arrangements
are not probable and that no accrual related to them is necessary under the
requirements of the Contingencies topic of the ASC.


F-44


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)


Registration rights -
We granted demand registration rights, effective six months from the date of a
certain October 2006 convertible note, for any unregistered common shares
issuable thereunder. Upon such demand, we would have 60 days to file a
registration statement, using our best efforts to promptly obtain the
effectiveness of such registration statement. 166,667 of the 282,416 total
principal and interest shares issued in November and December 2006 and subject
to these rights were included in a registration statement declared effective by
the SEC on June 15, 2007 and we have not received any demand for the
registration of the balance.
 
 We
granted a major shareholder demand registration rights, effective six months
from the January 2007 modification date of a certain convertible note, for any
unregistered common shares issuable thereunder. Upon such demand, we would have
60 days to file a registration statement, using our best efforts to promptly
obtain the effectiveness of such registration statement. 130,765 of the 464,932
shares issued in March 2007 and subject to these rights were included in a
registration statement declared effective by the SEC on June 15, 2007 and we
have not received any demand for the registration of the balance.


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


We
granted piggyback registration rights in connection with 47,500 shares and
25,000 options issued to consultants, as well as 29,167 warrants issued in
connection with a financing prior to April 30, 2010, which shares and options
were not included on the Shelf Registration declared effective by the SEC on
that date – see note 1. As the 47,500 shares and the 29,167 warrants do not
provide for damages or penalties in the event we do not comply with these
registration rights, we have concluded that these rights do not constitute
registration payment arrangements. Although the 25,000 options include cashless
exercise rights until they are registered, and therefore do constitute
registration payment arrangements, since the exercise price of $10.38 per share
was significantly in excess of the market price of $1.04 per share as of
September 30, 2010, we have concluded that no accrual related to these rights is
necessary as of that date under the requirements of the Contingencies topic of
the ASC.


F-45


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





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





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





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





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


F-46


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





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





This
program was subject only to the approval by our shareholders of a sufficient
increase in the number of authorized 2007 Plan options, which occurred in the
March 25, 2010 shareholder meeting. However, the granting and pricing of the
above performance bonus options by the Board is still pending, subject to
further discussions between the Board and the Executives. Furthermore, although
the performance objectives were met for the third quarter of fiscal 2010, we
have not recognized any related compensation expense on our financial statements
as of September 30, 2010 since the amount is not yet determinable. However, we
do not expect this compensation amount, once determined, to be material to our
financial results.





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


F-47


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





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





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




Other compensation –
In addition to the 12% allocation of the Company Sale Price to the Executives,
as discussed above, on August 11, 2009 our Compensation Committee determined
that an additional three percent (3.0%) of the Company Sale Price would be
allocated, on the same terms, with two percent (2.0%) allocated to the then four
outside Directors (0.5% each), as a supplement to provide appropriate
compensation for ongoing services as a director and as a termination fee,
one-half percent (0.5%) allocated to one additional executive-level employee and
the remaining one-half percent (0.5%) to be allocated by the Board and our
management at a later date, which will be primarily to compensate other
executives not having employment contracts, but may also include additional
allocation to some or all of these five senior Executives. On June 5, 2010, one
of the four outside Directors passed away and we are still in the process of
evaluating independent candidates to fill the resulting Board
vacancy.


F-48


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
  Consultant contracts
– We entered into a consulting contract, effective June 1, 2009, with an
individual for executive management services to be performed for our Infinite
and webcasting divisions. This contract calls for base compensation of $175,000,
plus $25,000 commission, per year. In addition we pay a travel allowance of
$5,000 per month for up to the first thirteen months and a one-time $15,000
moving expenses reimbursement. As part of the contract, we also granted a
four-year term (from vesting) option to purchase 66,667 common ONSM shares,
vesting over four years at 16,667 per year and exercisable at $3.00 per share -
see note 8. The contract is renewable by mutual agreement of the parties with
six months notice to the other. Termination of the contract without cause after
the end of the two-year contract term requires six months notice (which includes
a three month severance period) from the terminating party, although termination
with cause requires no notice.
 
 We have
entered into various agreements for financial consulting and advisory services
which, if not terminated as allowed by the terms of such agreements, will
require the issuance after September 30, 2010 of approximately 145,000
unregistered shares and options to purchase approximately 300,000 common shares
at $1.50 per share. The services related to these shares and options will be
provided over periods up to 12 months, and will result in a professional fees
expense of approximately $246,000 over that service period, based on the current
$0.76 market value of an ONSM common share as of December 23,
2010.


Lease commitments –
We are obligated under operating leases for our five offices (one each in
Pompano Beach, Florida, San Francisco, California and Colorado Springs, Colorado
and two in the New York City area), which call for monthly payments totaling
approximately $56,000. The leases have expiration dates ranging from 2011 to
2013 (after considering our rights of termination) and in most cases provide for
renewal options. Most of the leases have annual rent escalation
provisions.


The
three-year operating lease for our principal executive offices in Pompano Beach,
Florida expired September 15, 2010. The monthly base rental is currently
approximately $23,400 (including our share of property taxes and common area
expenses). We are currently in negotiations to extend this lease for an
additional three years, and have tentatively agreed to a starting monthly base
rental of approximately $21,100 (including our share of property taxes and
common area expenses), which would also be retroactive to September 15, 2009,
plus two percent (2%) annual increases. The proposed extension would provide one
two-year renewal option, with a three percent (3%) rent increase in year
one.





The
five-year operating lease for our office space in San Francisco expires July 31,
2015.  The monthly base rental (including month-to-month parking) is
approximately $8,900 with annual increases up to 5.1%. The lease provides one
five-year renewal option at 95% of fair market value and also provides for early
cancellation at any time after August 1, 2011, at our option, with six (6)
months notice and a payment of no more than approximately $25,000.


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


F-49


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





Lease commitments
(continued) – The three-year operating lease for office space in New York City
expires January 31, 2013, although both we and the landlord have the right to
terminate the lease without penalty, upon nine (9) months notice given any time
after February 1, 2011. The monthly base rental is approximately $12,000, with
no increases.





The
future minimum lease payments required under the non-cancelable leases
(including the tentatively agreed on Pompano lease terms, as described above),
plus the capital leases included in Notes Payable and more fully discussed in
note 4, are as follows:


Operating
                  
                  
                  Capital
                  
                  
                  AllYear Ending September 30:
                  
                  Leases
                  
                  
                  Leases
                  
                  
                  Leases2011
                  
                  $
                  613,546
                  
                  
                  $
                  9,938
                  
                  
                  $
                  623,4842012
                  
                  
                  473,120
                  
                  
                  
                  9,938
                  
                  
                  
                  483,0582013
                  
                  
                  272,174
                  
                  
                  
                  9,938
                  
                  
                  
                  282,1122014
                  
                  
                  -
                  
                  
                  
                  3,313
                  
                  
                  
                  3,3132015
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Total
      minimum lease payments
                  
                  $
                  1,358,840
                  
                  
                  $
                  33,127
                  
                  
                  $
                  1,391,967Less:
      amount representing interest
                  
                  
                  
                  
                  
                  
                  (5,798
                  )Present
      value of net minimum lease payments
                  
                  
                  
                  
                  
                  $
                  27,329Less:
      current portion
                  
                  
                  
                  
                  
                  
                  (7,266
                  )Long-term
      portion
                  
                  
                  
                  
                  
                  $
                  20,063




In
addition to the commitments listed above and which are not included in the above
table, we also lease equipment space at co-location or other equipment housing
facilities in South Florida; Atlanta, Georgia; Jersey City, New Jersey; San
Francisco, California and Colorado Springs, Colorado under varying terms
resulting in an aggregate monthly payment of approximately $8,000. Total rental
expense (including executory costs) for all operating leases was approximately
$851,000 and $849,000 for the years ended September 30, 2010 and 2009,
respectively.
 
 Bandwidth and co-location
facilities purchase commitments - We were a party to a bandwidth services
agreement with a national CDN (content delivery network) provider, which expired
on December 31, 2010, includes a minimum purchase commitment of approximately
$200,000 per year (based on June 30 anniversary dates) and requires us to use
that provider for at least 80% of our content delivery needs. We are in
compliance with this agreement, based on comparing our purchases through
September 30, 2010 to the corresponding pro-rata share of that commitment. We
have also entered into various agreements for our purchase of bandwidth and use
of co-location facilities, for an aggregate minimum purchase commitment of
approximately $365,000, such agreements expiring at various times through June
2013.




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




F-50


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK





Common
Stock





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


Effective
January 1, 2008, we entered into an agreement with a major shareholder (in
excess of 5% beneficial ONSM ownership) requiring the issuance of approximately
40,000 unregistered shares for financial consulting and advisory services, of
which we recorded the issuance of 15,000 shares, and the related professional
fee expense of approximately $70,000, for the year ended September 30,
2008.  As a result of an agreement signed in January 2009 between us
and that shareholder canceling all previous and future compensation under that
contract, we reflected the reversal of approximately $70,000 previously recorded
professional fee expense, as well as a corresponding reduction of additional
paid-in capital, for the year ended September 30, 2009.





During
the year ended September 30, 2009, we issued (i) 153,811 unregistered common
shares valued at approximately $294,000 (excluding the reduction for the
cancellation of 15,000 previously recorded consulting shares as discussed above)
and (ii) options to purchase our common shares valued at approximately $82,000,
which shares and options will be recognized as professional fees expense for
financial consulting and advisory services over various service periods of up to
12 months. Except for options to purchase 1,389 shares valued at approximately
$5,000 and issued to Mr. Leon Nowalsky, director, as compensation for services
to be rendered by him in connection with his appointment to the Board, none of
the other shares or options were issued to our directors or officers. 20,000 of
the shares were issued to a major shareholder (in excess of 5% beneficial ONSM
ownership) for investor relation and other consulting
services.





During
the year ended September 30, 2009, we issued 75,432 shares valued at
approximately $137,000 in connection with interest on the Equipment Notes – see
note 4.





During
the year ended September 30, 2009, we issued 29,727 shares in connection with
the conversion of Series A-10 preferred as well as 40,542 shares in payment of
dividends on Series A-10 and Series A-12 preferred, both issuances discussed in
more detail below.





During
the year ended September 30, 2010, we issued (i) 345,862 unregistered common
shares valued at approximately $639,000 and (ii) options to purchase our common
shares valued at approximately $120,000, which shares and options will be
recognized as professional fees expense for financial consulting and advisory
services over various service periods of up to 12 months. Other than options to
purchase 19,982 shares at $9.42 per share issued to certain of our directors and
valued at approximately $12,000 (see note 8), none of the other shares or
options were issued to our directors or officers. Professional fee expenses
arising from these and prior issuances of shares and options for financial
consulting and advisory services were approximately $796,000 and $383,000 for
the years ended September 30, 2010 and 2009, respectively.


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Common Stock
(continued)




As a
result of previously issued shares and options for financial consulting and
advisory services, we have recorded approximately $125,000 in deferred equity
compensation expense at September 30, 2010, to be amortized over the remaining
periods of service of up to 11 months. The deferred equity compensation expense
is included in the balance sheet caption prepaid expenses.




During
the year ended September 30, 2010, we issued shares and warrants for interest
and fees on convertible debentures as follows - (i) 79,289 unregistered common
shares valued at approximately $165,000 for interest on the Equipment Notes,
(ii) 149,802 unregistered common shares valued at approximately $321,000 for
prepaid interest and financing fees on the Greenberg Note, the Wilmington Notes
and the Lehmann Note and (iii) warrants having a Black-Scholes value of
approximately $32,000 in connection with the CCJ Note. See note 4.





During
the year ended September 30, 2010, we issued 12,501 unregistered common shares
valued at approximately $21,000 in connection with funding commitment letters
(“Letters”) – see note 4. 41,667 of the 366,667 restricted shares payable to
Rockridge as an origination fee (see note 4) related to borrowings during the
year ended September 30, 2010 and were reflected as an approximately $95,000
increase in paid in capital for that period.





On
September 17, 2010, we entered into a Purchase Agreement (the “Purchase
Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to
an initial purchase of 300,000 shares of our common stock and 420,000 shares of
our Series A-14 Preferred Stock (“Series A-14”), together with warrants to
purchase 540,000 of our common shares. In accordance with the Purchase
Agreement, LPC also received 50,000 shares of our common stock as a one-time
commitment fee and a cash payment of $26,250 as a one-time structuring fee. On
September 24, 2010, we received net proceeds of $873,750 from LPC in exchange
for our issuance of the above shares and warrants. After deducting legal,
accounting and other out-of-pocket costs incurred by us in connection with this
transaction, the net cash proceeds were $824,044. See notes 6 and 8 for further
details with respect to the Series A-14 and the warrants.


During
the period from October 13, 2010 through January 5, 2011 LPC purchased an
additional 405,000 shares of our common stock under that Purchase Agreement for
net proceeds of approximately $336,000.  LPC has also committed to
purchase, at our sole discretion, up to an additional 425,000 shares of our
common stock in installments over the remaining term of the Purchase Agreement,
generally at prevailing market prices, but subject to the specific restrictions
and conditions in the Purchase Agreement. There is no upper limit to the price
LPC may pay to purchase these additional shares. The purchase of our shares by
LPC will occur on dates determined solely by us and the purchase price of the
shares will be fixed on the purchase date and will be equal to the lesser of (i)
the lowest sale price of our common stock on the purchase date or (ii) the
average of the three (3) lowest closing sale prices of our common stock during
the twelve (12) consecutive business days prior to the date of a purchase by
LPC.  LPC shall not have the right or the obligation to purchase any
shares of our common stock from us at a price below $0.75 per
share.


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Common Stock
(continued)
 
 In
addition, we have agreed to use our best efforts to get, within 190 days from
the date of the Purchase Agreement, shareholder approval to sell up to an
additional 1,900,000 of our common shares to LPC, which upon such approval LPC
has agreed to purchase, at our sole discretion and subject to the same
restrictions and conditions in the Purchase Agreement.





The
Purchase Agreement has a term of 25 months but may be terminated by us at any
time after the first year at our discretion without any cost to us and may be
terminated by us at any time in the event LPC does not purchase shares as
directed by us in accordance with the terms of the Purchase Agreement. LPC may
terminate the Purchase Agreement upon certain events of default set forth
therein. The Purchase Agreement restricts our use of variable priced financings
for the greater of one year or the term of the Purchase Agreement and, in the
event of future financings by us, allows LPC the right to participate under
conditions specified in the Purchase Agreement.





The
shares of common stock sold and issued under the Purchase Agreement and the
shares of common stock issuable upon conversion of Series A-14, were sold and
issued pursuant to a prospectus supplement filed by us on September 24, 2010
with the Securities and Exchange Commission in connection with a takedown of an
aggregate of 1.6 million shares from our Shelf Registration.  In
connection with the Purchase Agreement, we also entered into a Registration
Rights Agreement (the “Registration Rights Agreement”) with LPC, dated September
17, 2010, under which we agreed, among other things, to use our best efforts to
keep the registration statement effective until the maturity date as defined in
the Purchase Agreement and to indemnify LPC for certain liabilities in
connection with the sale of the securities. Since there are no specified
damages payable by us in the event of a default under the Registration Rights
Agreement, we have determined that this is not a registration payment
arrangement, as that term is defined in the Derivatives and Hedging topic
(Contracts in Entity’s own Equity subtopic) of the ASC.


During
the year ended September 30, 2010, we issued 58,333 unregistered common shares
in connection with the conversion of Series A-12, as discussed in more detail
below.





Preferred
Stock





As of
September 30, 2009, the only preferred stock outstanding was Series A-12
Redeemable Convertible Preferred Stock (“Series A-12”). As of September 30,
2010, the only preferred stock outstanding was Series A-13 Convertible Preferred
Stock (“Series A-13”) and Series A-14 Convertible Preferred Stock (“Series
A-14”).





Series
A-10 Convertible Preferred Stock





The
Series A-10 had a coupon of 8% per annum, payable annually in cash (or
semi-annually at our option in cash or in additional shares of Series A-10). Our
Board of Directors declared a dividend payable on November 15, 2008 to Series
A-10 shareholders of record as of November 10, 2008 of 2,994 Series A-10
preferred shares, in lieu of a $29,938 cash payment.


F-53


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Preferred Stock
(continued)





Series
A-10 Convertible Preferred Stock (continued)





The
Series A-10 had a stated value of $10.00 per preferred share and had a
conversion rate of $1.00 per common share. The Series A-10 was not redeemable by
us and 17,835 shares of Series A-10 that were still outstanding as of December
31, 2008 were automatically converted into 178,361 common shares.  The
remaining 60,000 shares of Series A-10 that were still outstanding as of
December 31, 2008 were exchanged for Series A-12 preferred as discussed
below.





The
estimated fair value of warrants given in connection with the initial sale of
the Series A-10 (see note 8), plus the Series A-10’s beneficial conversion
feature, was allocated to additional paid-in capital and discount. The discount
was amortized as a dividend over the four-year term of the Series A-10, with the
final $20,292 amortized during the year ended September 30, 2009.





Series
A-12 Redeemable Convertible Preferred Stock





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





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





Series
A-12 dividends were payable in advance in the form of ONSM common shares, using
the average closing bid price of those shares for the five trading days
immediately preceding the Series A-12 purchase closing date. Accordingly, we
issued 39,216 common shares as payment of $64,000 dividends for the one year
period ending December 31, 2009, which was recorded on our balance sheet as
additional paid-in capital and discount and amortized as a dividend over the
one-year term of the Series A-12.


F-54


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Preferred Stock
(continued)





Series
A-12 Redeemable Convertible Preferred Stock (continued)





In
accordance with the terms of the Series A-12, after six months the holders could
require us, to the extent legally permitted, to redeem any or all Series A-12
shares purchased as Additional Shares at the additional purchase price of $10.00
per share.  Shares of Series A-12 acquired in exchange for shares of
Series A-10 had no redemption rights. On April 14, 2009, we entered into a
Redemption Agreement with one of the holders of the Series A-12, CCJ Trust,
under which the holder redeemed 10,000 shares of Series A-12 in exchange for our
payment of $100,000 on April 16, 2009. The remaining potentially redeemable
10,000 shares of Series A-12 was reflected as a $98,000 current liability on our
September 30, 2009 balance sheet ($100,000 stated value, net of a pro-rata share
of the total unamortized discount), which was reclassified to equity as of
December 31, 2009 when it was converted into common shares, along with the
remaining shares of Series A-12 owned by the same holder and having a stated
value of $250,000.





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





Series
A-13 Convertible Preferred Stock





Effective
December 17, 2009, our Board of Directors authorized the sale and issuance of up
to 170,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”). On
December 23, 2009, we filed a Certificate of Designation, Preferences and Rights
for the Series A-13 with the Florida Secretary of State. The Series A-13 has a
coupon of 8% per annum, an assigned value of $10.00 per preferred share and a
conversion rate of $3.00 per common share. Series A-13 dividends are cumulative
and must be fully paid by us prior to the payment of any dividend on our common
shares. Series A-13 dividends are declared quarterly but are payable at the time
of any conversion of A-13, in cash or at our option in the form of our common
shares, using the greater of (i) $3.00 per share or (ii) the average closing bid
price of a common share for the five trading days immediately preceding the
conversion. As of September 30, 2010, we have accrued Series A-13 dividends
through that date of $21,000, which are reflected as a current liability on our
balance sheet.





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





35,000
shares of Series A-13 were outstanding as of September 30, 2010. We incurred
$6,747 of legal fees and other expenses in connection with the issuance of these
shares, which was recorded on our balance sheet as a discount and is being
amortized as a dividend over the remaining term of the Series A-13.




F-55


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Preferred Stock
(continued)





Series
A-13 Convertible Preferred Stock (continued)





In
conjunction with and in consideration of January 2011 note transaction entered
into by us with CCJ Trust, it was agreed that certain terms of the 35,000 shares
of Series A-13 held by CCJ Trust at that date would be modified as follows
-  the conversion rate to common shares, as well as the minimum
conversion rate for payment of dividends in common shares, will be $2.00 per
share, the maturity date will be December 31, 2012 and dividends will be paid
quarterly, in cash or, at our option, in unregistered shares - see note 4. In
addition it was agreed that $28,000 in A-13 dividends for calendar 2010 would be
immediately paid by issuance of 14,000 unregistered common shares, using the
minimum conversion rate of $2.00 per share.




Series
A-14 Convertible Preferred Stock





Effective
September 17, 2010, our Board of Directors authorized the sale and issuance of
up to 420,000 shares of Series A-14 Preferred Stock (“Series A-14”). On
September 22, 2010, we filed a Certificate of Designations for the Series A-14
with the Florida Secretary of State. Series A-14 has a stated value of $1.25 per
preferred share and a fixed conversion rate of $1.25 per common
share.  Series A-14 has a onetime 5% dividend paid in cash, on the
first anniversary of the original issue date.  The holders of Series
A-14 may convert, at the option of the holder and subject to certain
limitations, each share of Series A-14 into one fully-paid, non-assessable share
of our common stock.  Any shares of Series A-14 that are still
outstanding as of second annual anniversary of the original issue date shall
automatically be converted into our common shares, using the same
ratio.  Series A-14 is senior to our common stock but subordinate to
Series A-13and the holders of Series A-14 shall not be
entitled to vote on any matters as to which holders of our common shares are
entitled to vote. Series A-14 is redeemable at our option for $1.56 per share
plus accrued but unpaid dividends, provided that the holder has the right to
convert to common during a ten day notice period prior to such
redemption.





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





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


F-56


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
6:  CAPITAL STOCK (Continued)





Preferred Stock
(continued)




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




F-57


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
7:  SEGMENT INFORMATION


Our
operations are comprised within two groups, Digital Media Services and Audio and
Web Conferencing Services. The primary operating activities of the Webcasting
division of the Digital Media Services Group, as well as our corporate
headquarters, are in Pompano Beach, Florida. The Webcasting division has its
main sales facility in New York City. The primary operating activities of the
Smart Encoding division of the Digital Media Services Group and the EDNet
division of the Audio and Web Conferencing Services Group are in San Francisco,
California. The primary operating activities of the DMSP and UGC divisions of
the Digital Media Services Group are in Colorado Springs, Colorado. The primary
operating activities of the Infinite division of the Audio and Web Conferencing
Services Group are in the New York City metropolitan area. All material sales,
as well as property and equipment, are within the United
States.  Detailed below are the results of operations by segment for
the years ended September 30, 2010 and 2009, and total assets by segment as of
the years then ended.





For the years ended September 30,2010
                    
                    
                    2009Revenue:Digital
      Media Services Group
                    
                    $
                    7,861,118
                    
                    
                    $
                    7,740,355Audio
      and Web Conferencing Services Group
                    
                    
                    8,832,988
                    
                    
                    
                    9,186,598Total
      consolidated revenue
                    
                    $
                    16,694,106
                    
                    
                    $
                    16,926,953Segment
      operating income (loss):Digital
      Media Services Group
                    
                    
                    1,868,112
                    
                    
                    
                    1,155,918Audio
      and Web Conferencing Services Group
                    
                    
                    2,432,394
                    
                    
                    
                    2,535,433Total
      segment operating income
                    
                    
                    4,300,506
                    
                    
                    
                    3,691,351Depreciation
      and amortization
                    
                    
                    (1,923,460
                    )
                    
                    
                    (3,195,291
                    )Corporate
      and unallocated shared expenses
                    
                    
                    (5,732,814
                    )
                    
                    
                    (5,765,798
                    )Write
      off deferred acquisition costs
                    
                    
                    -
                    
                    
                    
                    (504,738
                    )Impairment
      loss on goodwill and other intangible assets
                    
                    
                    (4,700,000
                    )
                    
                    
                    (5,500,000
                    )Other
      expense, net
                    
                    
                    (1,224,804
                    )
                    
                    
                    (556,309
                    )Net
      loss
                    
                    $
                    (9,280,572
                    )
                    
                    $
                    (11,830,785
                    )





September30,2010
                      
                      
                      2009Assets:Digital
      Media Services Group
                      
                      $
                      6,320,046
                      
                      
                      $
                      7,747,921Audio
      and Web Conferencing Services Group
                      
                      
                      13,300,614
                      
                      
                      
                      16,796,925Corporate
      and unallocated
                      
                      
                      1,091,757
                      
                      
                      
                      939,127Total
      assets
                      
                      $
                      20,712,417
                      
                      
                      $
                      25,483,973


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


F-58


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
8:  STOCK OPTIONS AND WARRANTS


As
of September 30, 2010, we had issued options and warrants still outstanding
to purchase up to 2,216,605 ONSM common shares, including 1,170,843 shares under
Plan Options; 41,962 shares under Non-Plan Options to employees and directors;
310,322 shares under Non-Plan Options to financial consultants; and 693,479
shares under warrants issued in connection with various financings and other
transactions.
 
 On
February 9, 1997, our Board of Directors and a majority of our shareholders
adopted the 1996 Stock Option Plan (the "1996 Plan"), which, including the
effect of subsequent amendments to the 1996 Plan, authorized up to 750,000
shares available for issuance as options and up to another 333,333 shares
available for stock grants. On September 18, 2007, our Board of Directors and a
majority of our shareholders adopted the 2007 Equity Incentive Plan (the “2007
Plan”), which authorized the issuance of up to 1,000,000 shares of ONSM common
stock pursuant to stock options, stock purchase rights, stock appreciation
rights and/or stock awards for employees, directors and consultants. The options
and stock grants authorized for issuance under the 2007 Plan were in addition to
those already issued under the 1996 Plan, although we may no longer issue
additional options or stock grants under the 1996 Plan, which expired on
February 9, 2007. On March 25, 2010, our Board of Directors and a majority of
our shareholders approved a 1,000,000 increase in the number of shares
authorized for issuance under the 2007 Equity Incentive Plan (the “2007 Plan”),
for total authorization of 2,000,000 shares.


Detail of
Plan Option activity under the 1996 Plan and the 2007 Plan for the years ended
September 30, 2010 and 2009 is as follows:


September 30, 2010
                
                
                September 30, 2009Number of
                    Shares
                
                
                Weighted
                    Average
                    Exercise Price
                
                
                Number of
                    Shares
                
                
                Weighted
                    Average
                    Exercise PriceBalance,
      beginning of period
                
                
                1,506,458
                
                
                $
                7.92
                
                
                
                1,350,500
                
                
                $
                7.86Granted
      during the period
                
                
                124,884
                
                
                $
                9.42
                
                
                
                463,542
                
                
                $
                8.52Expired
      or forfeited during the period
                
                
                (460,499
                )
                
                $
                6.46
                
                
                
                (307,584
                )
                
                $
                8.76Balance,
      end of the period
                
                
                1,170,843
                
                
                $
                8.62
                
                
                
                1,506,458
                
                
                $
                7.92Exercisable
      at end of the period
                
                
                1,019,454
                
                
                $
                8.85
                
                
                
                1,142,013
                
                
                $
                8.16




We
recognized compensation expense of approximately $816,000 and $1,128,000 for the
years ended September 30, 2010 and 2009, respectively, related to Plan Options
granted to employees and vesting during those periods. The unvested portion of
Plan Options outstanding as of September 30, 2010 (and granted on or after our
October 1, 2006 adoption of the requirements of the Compensation - Stock
Compensation topic of the ASC) represents approximately $700,000 of potential
future compensation expense, which excludes approximately $9,000 related to the
ratable portion of those unvested options allocable to past service periods and
recognized as compensation expense as of September 30, 2010.




F-59


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MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)





The
outstanding Plan Options for the purchase of 1,170,843 common shares all have
exercise prices equal to or greater than the fair market value at the date of
grant, the exercisable portion has a weighted-average remaining life of
approximately 2.4 years and are further described below.


Grant date
                    
                    Description
                    
                    Total number
                        of underlying
                        common
                        shares
                    
                    
                    Vested portion
                      of underlying
                      common
                      shares
                    
                    
                    Exercise
                        price
                        per
                        share
                    
                    Expiration
                      dateDec
      2004
                    
                    Senior
      management
                    
                    
                    25,000
                    
                    
                    
                    25,000
                    
                    
                    $
                    7.26
                    
                    Aug
      2014Sept
      2006
                    
                    Directors
      and senior management
                    
                    
                    108,333
                    
                    
                    
                    108,333
                    
                    
                    $
                    4.26
                    
                    Sept
      2011Sept
      2006
                    
                    Employees
      excluding senior management
                    
                    
                    96,166
                    
                    
                    
                    96,166
                    
                    
                    $
                    4.26
                    
                    Sept
      2011March 2007
                    
                    Employees
      excluding senior management
                    
                    
                    4,167
                    
                    
                    
                    4,167
                    
                    
                    $
                    13.68
                    
                    March
      2011April
      2007
                    
                    Infinite
      Merger – see note 2
                    
                    
                    25,000
                    
                    
                    
                    25,000
                    
                    
                    $
                    15.00
                    
                    April
      2012Sept
      2007
                    
                    Senior
      management employment contracts – see note 5
                    
                    
                    356,250
                    
                    
                    
                    272,917
                    
                    
                    $
                    10.38
                    
                    Sept
      2012 –
                      Sept
      2016Dec
      2007
                    
                    Leon
      Nowalsky – new director
                    
                    
                    8,333
                    
                    
                    
                    8,333
                    
                    
                    $
                    6.00
                    
                    Dec
      2011Dec
      2007
                    
                    Employees
      excluding senior management
                    
                    
                    1,667
                    
                    
                    
                    1,111
                    
                    
                    $
                    6.00
                    
                    Dec
      2011April
      2008
                    
                    Employees
      excluding senior management
                    
                    
                    2,500
                    
                    
                    
                    1,666
                    
                    
                    $
                    6.00
                    
                    April
      2012May
      2008
                    
                    Infinite
      management consultant – see note 5
                    
                    
                    16,667
                    
                    
                    
                    16,667
                    
                    
                    $
                    6.00
                    
                    May
      2013Aug
      2008
                    
                    Employees
      excluding senior management
                    
                    
                    67,500
                    
                    
                    
                    67,500
                    
                    
                    $
                    6.00
                    
                    Aug
      2012May
      2009
                    
                    Infinite
      management consultant – see note 5
                    
                    
                    66,667
                    
                    
                    
                    16,667
                    
                    
                    $
                    3.00
                    
                    Jun
      2014 –
                      Jun
      2018May
      2009
                    
                    Employees
      excluding senior management
                    
                    
                    50,000
                    
                    
                    
                    33,334
                    
                    
                    $
                    3.00
                    
                    May
      2013 –
                      Jul
      2015Aug
      2009
                    
                    Directors
      and senior management
                    
                    
                    133,334
                    
                    
                    
                    133,334
                    
                    
                    $
                    15.00
                    
                    Aug
      2014Aug
      2009
                    
                    Directors
      and senior management
                    
                    
                    83,449
                    
                    
                    
                    83,449
                    
                    
                    $
                    9.42
                    
                    Aug
      2014Aug
      2009
                    
                    Director
                    
                    
                    926
                    
                    
                    
                    926
                    
                    
                    $
                    20.256
                    
                    Aug
      2014Dec
      2009
                    
                    Directors
      and senior management
                    
                    
                    124,884
                    
                    
                    
                    124,884
                    
                    
                    $
                    9.42
                    
                    Dec
      2014Total
      common shares underlying  Plan Options as of September 30,
      2010
                    
                    
                    1,170,843
                    
                    
                    
                    1,019,454


On August
11, 2009, our Compensation Committee granted 217,709 fully vested five-year Plan
Options to certain executives, directors and other management in exchange for
the cancellation of an equivalent number of fully vested Non Plan Options held
by those individuals and expiring at various dates through December 2009, with
no change in the exercise prices, which ranged from 9.42 to $20.256 per share
and were all in excess of the market value of an ONSM share as of August 11,
2009. As a result of this cancellation and the corresponding issuance, we
recognized non-cash compensation expense of approximately $191,000 for the year
ended September 30, 2009, of which $177,000 was included as part of the total
non-cash compensation expense of $1,128,000 discussed above and the remainder
recognized as professional fees expense.


F-60


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)


On
December 17, 2009, our Compensation Committee granted 124,884 fully vested
five-year Plan Options to certain executives, directors and other management in
exchange for the cancellation of an equivalent number of fully vested Non Plan
Options held by those individuals and expiring in December 2009, with no change
in the $9.42 exercise price, which was in excess of the market value of an ONSM
share as of December 17, 2009. As a result of this cancellation and the
corresponding issuance, we recognized non-cash compensation and professional fee
expense aggregating approximately $77,000 for the year ended September 30, 2010,
of which $65,000 was included as part of the total non-cash compensation expense
of $816,000 discussed above and the remainder recognized as professional fees
expense.
 
 As of
September 30, 2010, there were outstanding Non-Plan Options issued to employees
and directors for the purchase of 41,962 common shares, which were issued during
fiscal 2005 in conjunction with the Onstream Merger (see note 2). These options
are immediately exercisable at $20.26 per share and expire at various times from
July 2012 to May 2013.
 
 As of
September 30, 2010, there were outstanding and fully vested Non-Plan Options
issued to financial consultants for the purchase of 310,322 common shares, as
follows:


Issuance period
                    
                    Number of
                        common
                        shares
                    
                    
                    Exercise price
                        per share
                    
                    Expiration
                        DateOctober
      2009
                    
                    
                    75,000
                    
                    
                    $3.00
                    
                    Oct
      2013July
      2010
                    
                    
                    50,000
                    
                    
                    $6.00
                    
                    July
      2014Year
      ended September 30, 2010
                    
                    
                    125,000August
      2009
                    
                    
                    16,667
                    
                    
                    $3.00
                    
                    Aug
      2013September
      2009
                    
                    
                    8,333
                    
                    
                    $3.00
                    
                    Sept
      2013Year
      ended September 30, 2009
                    
                    
                    25,000October
      2007
                    
                    
                    25,000
                    
                    
                    $10.38
                    
                    Oct
      2011October
      2007
                    
                    
                    16,667
                    
                    
                    $10.98
                    
                    Oct
      2011Year
      ended September 30, 2008
                    
                    
                    41,667October
      - December 2006
                    
                    
                    12,500
                    
                    
                    $6.00
                    
                    Oct
      - Dec 2010December
      2006
                    
                    
                    6,667
                    
                    
                    $9.00
                    
                    December
      2010January
      2007
                    
                    
                    81,666
                    
                    
                    $14.76
                    
                    Oct
      2010 - Jan 2011March
      2007
                    
                    
                    3,531
                    
                    
                    $14.88
                    
                    March
      2012Year
      ended September 30, 2007
                    
                    
                    104,364March
      – September 2006
                    
                    
                    14,291
                    
                    
                    $6.30
                    
                    March
      2011Year
      ended September 30, 2006
                    
                    
                    14,291Total
      common shares underlying Non-Plan consultant options as of September 30,
      2010
                    
                    
                    310,322


F-61


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010




NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)
 
 As of
September 30, 2010, there were outstanding vested warrants, issued in connection
with various financings, to purchase an aggregate of 693,479 shares of common
stock, as follows:


Description of transaction
                  
                  Number of
                      common
                      shares
                  
                  
                  Exercise price
                      per share
                  
                  Expiration
                      DateLPC
      Purchase Agreement – September 2010 – see note 6
                  
                  
                  540,000
                  
                  
                  $2.00
                  
                  September
      2015CCJ
      Note – December 2009 – see note 4
                  
                  
                  29,167
                  
                  
                  $3.00
                  
                  December
      2013Placement
      fees – common share offering – March and April 2007
                  
                  
                  57,037
                  
                  
                  $16.20
                  
                  March
      and April 20128%
      Subordinated Convertible Debentures – March and April
      2006
                  
                  
                  67,275
                  
                  
                  $9.00
                  
                  March
      and April 2011Total
      common shares underlying warrants as of September 30,
      2010
                  
                  
                  693,479





With
respect to the warrants issued in connection with the LPC Purchase Agreement,
both the number of underlying shares as well as the exercise price are subject
to adjustment in accordance with certain anti-dilution provisions.Due
to the price-based anti-dilution protection provisions of these warrants (also
known as “down round” provisions) and in accordance with ASC Topic 815,
“Contracts in Entity’s Own Equity”, we are required to recognize these warrants
as a liability at their fair value on each reporting date. These warrants were
reflected as a non-current liability of $386,404 on our consolidated balance
sheet as of September 30, 2010. Subsequent changes in the fair value of this
liability will be recognized in our consolidated statement of operations as
other income or expense. See note 1 – Effects of Recent Accounting
Pronouncements.
 
 The LPC
warrants are not exercisable for the first six months after issuance and contain
certain cashless exercise rights. The number of shares of ONSM common stock that
can be issued upon the exercise of these 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 4.99% of our
issued and outstanding common stock, although this percentage may be changed at
the holder’s option upon not less than 61 days advance notice to us and provided
the changed limitation does not exceed 9.99%.


With
respect to the warrants issued in connection with the sale of 8% Subordinated
Convertible Debentures, the number of shares of ONSM common stock that can be
issued upon the exercise of these $9.00 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 our
issued and outstanding common stock.


The
exercise prices of all of the above warrants are subject to adjustment for
various factors, including in the event of stock splits, stock dividends, pro
rata distributions of equity securities, evidences of indebtedness, rights or
warrants to purchase common stock or cash or any other asset or mergers or
consolidations. Such adjustment of the exercise price would in most cases result
in a corresponding adjustment in the number of shares underlying the warrant.
See note 5 related to certain registration payment arrangements and related
provisions contained in certain of the above warrants.


F-62


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2010





NOTE
9:  SUBSEQUENT EVENTS





Notes 1
(Liquidity - sale of common shares to LPC, funding commitment letter), 2
(Auction Video - patent filings), 4 (CCJ Note – modifications, Greenberg Note
and Wilmington Notes - early repayment with cash and shares, Equipment Notes -
shares issued for interest), 5 (Narrowstep litigation developments, NASDAQ
listing issues) and 6 (Series A-13 – modifications) contain disclosure with
respect to transactions occurring after September 30, 2010.




F-63