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, 2009





o
            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
registered





None
              
              not applicable





Securities
      registered under Section 12(g) of the Act:
                      common stock(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    o  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    x  Yes    o  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 o





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.05
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 x No o





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.  o





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





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





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes o 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,
2009 was approximately $11.6 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, 2009,
44,689,699 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.







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, 2009, 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 99 full time employees as of September 30, 2009, with
operations organized in two main operating groups:





·
            Digital
      Media Services Group


·
            Audio
      and Web Conferencing Services Group





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, our Smart Encoding division and our Travel division.  This
group represented approximately 45.7% and 44.6% of our revenues for the years
ended September 30, 2009 and 2008, 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.


2





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 was made
available to our customers in October 2006. . This initial version of the DMSP
offered for sale to the general public since October 2006 is known as the “Store
and Stream” version.  In February 2009, we launched “Streaming
Publisher”, an additional version of the DMSP platform. Streaming Publisher is
designed to provide enhanced capabilities for advanced users such as publishers,
media companies and other content developers. The new Streaming Publisher
upgrade to the DMSP is a key step in our objective to address the developing
online video advertising market and includes features such as automated
transcoding (the ability to convert media files into multiple file formats),
player gallery (the ability to create various video players and detailed usage
reports), as well as advanced permissions, security and syndication features.
Users of the basic Store and Stream version of the DMSP may easily upgrade to
the Streaming Publisher version for a higher monthly fee.





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.





Our
Travel division, which operates primarily from Pompano Beach, Florida, produces
and distributes Internet-based multi-media streaming videos related to hotels,
resorts, time-shares, golf facilities, and other travel
destinations.


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 54.3% and 55.4% of our revenues for the years
ended September 30, 2009 and 2008, 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, 2009 or 2008.





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 insurance (including
umbrella coverage) of approximately $4.0 million. The general liability
insurance may not cover all potential claims of this type or may not be adequate
to indemnify us for any liability to which we may be exposed. Any liability not
covered by insurance or in excess of insurance coverage could have a material
adverse effect on our business, results of operations and financial
condition.





Our audio
and video networking services are conducted primarily over telephone lines,
which are heavily regulated by the various Federal and other agencies. 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”). In August 2008, February 2009 and May 2009, the USPO
issued non-final rejections of the claims pending in the first of the two
applications. In October 2009 we submitted an amendment to the first of the two
applications, which amendment we expect the USPO to respond to within ninety
days after the date of our submission. 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.





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.


6





Employees





At December 24, 2009 we had
approximately 95 full time employees, of whom 53 were design, production and
technical personnel, 23 were sales and marketing personnel and 19 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.  Our lease
      expires on September 15, 2010 and provides for a two-year renewal
      option. The monthly base rental is approximately $22,500 (including our
      share of property taxes and common area expenses) with annual five percent
      (5%) increases.





·
            an
      approximately 8,500 square foot facility at 200 Vallejo Street 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 April 30, 2014 and provides
      for one five-year renewal option at 95% of fair market value and also
      provides for early cancellation at any time after April 30, 2010, at our
      option, with six months notice and a payment of no more than approximately
      $44,000.   The monthly base rental is approximately $16,800
      (including month-to-month parking) with annual increases up to
      4.4%.





·
            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 440 Ninth Avenue, 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 monthly rental is approximately
      $6,600 and the lease expires on January 31,
  2010.




7




·
            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 Effective Time did not
occur 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 has no basis in fact or in law for any claim and
accordingly, this matter has not been reflected as a liability on our financial
statements. On December 18, 2009, we were served with a summons and we intend to
file the required response on or before the required deadline and to vigorously
defend against all claims. Furthermore, we do not expect the ultimate resolution
of this matter to have a material impact on our financial position or results of
operations.





On May
26, 2009, we were served with a summons and complaint filed in Broward County,
Florida, containing a breach of contract claim against us by a firm seeking
compensation for legal services allegedly rendered to us, plus court costs, in
the amount of approximately $383,000. We have accrued approximately $115,000
related to this matter on our financial statements as of September 30, 2009.
Certain discovery activities by the parties are in process, mediation has been
set for January 26, 2010 and trial has been set for March 8, 2010. We believe
that the ultimate resolution of the matter will not have a material adverse
effect on our 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 management that the resolution of
these outstanding claims will not have a material adverse effect on our
financial position or results of operations.





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





None.


8





PART
II





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





Our common stock is quoted on the
NASDAQ Capital Market, under the trading 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, 2007 through December
24, 2009. These prices do not include retail mark-ups, markdowns or commissions,
and may not necessarily represent actual transactions.





High
                  
                  
                  LowFISCAL
      YEAR 2008First
      Quarter
                  
                  $
                  1.66
                  
                  
                  $
                  0.80Second
      Quarter
                  
                  $
                  1.03
                  
                  
                  $
                  0.62Third
      Quarter
                  
                  $
                  0.99
                  
                  
                  $
                  0.66Fourth
      Quarter
                  
                  $
                  0.83
                  
                  
                  $
                  0.29FISCAL
      YEAR 2009First
      Quarter
                  
                  $
                  0.47
                  
                  
                  $
                  0.22Second
      Quarter
                  
                  $
                  0.32
                  
                  
                  $
                  0.14Third
      Quarter
                  
                  $
                  0.33
                  
                  
                  $
                  0.23Fourth
      Quarter
                  
                  $
                  0.59
                  
                  
                  $
                  0.27FISCAL
      YEAR 2010First
      Quarter (to Dec 24)
                  
                  $
                  0.44
                  
                  
                  $
                  0.27





On
December 24, 2009, the last reported sale price of the common stock on the
NASDAQ Capital Market was $0.28 per share.   As of December 24,
2009 there were approximately 554 shareholders of record of the common
stock.





Dividend
Policy





We have
never declared or paid any cash dividends on our common stock.  We
currently expect to retain future earnings, if any, to finance the growth and
development of our business. Dividends related to the Series A-13 Convertible
Preferred are cumulative and must be fully paid by us prior to the payment of
any dividend on our common stock. Dividends related to the Series
A-12 Redeemable Convertible Preferred were paid in advance.





Recent
Sales of Unregistered Securities





During
the period from August 8, 2009 through September 30, 2009, we recorded the
issuance of 262,500 unregistered shares of common stock for financial consulting
and advisory and legal services. The services are being provided over a period
of one to five months, and will result in a professional fees expense of
approximately $89,500 over the service period. None of these shares were issued
to our directors or officers.





During
the period from October 1, 2009 through December 24, 2009, we recorded the
issuance of 147,500 unregistered shares of common stock for financial consulting
and advisory services. The services are being provided over a period of three to
twelve months and will result in a professional fees expense of approximately
$41,000 over the service period. None of these shares were issued to our
directors or officers.




9




On
November 11, 2009, we issued 209,500 unregistered shares of common stock for
interest on $1,000,000 face value convertible debentures for the period from May
2009 through October 2009. The shares were in satisfaction of interest expense
of approximately $77,515 recognized over that period. None of these shares were
issued to our directors or officers.




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 $0.50 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
ONSM common shares, using the greater of (i) $0.50 per share or (ii) the average
closing bid price of a common share for the five trading days immediately
preceding the conversion.




Any
shares of Series A-13 that are still outstanding as of December 31, 2011 will
automatically convert into ONSM 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 $1.50 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 ONSM common shares are
entitled to vote. Holders of Series A-13 are not entitled to registration
rights.





During
August 2009, CCJ Trust remitted $200,000 to us as a short term advance bearing
interest at .022% per day (equivalent to approximately 8% per annum) until the
date of repayment or unless the parties mutually agreed to another financing
transaction(s) prior to repayment. This advance was included in accounts payable
and accrued liabilities on our September 30, 2009 balance sheet. On December 29,
2009, we entered into an agreement with CCJ Trust 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 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) $0.50 per share. In conjunction
with and in consideration of this note transaction, 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 plus four-year warrants for the purchase of 175,000 ONSM common shares at
$0.50 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 will
receive an aggregate of seventy-five thousand (75,000) unregistered
shares.  One of these funding commitment letters, for $250,000, was
executed by Mr. Charles Johnston, one of our directors.


10


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.




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,
2009.





Plan Category
                        
                        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)
                        
                        
                        3,740,000
                        
                        
                        $1.10
                        
                        
                        None2007
      Equity Incentive Plan (2)
                        
                        
                        5,298,750
                        
                        
                        $1.47
                        
                        
                        
                        526,250Equity
      compensation plans approved by shareholders (3)
                        
                        
                        1,102,928
                        
                        
                        $1.99
                        
                        
                        NoneEquity
      compensation plans not approved by shareholders (4)
                        
                        
                        1,619,346
                        
                        
                        $1.54
                        
                        
                        
                        910,000





1)
              On
      February 9, 1997, our Board of Directors and a majority of our
      shareholders adopted the 1996 Stock Option Plan (the "1996 Plan"). On
      April 11, 2002, an amendment to the 1996 Plan, ratified by a majority of
      our shareholders, reserved an aggregate of 733,334 plan options and added
      an equity compensation component. On December 15, 2004, a majority of our
      shareholders voted to increase the number of shares available for issuance
      under the 1996 Plan to 3,500,000. On September 13, 2005, a majority of our
      shareholders voted to increase the number of shares available for issuance
      under the 1996 Plan to 6,500,000 (up to 4,500,000 shares for issuance as
      options and up to another 2,000,000 shares for stock grants). 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 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 6,000,000 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, as
      discussed in footnote 1
above.


11





3)
              On
      December 15, 2004, a majority of our shareholders voted to issue 1,620,284
      Non-Plan options to certain executives, directors and other management in
      connection with the Onstream Merger, of which (i) 506,250 were cancelled
      on August 11, 2009 in exchange for the issuance of an equivalent number of
      2007 Plan Options and (ii) 11,106 had expired as of September 30,
      2009.





4)
              During
      the fiscal years ended September 30, 2005 through 2009, we issued Non-Plan
      options to consultants in exchange for financial consulting and advisory
      services, 1,619,346 of which were still outstanding and fully vested as of
      September 30, 2009. These outstanding options are summarized
      below:





Issuance period
                    
                    Number
                        of options
                    
                    
                    Exercise price
                        per share
                    
                    Expiration
                        DateYear
      ended September 30, 2009
                    
                    
                    350,000
                    
                    
                    
                    $0.50
      - $1.00
                    
                    Aug
      - Sept 2013Year
      ended September 30, 2008
                    
                    
                    250,000
                    
                    
                    
                    $1.73
      - $1.83
                    
                    Oct
      2011Year
      ended September 30, 2007
                    
                    
                    626,184
                    
                    
                    
                    $1.00
      - $2.48
                    
                    Oct
      2010 – Mar 2012Year
      ended September 30, 2006
                    
                    
                    380,750
                    
                    
                    
                    $1.00
      - $1.05
                    
                    Oct
      2009 – Mar 2011Year
      ended September 30, 2005
                    
                    
                    12,412
                    
                    
                    
                    $1.65 - $3.376
                    
                    Dec
      2009 – Mar 2010Total
      Non-Plan consultant optionsas
      of September 30, 2009
                    
                    
                    1,619,346





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, 2009 of approximately 110,000
unregistered shares and 800,000 options to purchase common shares, at exercise
prices from $0.50 to $1.00 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.


12





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 95 full time employees as of December 24, 2009, with operations
organized in two main operating groups:





·
            Digital
      Media Services Group


·
            Web
      and Audio Conferencing 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, our Smart Encoding division and our Travel division.





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,  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.  Our Travel
division, which operates primarily from Pompano Beach, Florida, produces
and distributes Internet-based multi-media streaming videos related to hotels,
resorts, time-shares, golf facilities, and other travel
destinations.





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.





Fiscal
2009 Highlights and Recent Developments





During
fiscal 2009 we received $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 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 and the
Note and Stock Purchase Agreement also provides that Rockridge may receive an
origination fee of 2,200,000 restricted ONSM common shares. See Liquidity and
Capital Resources.


13





On
December 7, 2009 we entered into an agreement with a certain financial
institution (the “Lender”) whereby our collateralized line of credit arrangement
(the “Line”) was amended to extend it for two years through December 28, 2011
and to increase the borrowing limit to $2.0 million (subject to our accounts
receivable balances and aging).  In addition, effective December 28,
2009, the outstanding balance will bear interest at 13.5% per annum, adjusted
for future changes in the prime rate and we will incur 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%), with no
monitoring fee. As a result of this amendment, certain financial covenants were
also relaxed. See Liquidity and Capital Resources.





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 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.





We
received a letter from NASDAQ dated January 4, 2008 indicating that we had 180
calendar days, or until July 2, 2008, to regain compliance with what is now
Listing Rule 5550 (a) (2) – formerly Marketplace Rule 4310(c)(4) (the “Rule”),
which is necessary in order to be eligible for continued listing on the NASDAQ
Capital Market. The NASDAQ letter indicated that our non-compliance with the
Rule was as a result of the bid price of ONSM common stock closing below $1.00
per share for the preceding thirty consecutive business days.  After a
series of extensions arising from NASDAQ’s suspension of their enforcement of
this listing requirement, the final extension ended on July 31,
2009.  Since we were in a bid price compliance period at the time of
the initial suspension, we remained at the same stage of the process we were in
when the NASDAQ first announced the suspension until that suspension was
terminated on July 31, 2009. Accordingly we were subsequently notified by NASDAQ
that we had until October 16, 2009 to regain compliance with the Rule. On
October 19, 2009, we received a letter from NASDAQ stating that since we had not
regained compliance with the Rule as of October 16, 2009, our common stock was
subject to delisting. However, such delisting would not occur if we requested a
hearing with the NASDAQ Listing Qualifications Panel (“the “Panel”) and pending
the Panel’s decision subsequent to that hearing.




We
requested such a hearing with the Panel, which we attended on December 3, 2009,
and at which time we presented our plan for regaining compliance with the Rule
and requested that our securities be allowed to remain listed pending the
completion of that plan. Based on the Panel’s consideration of that plan, as
well as any other relevant factors, the Panel has the ability to grant us a
period of up to 180 days (counting from the date of the October 19, 2009 letter)
to regain compliance with the Rule. As of December 29, 2009, the Panel had not
informed us of their decision and there can be no assurance that the Panel will
grant our request for continued listing.


14


We might
be considered compliant with the 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.  The closing ONSM share price was $0.28 per
share on December 24, 2009. Although we have not decided on such action, we have
been advised that as a Florida corporation we may implement a reverse split of
our common shares without shareholder approval, provided a proportionate
reduction is made in the number of our authorized common shares and we provide
appropriate advance notice to NASDAQ and other applicable
authorities.


The terms
of the 8% Senior Convertible Debentures and the 8% Subordinated Convertible
Debentures (and the related warrants) issued by us from December 2004 through
April 2006, plus the common shares issued by us in connection with the April
2007 Infinite Merger, contain penalty clauses if our common stock is not traded
on NASDAQ or a similar national exchange.


On
December 1, 2009, Narrowstep filed a complaint against us in the Court of
Chancery of the State of Delaware, seeking $14 million in damages plus other
fees, costs, interest and other remedies in connection with our termination of
the Narrowstep Merger Agreement. After reviewing the complaint, we determined
that Narrowstep has no basis in fact or in law for any claim and accordingly,
this matter has not been reflected as a liability on our financial statements.
Furthermore, we do not expect the ultimate resolution of this matter to have a
material impact on our financial position or results of operations. See details
in Item 3 – Legal Proceedings above.





On May
26, 2009, we were served with a summons and complaint filed in Broward County,
Florida, containing a breach of contract claim against us by a firm seeking
compensation for legal services allegedly rendered to us, plus court costs, in
the amount of approximately $383,000. We have accrued approximately $115,000
related to this matter on our financial statements as of September 30, 2009. We
believe that the ultimate resolution of the matter will not have a material
adverse effect on our financial position or results of operations. See details
in Item 3 – Legal Proceedings above.





Revenue
Recognition





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


Our
Digital 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.
 
 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.





The
Webcasting division charges for live and on-demand webcasting at the time an
event is accessible for streaming over the Internet. The Travel division
recognizes production revenue at the time of completion of the related video or
website. Travel distribution revenue is recognized when a user watches a video
on the Internet, if charged on a per hit basis, or over the term of the
contract, if charged as a fixed monthly fee.
  15
  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 Travel division revenues, 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, 2009 was approximately
$11.8 million ($0.27 loss per share) as compared to a loss of approximately $6.6
million ($0.16 loss per share) for the prior fiscal year, an increase in our
loss of approximately $5.3 million (80%). The increased net loss was primarily
due to a $5.5 million charge for impairment of goodwill and other intangible
assets in the current fiscal year (arising from the difference between our
market capitalization, as adjusted, and our net book value - i.e., stockholders’
equity as reflected in our financial statements) versus no comparable amount in
the prior fiscal year.


16


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





Years Ended September 30,2009
                  
                  
                  2008Revenue:DMSP
      and hosting
                  
                  
                  10.1
                  %
                  
                  
                  8.2
                  %Webcasting
                  
                  
                  33.5
                  
                  
                  
                  33.7Audio
      and web conferencing
                  
                  
                  41.9
                  
                  
                  
                  41.3Network
      usage
                  
                  
                  11.8
                  
                  
                  
                  12.7Other
                  
                  
                  2.7
                  
                  
                  
                  4.1Total
      revenue
                  
                  
                  100.0
                  %
                  
                  
                  100.0
                  %Cost
      of revenue:DMSP
      and hosting
                  
                  
                  3.3
                  %
                  
                  
                  3.5
                  %Webcasting
                  
                  
                  9.9
                  
                  
                  
                  12.1Audio
      and web conferencing
                  
                  
                  11.4
                  
                  
                  
                  8.4Network
      usage
                  
                  
                  5.1
                  
                  
                  
                  5.3Other
                  
                  
                  2.8
                  
                  
                  
                  3.7Total
      costs of revenue
                  
                  
                  32.5
                  %
                  
                  
                  33.0
                  %Gross
      margin
                  
                  
                  67.5
                  %
                  
                  
                  67.0
                  %Operating
      expenses:Compensation
                  
                  
                  57.9
                  %
                  
                  
                  52.6
                  %Professional
      fees
                  
                  
                  7.5
                  
                  
                  
                  11.2Write
      off deferred acquisition costs
                  
                  
                  3.0
                  
                  
                  
                  -Impairment
      loss on goodwill and otherintangible
      assets
                  
                  
                  32.5
                  
                  
                  
                  -Other
      general and administrative
                  
                  
                  14.4
                  
                  
                  
                  15.6Depreciation
      and amortization
                  
                  
                  18.9
                  
                  
                  
                  24.0Total
      operating expenses
                  
                  
                  134.2
                  %
                  
                  
                  103.4
                  %Loss
      from operations
                  
                  
                  (66.7
                  )%
                  
                  
                  (36.4
                  )%Other
      expense, net:Interest
      expense
                  
                  
                  (3.9
                  )%
                  
                  
                  (1.3
                  )%Other
      income, net
                  
                  
                  0.6
                  
                  
                  
                  0.4Total
      other expense, net
                  
                  
                  (3.3
                  )%
                  
                  
                  (0.9
                  )%Net
      loss
                  
                  
                  (70.0
                  )%
                  
                  
                  (37.3
                  )%


17
  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)2009
                
                
                2008
                
                
                Amount
                
                
                PercentTotal
      revenue
                
                $
                16,926,953
                
                
                $
                17,587,223
                
                
                $
                (660,270
                )
                
                
                (3.8
                )%Total
      costs of revenue
                
                
                5,493,533
                
                
                
                5,811,025
                
                
                
                (317,492
                )
                
                
                (5.5
                )%Gross
      margin
                
                
                11,433,420
                
                
                
                11,776,198
                
                
                
                (342,778
                )
                
                
                (2.9
                )%General
      and administrative expenses
                
                
                13,507,867
                
                
                
                13,963,452
                
                
                
                (455,585
                )
                
                
                (3.3
                )%Write
      off deferred acquisition costs
                
                
                504,738
                
                
                
                -
                
                
                
                504,738
                
                
                
                -Impairment
      loss on goodwill and otherintangible
      assets
                
                
                5,500,000
                
                
                
                -
                
                
                
                5,500,000
                
                
                
                -Depreciation
      and amortization
                
                
                3,195,291
                
                
                
                4,215,669
                
                
                
                (1,020,378
                )
                
                
                (24.2
                )%Total
      operating expenses
                
                
                22,707,896
                
                
                
                18,179,121
                
                
                
                4,528,775
                
                
                
                24.9
                %Loss
      from operations
                
                
                (11,274,476
                )
                
                
                (6,402,923
                )
                
                
                4,871,553
                
                
                
                76.1
                %Other
      expense, net
                
                
                (556,309
                )
                
                
                (158,535
                )
                
                
                397,774
                
                
                
                250.9
                %Net
      loss
                
                $
                (11,830,785
                )
                
                $
                (6,561,458
                )
                
                $
                5,269,327
                
                
                
                80.3
                %





Revenues
and Gross Margin





Consolidated
operating revenue was approximately $16.9 million for the year ended September
30, 2009, a decrease of approximately $660,000 (3.8%) from the prior fiscal
year, primarily due to decreased revenues of the Audio and Web Conferencing
Services Group, although revenues of the Digital Media Services Group also
decreased during this period.


Audio and
Web Conferencing Services Group revenues were approximately $9.2 million for the
year ended September 30, 2009, a decrease of approximately $549,000 (5.6%) from
the prior fiscal year. This decrease was primarily a result of (i) decreased
network usage service fees from the EDNet division and (ii) decreased network
equipment sales and rental revenues from the EDNet division, which decreases we
believe resulted from a reduction in television and movie production activity in
the current year in response to a general economic slow-down.





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. In April 2008, we announced
Infinite’s strategic partnership with Proforma, a leading provider of graphic
communications solutions. In August 2008, we announced that Infinite signed a
reseller agreement with Copper Conferencing, one of the nation’s leading,
carrier-class conferencing services providers for small and medium-sized
businesses. In March 2009 we announced Infinite’s master agency agreement with
Presidio Networked Solutions, a systems integrator. In April 2009, we announced
Infinite’s collaboration with PeerPort to launch WebMeet Community, an
integrated suite of virtual collaboration services. 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 recently began a reorganization of the
Infinite management and sales staff, which included the hiring of a new
divisional president in June 2009. Therefore, due to the expected effects of the
recent Infinite reorganization still in process, as well as the EDNet trends
discussed above which we expect will continue for the foreseeable future, we do
not expect the fiscal 2010 revenues of the Audio and Web Conferencing Services
Group (for the year as a whole) to exceed the fiscal 2009
amounts.


18





Digital
Media Services Group revenues were approximately $7.7 million for the year ended
September 30, 2009, a decrease of approximately $111,000 (1.4%) from the prior
fiscal year. This decrease was primarily due to an approximately $254,000 (4.3%)
decrease in Webcasting division revenues plus smaller decreases in certain other
divisions. However we recorded an approximately $265,000 (18.4%) net increase in
DMSP and hosting division revenues over the prior fiscal year. This increase in
DMSP and hosting division revenues included (i) an approximately $320,000
increase in DMSP “Store and Stream” and “Streaming Publisher” revenues and (ii)
an approximately $44,000 increase in hosting and bandwidth charges to certain
larger DMSP customers serviced by our Smart Encoding division.





As of
September 30, 2009, we had 329 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 252 subscribers as of September 30, 2008.
Including large DMSP hosting customers supported by our Smart Encoding Division,
these customer counts were 345 and 268, respectively. We expect this DMSP
customer base to continue to grow, especially as a result of our recent launch
of version 2 of “Streaming Publisher”. Streaming Publisher is designed to
provide enhanced capabilities for advanced users such as publishers, media
companies and other content developers. The Streaming Publisher upgrade to the
DMSP is a key step in our objective to address the developing online video
advertising market and includes features such as automated transcoding (the
ability to convert media files into multiple file formats), player gallery (the
ability to create various video players and detailed usage reports), as well as
advanced permissions, security and syndication features. Users of the basic
Store and Stream version of the DMSP may easily upgrade to the Streaming
Publisher version for a higher monthly fee.





In
addition to the development of these additional features and products, we have
made progress on our development of an enhanced video search function, which is
now referred to as Video Search Engine Optimization (VSEO). VSEO is based on the
software and hardware infrastructure purchased primarily from Autonomy/Virage
plus the allocation of internal resources from our programming and development
professionals.  Although the timing of further VSEO development is
subject to our overall development priorities, it is currently expected to be
released no later than the end of fiscal 2010.





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 is being 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 is 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.


19




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”). In August 2008, February 2009 and May 2009, the USPO
issued non-final rejections of the claims pending in the first of the two
applications. In October 2009 we submitted an amendment to the first of the two
applications, which amendment we expect the USPO to respond to within ninety
days after the date of our submission. Regardless of this, 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. As a result of this technology, plus other enhancements to the
DMSP as noted above and our increased sales and marketing focus on opportunities
with social networks and other high-volume users of digital rich media, as well
as a result of sales of the recently launched version of Streaming Publisher, we
expect the fiscal 2010 DMSP and hosting revenues (for the year as a whole) to
exceed the corresponding fiscal 2009 amounts, although such increase cannot be
assured.





As
mentioned above, webcasting revenues decreased by 4.3% for the year ended
September 30, 2009 as compared to the prior fiscal year. However, the number of
webcasts produced increased to approximately 7,400 webcasts for the year ended
September 30, 2009, versus approximately 6,800 webcasts for the prior fiscal
year. Since most of the 600 event increase was attributable to audio events with
a lower per-event cost than video events, the average revenue per webcast event
decreased to approximately $773 for the current fiscal year period as compared
to approximately $872 for 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.





Although
webcasting revenues declined during the fourth quarter of fiscal 2009 from the
revenue levels for the first three quarters of that fiscal year, we are already
seeing the start of a return to those previous revenue levels, based on order
flow and other sales activity thus far for the first quarter of fiscal 2010. We
remain optimistic with respect to an increased level of revenues during fiscal
2010 as a result of this initial revenue improvement as well as the following
factors which we believe will favorably impact our webcasting revenues in fiscal
2010:





·
              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. Under the strategic global reseller
      agreement, BT Conferencing will now be offering our webcasting, iEncode
      and digital media services to its new and existing clients worldwide. In
      addition, we will be using BT Conferencing infrastructure and services to
      support our operations.





·
              Expanding
      government 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. We recognized related revenues for all of the above
      government-related contracts of approximately $265,000 and $243,000 for
      the years ended September 30, 2009 and 2008,
  respectively.


20


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.





·
            New
      products and technology - We recently launched iEncodeTM, 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 and we introduced version
      2 (V2) of iEncodeTM in June 2009, V2 was not available for delivery to our
      customers until December 2009. We expect to ship 20 V2 units and supply V2
      upgrades to the more than 20 existing installations of the prior version
      of these appliances (40 total) by the end of the second fiscal 2010
      quarter.As a
      result, we expect iEncodeTM sales to increase to more meaningful levels in
      fiscal 2010, as compared to fiscal
2009.





We have
recently completed several feature enhancements to our proprietary webcasting
platform, including embedded Flash video and animations as well as a webinar
service providing the means to hold a virtual seminar online in real time and
both audio and video editing capabilities. In addition, we recently announced an
upgrade to our webcasting service, featuring broadcast quality video using the
industry standard 16:9 aspect ratio, which we named Visual Webcaster HDTM. The
new upgrade includes the ability to use high definition cameras and other HD
sources input via SDI (Serial Digital Interface) into our encoders, providing a
broadcast-quality experience.





During
fiscal 2009, we began the development of the MarketPlace365TM (MP365) platform,
which will enable the creation of on-line virtual marketplaces, trade shows and
social communities. 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. MP365 will be available for
sale by January 2010 and we already have several expressions of interest and/or
preliminary commitments for MP365 marketplaces from the existing publishers and
trade show companies that we have already introduced the product to. We have had
very positive feedback from our existing distributors and clients for the
initial trial version of this product, and we expect to be able to sign a
meaningful number of promoter contracts within the next several months. In
December 2009, we announced an agreement with the Tarsus Group plc (“Tarsus”) to
implement and market MP365 to Tarsus' more than 19,000 trade shows and 2,000
suppliers that are part of their Trade Show News Network (www.TSNN.com), a
leading online resource for the trade show, exhibition and event industry.Due to the
significant revenue potential from a single MP365 sale, which we estimate to be
as much as $250,000 per year, we expect this product will have a significant
impact on our future revenues. However, every MP365 sale will not be expected to
generate this level of revenue and the attainment of any revenue from a MP365
sale 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 revenues, the anticipated increases in
DMSP and hosting revenues and revenues upon the introduction of
MarketPlace365TM, all as discussed
above, we expect the fiscal 2010 revenues of the Digital Media Services Group
(for the year as a whole) to exceed the corresponding fiscal 2009 amounts,
although such increase cannot be assured.


21


Consolidated
gross margin was approximately $11.4 million for the year ended September 30,
2009, a decrease of approximately $343,000 (2.9%) from the prior fiscal year.
This decrease was due to approximately $863,000 less gross margin from the Audio
and Web Conferencing Services Group, corresponding to the $549,000 decrease in
Audio and Web Conferencing Services Group revenues as discussed above, as well
as decreased gross margin percentage on those revenues from 74.2% to 69.2%.
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 67.5% for
the year ended September 30, 2009, versus 67.0% for the prior fiscal
year.


The
consolidations of two of our co-location facilities into two other existing
locations are in process and expected to be completed during the second fiscal
2010 quarter. During the third fiscal 2010 quarter, we are planning to
discontinue the use of a third-party software application incorporated as part
of our DMSP and hosting services in favor of a less costly application. During
the fourth fiscal 2010 quarter, we are also planning to reduce the number of
telephone switches and/or switch locations used by our Infinite division. These
consolidations, as well as recently negotiated reductions in our bandwidth and
telephone line and usage rates, are expected to reduce our cost of sales by
approximately $400,000 during fiscal 2010, as compared to those costs for fiscal
2009, although such results cannot be assured.




Based
primarily on our expectations of increased Digital Media Services Group sales,
as well as the cost savings in process and expected to have some impact in
fiscal 2010, both as discussed above, we expect consolidated gross margin (in
dollars) for fiscal year 2010 (for the year as a whole) to exceed the prior
fiscal year, although such increase cannot be assured.





Operating
Expenses





Consolidated
operating expenses were approximately $22.7 million for the year ended September
30, 2009, an increase of approximately $4.5 million (24.9%) over the prior
fiscal year, primarily due to charges in the current fiscal year for (i)
goodwill impairment and (ii) a write off of deferred acquisition costs, versus
no comparable amounts in the prior fiscal year. The effect of such charges,
which totaled approximately $6.0 million, plus the effect of an increase of
approximately $546,000 in compensation expense for the year ended September 30,
2009, was partially offset by declines in professional fees expense and
depreciation and amortization expense in the current fiscal year as compared to
those amounts in the prior fiscal year.


The
Intangibles - Goodwill and Other topic of the Accounting Standards Codification
(“ASC”) issued by the Financial Accounting Standards Board (“FASB”), 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. 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 Acquired Onstream as
of December 31, 2008, including an assessment of the fair value of the net
assets of this reporting unit 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. Although,
based on these factors, the first step of the two step testing process of
Acquired Onstream’s net assets (which include the DMSP) 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, our stock price and 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 three
months ended December 31, 2008. None of our reporting units with significant
goodwill or intangible assets were scheduled for a recurring annual impairment
review during the September 30, 2009 quarter and as of September 30, 2009, we
noted no business or other conditions that would indicate the necessity for
interim “step one” testing of individual reporting units for impairment.
Therefore, the comparison of our market capitalization to our net book value as
of September 30, 2009 was not considered to be relevant at that date, and the
non-cash expense for the impairment of our goodwill and other intangible assets
was also $5.5 million for the year ended September 30, 2009. However, if our
stock price and market value continue at the December 24, 2009 levels ($0.28 per
share) or decline further, such condition may result in future non-cash
impairment charges to our results of operations related to our goodwill and
other intangible assets arising from our next scheduled recurring annual
impairment review, which will be as of December 31, 2009.




22


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. As a result
of this termination, we recorded the write-off of $504,738 of certain previously
deferred acquisition-related costs, which is reflected in our operating results
for the year ended September 30, 2009. We may incur additional future costs and
expenses related to Narrowstep but not included in this write-off, arising from
a lawsuit filed against us by Narrowstep on December 1, 2009 – see further
discussion in Item 3 - Legal Proceedings above. We do not expect the ultimate
resolution of this matter to have a material impact on our financial position or
results of operations, although this cannot be assured.





Compensation
expense for the year ended September 30, 2009 was approximately $546,000 (5.9%)
greater than the prior fiscal year. This increase was primarily due an
approximately $448,000 increase in our Infinite division’s selling and operating
payroll expenses and an approximately $245,000 increase in non-cash expenses
related to equity-based compensation (shares and options) for all divisions,
partially offset by an approximately $399,000 increase in the amount of internal
software development salaries and benefits capitalized by us, all items for
fiscal 2009 as compared to fiscal 2008. On August 11, 2009, our Compensation
Committee granted 1,306,250 five-year Plan Options to senior management in
exchange for the cancellation of an equivalent number of non-Plan Options held
by those individuals and expiring at various dates through December 2009, with
no change in the exercise prices, which are all in excess of the market value of
an ONSM share as of August 11, 2009. As a result of this cancellation and
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 in compensation expense and the remainder recognized as
professional fee expense.





During
fiscal year 2009, we have taken aggressive steps to reduce operating costs,
including compensation related expenses.  In addition, 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. This action, as
well as payroll cost reduction actions we took during fiscal 2009, represent
anticipated compensation expense reductions of approximately $1.3 million for
fiscal 2010, as compared to fiscal 2009.  Regardless of the above, it
is possible that some or all of this savings will be offset by compensation cost
increases as a result of other actions we may deem necessary in fiscal 2010 as
compared to fiscal 2009.




23


On
December 17, 2009, our Compensation Committee granted 749,305 five-year Plan
Options to senior management in exchange for the cancellation of an equivalent
number of Non-Plan Options held by those individuals 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 corresponding issuance, we expect to recognize non-cash compensation and
professional fee expense of approximately $127,000 for the three months ended
December 31, 2009.





Professional
fee expense for the year ended September 30, 2009 was approximately $701,000
(35.6%) less than the prior fiscal year. This decrease is primarily due to lower
non-cash expenses related to equity-based compensation (shares and options) paid
for financial and other consulting services.





Depreciation
and amortization expense for the year ended September 30, 2009 was approximately
$1.0 million (24.2%) less than 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 loss we recorded during
the three months ended December 31, 2008, which was recorded as a reduction of
the historical depreciable cost basis of those assets as of that
date.





Based
primarily on expected reductions in compensation costs for fiscal 2010 compared
to fiscal 2009 as discussed above, we expect our consolidated operating expenses
for fiscal year 2010 to be less than the corresponding prior year amounts
(excluding any reduction arising from the lack of goodwill impairment charges or
write-offs of acquisition costs in fiscal 2010 as compared to those costs in
fiscal 2009), although this cannot be assured.





Other
Expense





Other
expense of approximately $556,000 for the year ended September 30, 2009
represented an approximately $398,000 (250.9%) increase as compared to the prior
fiscal year. This additional expense was primarily related to an increase in
interest expense of approximately $407,000, arising from a much higher level of
interest bearing debt, as well as increased effective interest rates, for the
year ended September 30, 2009 as compared to the year ended September 30, 2008.
As of September 30, 2009, we had outstanding interest bearing debt with a total
face amount of approximately $3.8 million, which was primarily comprised of (i)
approximately $1.4 million in borrowings outstanding for working capital under a
line of credit arrangement with a financial institution, collateralized by our
accounts receivable and bearing interest at prime plus 11% (14.25%) as of
September 30, 2009, (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 and incurring interest expense at 12% per annum. In addition to these
stated interest amounts, we are also recognizing interest expense as a result of
amortizing discount on these debts. As compared to the approximately $3.8
million of interest bearing debt as of September 30, 2009, the total was
approximately $2.9 million as of September 30, 2008. In addition to this debt
increase of approximately $900,000 during fiscal 2009, the interest rate on our
working capital line of credit increased from prime plus 8% (13.0%) as of
September 30, 2008 to 14.25% as of September 30, 2009 and the Rockridge Note
borrowings in April 2009 carried an effective interest rate of 44.3% per annum
until the September 2009 amendment, at which time the effective interest rate
was reduced to approximately 28.0% per annum.





As
discussed above our collateralized line of credit arrangement (the “Line”) was
amended in December 2009 and as a result the borrowing limit was increased to
$2.0 million and 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 December 24, 2009, the amended terms would represent
increased interest expense, including the monitoring fee, of approximately
$40,000 per year.




24


Based on
the increased outstanding balance as well as the increased interest rate on the
Line effective in December 2009, the Rockridge note being outstanding for a full
year in fiscal 2010 as compared to a portion of fiscal 2009, an additional
borrowing of $500,000 under the Rockridge Note on October 29, 2009, and
potential further borrowings in fiscal 2010 in order to address our working
capital deficit, we anticipate our interest expense during fiscal 2010 to be
greater than it was in fiscal 2009.





Liquidity
and Capital Resources





Our
financial statements for the year ended September 30, 2009 reflect a net loss of
approximately $11.8 million, although cash provided by operations for that
period was approximately $322,000. Although we had cash of approximately
$541,000 at September 30, 2009, our working capital was a deficit of
approximately $2.4 million at that date.





During
the year ended September 30, 2009, we obtained financing from three primary
sources – i) the Line, collateralized by our accounts receivable, under which we
borrowed approximately $182,000 (net of repayments) during the year, ii) the
Rockridge Note, collateralized by all our assets not pledged under the Line,
under which we borrowed approximately $1,364,000 (net of repayments) during the
year and iii) $100,000 in cash proceeds from our sale of Series A-12 preferred
in December 2008, net of subsequent redemptions.





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
24, 2009) 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. We
have not been in compliance with certain loan covenants through June 30, 2009,
although the Lender has granted waivers through that date. In December 2009 the
Lender agreed that (i) weare not required to comply with the debt service coverage covenant for
the quarter ended September 30, 2009 and the next compliance date for this
covenant will be September 30, 2010 and (ii) effective for the quarter ended
September 30, 2009, we are no longer required to comply with the minimum
tangible net worth covenant.





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 is repayable in equal monthly installments of $45,202 extending
through August 14, 2013 (the “Maturity Date”), which installments include
principal (except for a $500,000 balloon payable 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 after September 4, 2010and 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 Note and Stock Purchase Agreement also provides that Rockridge may
receive an origination fee of 2,200,000 restricted ONSM common 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 $0.20 per
share.




25


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 $0.40 per share.





We
prepaid the dividends on all initially issued shares of Series A-12 ($800,000
stated value) through the date of the automatic conversion to ONSM common shares
(December 31, 2009). In accordance with the terms of the Series A-12, at any
time after June 30, 2009 until it automatically converts to ONSM common shares
on December 31, 2009, the holders may require us, to the extent legally
permitted, to redeem up to 20,000 shares ($200,000 stated value) of the Series
A-12 shares. On April 14, 2009, we entered into a Redemption Agreement with one
of the holders of the Series A-12, under which the holder redeemed 10,000 shares
of Series A-12 in exchange for our payment of $100,000 on April 16, 2009.
Accordingly, until December 31, 2009, we may be required to redeem up to another
10,000 Series A-12 shares by the other holder.





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 the debt (i) would be unsecured and subordinated to the Company’s
other debts, (ii) would be subject to approval by our other creditors having the
right of such pre-approval, (iii) would provide for no principal or interest
payments in cash prior to December 31, 2010, although, at our option,
consideration may be given in the form of equity issued before that date and
(iv) would provide that any cash repayment of principal after that date would be
in equal monthly installments over at least one year but no greater than four
years. The rate of return on such debt, including cash and equity consideration
given, would be negotiable based on market values at the time of funding but in
any event would be not be greater than (i) a cash coupon rate of fifteen percent
(15%) per annum and a (ii) total effective interest rate of thirty percent (30%)
per annum (such rate including the cash coupon rate plus the fair value of our
shares given and/or the Black-Scholes valuation of debt conversion features
and/or issuance of options and/or warrants).  As consideration for
these commitment letters, the issuing entities will receive an aggregate of
seventy-five thousand (75,000) unregistered shares.




26


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 209,500 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
$77,515 on our books, based on the fair value of those shares on the issuance
date. The next interest due date is April 30, 2009 and the principal is not due
before June 2011. 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 $0.80 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.





We are
also obligated under 2 capital leases: (i) a capital lease for audio
conferencing equipment payable in equal monthly payments of $10,172 through
August 2010, which includes interest at approximately 5% per annum, plus an
optional final payment based on fair value, but not to exceed $16,974 and (ii) a
capital lease for telephone equipment payable in equal monthly payments of $828
through January 2014, which includes interest at approximately 11% per
annum.





Projected
capital expenditures for the twelve months ended September 30, 2010 total
approximately $1.4 million which includes software development and hardware
upgrades to the DMSP, the webcasting system (including iEncode), the audio and
web conferencing infrastructure and software development and hardware costs in
connection with the MarketPlace365 platform. This total includes the payment of
approximately $360,000 reflected by us as accounts payable at September 30, 2009
(which will not be reflected as capital expenditures in our cash flow statement
until paid).  This total also includes at least $700,000 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. In addition, approximately $119,000 of the Narrowstep
acquisition costs first deferred and then written off by us through September
30, 2009 are included in accounts payable at that date and will not be reflected
as capital expenditures in our cash flow statement until paid.





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 and then was
amended twice (on August 13, 2008 and on September 15, 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 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 has no
basis in fact or in law for any claim and accordingly, this matter has not been
reflected as a liability on our financial statements. On December 18, 2009, we
were served with a summons and we intend to file the required response on or
before the required deadline and to vigorously defend against all claims.
Furthermore, we do not expect the ultimate resolution of this matter to have a
material impact on our financial position or results of operations.





In May
2009, we were sued for breach of contract for legal services allegedly rendered
to us in the amount of approximately $383,000. We have accrued approximately
$115,000 related to this matter on our financial statements as of June 30, 2009
and believe that the ultimate resolution of this matter will not have a material
adverse effect on our financial position or results of operations.




27


In August
2009, we received a letter from the vendor of certain software used in our Smart
Encoding division, stating that the related licenses would be terminated if
payment of approximately $306,000 ($282,000 of which is accrued as a liability
on our June 30, 2009 balance sheet) was not made by September 4, 2009 and that
our obligation to pay this amount would not be affected by such license
termination. We believe that the termination of these licenses would not have a
material effect on our ongoing operations and furthermore believe that we have
meritorious defenses supporting our lack of payment to date, including product
performance and integration issues.





During
February 2009, we took actions to reduce our operating costs, primarily
personnel related, by approximately $65,000 per month. During October 2009, we
took additional actions to reduce our operating costs, primarily personnel
related, by another approximately $62,000 per month. We recently began to
identify and implement certain infrastructure related cost savings, which
actions we expect will reduce our operating costs (cost of sales) by another
approximately $45,000 per month, once they are fully implemented by the end of
fiscal 2010.





We have
estimated that, based on the above reductions in our expenditure levels,
we will require an approximately 2% increase in our consolidated
revenues in fiscal 2010, as compared to fiscal 2009, in order to adequately fund
our minimum anticipated expenditures (including debt service and a basic
level of capital expenditures) through September 30, 2010.  We have
estimated that, in addition to this ongoing revenue increase, we will also
require aggregate financing of approximately $500,000, (funded over several
months starting in January 2010 and in addition to the $500,000 loan proceeds
received from Rockridge in October 2009) to adequately address our current
working capital deficit, to the extent past due vendor and other payments are
believed by us to be necessary for us to continue our operations.





We have
implemented specific actions, including hiring additional sales personnel,
developing new products and initiating new marketing programs, geared towards
achieving the above revenue increases. The costs associated with these actions
were contemplated in the above calculations.  However, in the event we
are unable to achieve these revenue increases, we believe that a
combination of identified decreases in our current level of expenditures that we
would implement and the raising of additional capital in the form of debt and/or
equity that we believe we could obtain from identified sources (including but
not limited to the issuers of the funding commitment letters discussed above)
would be sufficient to allow us to operate through September 30, 2010. We will
closely monitor our revenue and other business activity through the remainder of
fiscal 2010 to determine if further cost reductions, the raising of additional
capital or other activity is considered necessary.





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 $0.50 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
ONSM common shares, using the greater of (i) $0.50 per share or (ii) the average
closing bid price of a common share for the five trading days immediately
preceding the conversion.




Any
shares of Series A-13 that are still outstanding as of December 31, 2011 will
automatically convert into ONSM 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 $1.50 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 ONSM common shares are
entitled to vote. Holders of Series A-13 are not entitled to registration
rights.





28


During
August 2009, CCJ Trust remitted $200,000 to us as a short term advance bearing
interest at .022% per day (equivalent to approximately 8% per annum) until the
date of repayment or unless the parties mutually agreed to another financing
transaction(s) prior to repayment. This advance was included in accounts payable
and accrued liabilities on our September 30, 2009 balance sheet. On December 29,
2009, we entered into an agreement with CCJ Trust 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 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) $0.50 per share. In conjunction
with and in consideration of this note transaction, 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 plus four-year warrants for the purchase of 175,000 ONSM common shares at
$0.50 per share.




Our
accumulated deficit was approximately $114.1 million at September 30, 2009. We
have incurred losses since our inception and our operations have been financed
primarily through the issuance of equity and debt. Cash used for operations will
be affected by numerous known and unknown risks and uncertainties including, but
not limited to, our ability to successfully market and sell the DMSP, iEncode
and MarketPlace365, market our other existing products and services, the degree
to which competitive products and services are introduced to the market, and our
ability to control overhead expenses as we grow.





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 funding
commitment letters 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. There are no assurances whatsoever that the issuers of
the funding commitment letters will be willing and/or able to provide cash
upon our request and/or that we will be able to borrow further funds and/or sell
the unissued portion of the authorized Series A-13 or other forms of equity or
that we will increase our revenues and/or control our expenses to a level
sufficient to provide positive cash flow. We cannot assure that our revenues
will continue at their present levels, nor can we assure that they will not
decrease.





As long
as our cash flow from sales remains insufficient to completely fund operating
expenses, financing costs and capital expenditures, we will continue depleting
our cash and other financial resources. As a result of the uncertainty as to our
available working capital over the upcoming months, we may be required to delay
or cancel certain of the projected capital expenditures, some of the planned
marketing expenditures, or other planned expenses. In addition, it is possible
that we will need to seek additional capital through equity and/or debt
financing.  If we raise additional capital through the issuance of
debt, this will result in increased interest expense. If we raise additional
funds through the issuance of equity or convertible debt securities, the
percentage ownership of our company held by existing shareholders will be
reduced and those shareholders may experience significant
dilution.





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




29


Cash
provided by operating activities was approximately $322,000 for the year ended
September 30, 2009, as compared to approximately $69,000 provided by operations
for the prior fiscal year. The $322,000 reflects our net loss of approximately
$11.8 million, reduced by approximately $11.1 million of non-cash expenses
included in that loss as well as by approximately $1.0 million arising from a
net decrease in non-cash working capital items during the period. The decrease
in non-cash working capital items for the year ended September 30, 2009 is
primarily due to an approximately $940,000 increase in accounts payable and
accrued liabilities. This compares to a net decrease in non-cash working capital
items of approximately $414,000 for the prior fiscal year. The primary non-cash
expenses included in our loss for the year ended September 30, 2009 were $5.5
million arising from a charge for impairment of goodwill and other intangible
assets, $3.2 million of depreciation and amortization, approximately $1.1
million of employee compensation expense arising from the issuance of stock and
options, an approximately $505,000 write off of deferred acquisition costs and
approximately $383,000 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.





Cash used
in investing activities was approximately $1.4 million for the year ended
September 30, 2009 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, although the current period also
included approximately $188,000 of Narrowstep acquisition costs that were
included in the $505,000 write off of such costs recorded during fiscal
2009.





Cash
provided by financing activities was approximately $957,000 for the year ended
September 30, 2009 as compared to approximately $1.5 million for the prior
fiscal year. Current and prior period financing activities primarily related to
net proceeds from notes payable and convertible debentures, net of repayments.
The current period also included proceeds from the sale of A-12 preferred
shares, net of redemptions.





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 $19.0 million at September
30, 2009, representing approximately 75% of our total assets and 104% of the
book value of shareholder equity. In addition, property and equipment as of
September 30, 2009 includes approximately $928,000 (net of depreciation) related
to the DMSP.





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.
 30


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.
We will closely monitor and evaluate all such factors as of December 31, 2009
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-57, which appear at the end of this annual
report.


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


None.


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, 2009, we have
carried out an evaluation of the effectiveness of the design and operation of
our company's disclosure controls and procedures. This evaluation was carried
out under the supervision and with the participation of our company's
management, including our company's President along with our company's Chief
Financial Officer. Based upon that evaluation, our company's President along
with our company's Chief Financial Officer concluded that our company's
disclosure controls and procedures are effective. Based upon that evaluation, no
change in our company's internal controls over financial reporting has occurred
during the quarter then ended, which has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.


Disclosure controls and procedures and
other procedures that are designed to ensure that information required to be
disclosed in our reports filed or submitted under the Securities Exchange Act of
1934 is recorded, processed, summarized and reported, within the time period
specified in the Securities and Exchange Commission's rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed in our
reports filed under the Securities Exchange Act of 1934 is accumulated and
communicated to management including our President and Chief Financial Officer
as appropriate, to allow timely decisions regarding required
disclosure.
 
 31


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, 2009, 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.





This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting. Our
management’s report was not subject to attestation by our registered public
accounting firm, pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.


ITEM
      9B.
              OTHER
      INFORMATION


None.


32


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
              
              53
              
              Chairman
      of the Board, President and Chief Executive OfficerClifford
      Friedland
              
              58
              
              Vice
      Chairman of the Board, Senior Vice President Business
      DevelopmentAlan
      M. Saperstein
              
              50
              
              Director,
      Chief Operating Officer and TreasurerDavid
      Glassman
              
              58
              
              Senior
      Vice President and Chief Marketing OfficerRobert
      E. Tomlinson
              
              52
              
              Senior
      Vice President and Chief Financial OfficerRobert
      J. Wussler  (1)(2)(3)(4)
              
              73
              
              DirectorCharles
      C. Johnston  (1)(2)(3)
              
              74
              
              DirectorCarl
      L. Silva (1)(2)(3)(4)
              
              46
              
              DirectorLeon
      Nowalsky (2)(3)
              
              48
              
              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.  Since our inception in May 1993, Mr. Selman has served
as our Chief Executive Officer, President, and a director and, from September
1996 through June 1999 and from August 1, 2004 through December 15, 2004, as our
Chief Financial Officer.  From March 1985 through May 1993, Mr. Selman
was Chairman of the Board, President and Chief Executive Officer of SK
Technologies Corporation (NASDAQ:SKTC), a 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.


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


33


Alan M.
Saperstein.  Mr. Saperstein has served as our Executive Vice
President, Treasurer and a director since our inception in May 1993, and has
been our Chief Operating Officer since December 2004. 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.





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. Clients included Action Pay Per View. Mr. Glassman was President and
co-founder of Long Distance America, one of the first competitive long distance
operators after the breakup of AT&T from January 1984 to December 1987. Mr.
Glassman was a communications consultant from January 1981 to January 1984
providing services to United States Satellite Systems Inc. and United Satellite
Communications Inc. Mr. Glassman was co-founder and director of All American
Hero, Inc., from January 1981 until December 1986. Mr. Glassman received a B.S.
in Business Management from Florida International University.


Robert E.
Tomlinson.On December 15, 2004 Mr. Tomlinson was appointed our Chief
Financial Officer.  Mr. Tomlinson joined us as Vice President-Finance
in September 2004. Mr. Tomlinson started his financial and accounting career in
1977 with the international accounting firm of Price Waterhouse. In 1982 he left
that firm to join Embraer, an international aircraft manufacturing and support
firm, at their U.S. subsidiary in Fort Lauderdale, Florida, where he managed all
financial functions and eventually was named Senior Vice President-Finance and a
member of the U.S. firm’s Board of Directors. Mr. Tomlinson left Embraer in 1994
and joined staffing and human resource firm OutSource International, serving as
its Chief Financial Officer and helping to take the company public in 1997. Mr.
Tomlinson's areas of responsibility at OutSource International included
corporate accounting, treasury and risk management. From when he left OutSource
International in February 2000 until 2002 he worked as an independent certified
public accountant, focusing on accounting and tax services to corporations. From
2002 until joining us, Mr. Tomlinson served as CFO for Total Travel and Tickets,
a Fort Lauderdale based ticket broker.  Mr. Tomlinson has held an
active Certified Public Accountant license since 1978.
 
 Robert J.
Wussler.  Mr. Wussler has been a member of our Board of
Directors since July 1999 and serves on our Audit, Compensation, Governance and
Nominating and Finance Committees. Mr. Wussler is currently the Chairman of the
Wussler Group, a global entity in the telecommunication business. Mr. Wussler
has been the President of Ted Turner Pictures LLC and Chairman of the Board of
Directors of Team Sports Entertainment, Inc., a publicly-traded company (OTC
Bulletin Board:TSPT) that is in the closed-wheel auto racing business. Prior to
that, he served as Chairman, Chief Executive Officer and President of U.S.
Digital Communications, Inc., a global satellite communications firm. From June
1995 to May 1998, Mr. Wussler was President and Chief Executive Officer of
Affiliate Enterprises, Inc., a company formed by ABC Television affiliates to
pursue new business opportunities. From 1989 to 1992, he was President and Chief
Executive Officer of COMSAT Video Enterprises. From 1980 to 1990, he was Senior
Vice President and Chief Operating Officer of Turner Broadcasting System. Mr.
Wussler spent 21 years at CBS in various capacities, starting in the mailroom,
and served as President of CBS Television and Sports from 1975 to
1978.
 34


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 is a member of the board of directors of AuthentiDate Holding
Company (Nasdaq National Market: ADAT), Internet Commerce Corporation (Nasdaq
National Market: ICCA) and McData Corporation (Nasdaq National Market: MCDT).
Mr. Johnston serves as a Trustee of Worcester Polytechnic Institute and earned
his B.S. degree from WPI in 1957.





Carl
Silva.  Mr. Silva, who 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 20 years of
experience in the telecommunications and high tech industry, and he has held a
variety of positions in business development, sales, marketing, software
engineering, and systems engineering during this time. In May 2003, Mr. Silva
started Anza Borrego Partners (ABP) as a management consulting firm designed to
support entrepreneurs in the growth of their businesses.  Mr. Silva is
currently president and CEO or Cognigen Business Systems, Inc., a joint venture
of ABP and Cognigen Networks, Inc. (NASDAQ: CNGW) formed for the
purpose of providing broadband services to the quick service retail industry.
Mr. Silva is also Chief Scientist of Nexaira, a company involved in the
distribution and support of 3G mobile broadband and Router
solutions.  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.





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; W2Com, LLC, a video conferencing and distance learning
provider which was acquired by Arel Communications & Software, Ltd. (NASDAQ:
ARLC).





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.
 35


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. Wussler, 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 seven
directors.





Director
Compensation Table


The following table presents director
compensation (excluding directors who are Named Executive Officers) for the
year ended September 30, 2009:


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)
                    
                    $
                    15,000
                    
                    
                    
                    -0-
                    
                    
                    $
                    7,037
                    (2)
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    $
                    22,037Charles
      C. Johnston (4)
                    
                    $
                    15,000
                    
                    
                    
                    -0-
                    
                    
                    $
                    6,380
                    (2)
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    
                    -0-
                    
                    
                    $
                    21,380Carl
      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.





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 100,000 shares of our common stock with an exercise
      price of $1.57 per share (fair market value on the date of
      issuance). On August 11, 2009, our Compensation Committee granted
      80,110 fully vested five-year Plan Options (40,055 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, using the
      Black-Scholes model. On December 17, 2009, our Compensation Committee
      granted 119,890 fully vested five-year Plan Options (59,945 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 expect to recognize
      non-cash professional fee (director compensation) expense of approximately
      $59,944 ($29,972 each) for the three months ended December 31, 2009, using
      the Black-Scholes model.





In
December 2004, Mr. Wussler was issued immediately exercisable five-year Non-Plan
options to purchase 5,555 ONSM common shares at $3.376 per share, which we
granted him in exchange for warrants issued to him by Acquired Onstream. On
August 11, 2009, our Compensation Committee granted 5,555 fully vested five-year
Plan Options to Mr. Wussler in exchange for the cancellation of these Non-Plan
Options held by him 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 $657 for the year ended September 30, 2009, using the
Black-Scholes model.


36


No other
options were issued to the directors who were not also Named Executive Officers
during the year ended September 30, 2009.





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, 2009 members of our Board of Directors
      (excluding those who are Named Executive Officers) held outstanding
      options to purchase an aggregate of 607,408 shares of our common stock at
      prices ranging from $0.71 to $3.376 per share. 1,853 of these options held
      by Mr. Silva expired in December 2009. In addition to the 205,555 options
      discussed above, 400,000 options are still held as
  follows:





Messrs.
Wussler and Johnston each hold immediately exercisable five-year Plan options to
purchase 100,000 shares of our common stock with an exercise price of $1.12 per
share (fair market value on the date of issuance), issued to them in July
2005.





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





Messrs.
Wussler and Johnston each hold immediately exercisable five-year Plan options to
purchase 50,000 shares of our common stock with an exercise price of $0.71 per
share (above fair market value on the date of issuance), issued to them in
September 2006.





Mr. Leon
Nowalsky holds immediately exercisable four-year Plan options to purchase 50,000
shares of our common stock with an exercise price of $1.00 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 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.





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. It also holds special meetings whenever circumstances require and may
act by majority written consent. During the fiscal year ended September 30,
2009, there were four meetings of the Board, and the Board took action ten times
by written consent. The Board of Directors has four standing committees as
discussed below and may, from time to time, establish additional
committees.





Audit
Committee





The Audit
Committee of the Board of Directors is responsible for the engagement of our
independent public accountants, approves services rendered by our accountants,
reviews the activities and recommendations of our internal audit department, and
reviews and evaluates our accounting systems, financial controls and financial
personnel. The Board has previously adopted a charter for the Audit Committee.
Pursuant to the requirements of the Securities and Exchange Commission which
requires that we provide our shareholders with a copy of the Audit Charter at
least once every three years, we have included a copy of the Audit Charter as
Appendix B to our proxy statement for our 2007 Annual Meeting filed with the SEC
on July 31, 2007.




37


The Audit
Committee is presently composed of Messrs. Johnston (chairman), Wussler 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 in fiscal 2009.





Compensation
Committee





The Compensation Committee establishes
and administers our executive compensation practices and policies, reviews the
individual elements of total compensation for elected officers and recommends
salary adjustments to the board of directors.  In addition, the
Compensation Committee administers our 1996 Stock Option Plan and our 2007
Equity Incentive Plan and determines the number of performance shares and other
equity incentives awarded to elected officers and the terms and conditions of
which they are granted, amends compensation plans within the scope of the
Compensation Committee's authority and recommends plans and plan amendments to
the board, sets company policy for employee benefit programs and plans and
oversees administration of employee retirement plans and various other benefit
plans as we may establish from time to time. The Compensation Committee is
presently composed of Messrs. Silva (chairman), Wussler, Johnston and Nowalsky.
The Compensation Committee met (in-person and/or by telephone conference) four
times and took action by written resolution once in fiscal 2009.





Finance
Committee





The Finance Committee reviews and makes
recommendations concerning:




·
            proposed
      dividend actions, stock splits and
repurchases,




·
            current
      and projected capital requirements,




·
            issuance
      of debt or equity securities,




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




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




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




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




Messrs. Wussler and Silva are the
members of the Finance Committee. The Finance Committee met in fiscal 2009 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:


38




·
            the
      responsibilities and functions of the Board and Board committees and with
      respect to Board compensation,




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




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




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







The
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.




·
            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, Wussler 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-person and/or by telephone conference) one
time in fiscal 2009, as well as in conjunction with meetings of the full Board
of Directors.


39


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.


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, 2009 and Forms 5 and amendments thereto
furnished to us with respect to the fiscal year ended September 30, 2009, 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,
2009, other than indicated below.


40


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 580,250
options granted each of them on August 11, 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.





Robert
Tomlinson, our CFO, has not filed a Form 4 on a timely basis related to 150,000
options granted to him on August 11, 2009 (as replacement for expiring options –
See Item 11 – Executive Compensation). Mr. Tomlinson has represented to us that
he will file this form as soon as practicable.





Charles
Johnston and Robert Wussler, two of our directors, have not filed a Form 4 on a
timely basis related to 40,055 options granted to each of them on August 11,
2009 (as replacement for expiring options – See Item 10 – Director Compensation
table). Mr. Johnston and Mr. Wussler have represented to us that they will file
these forms as soon as practicable.





Robert
Wussler, one of our directors, has not filed a Form 4 on a timely basis related
to 5,555 options granted to him on August 11, 2009 (as replacement for expiring
options – See Item 10 – Director Compensation table). Mr. Wussler has
represented to us that he will file this form as soon as
practicable.





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”):





STOCK
                                                                                          
                                                                                          
                                                                                          OPTION
                                                                                          
                                                                                          
                                                                                          SECURITIES
                                                                                          
                                                                                          
                                                                                          ALL OTHER
                                                                                          
                                                                                          
                                                                                          TOTALNAME AND
                                                                                          
                                                                                          FISCAL
                                                                                          
                                                                                          
                                                                                          
                                                                                          
                                                                                          BONUS
                                                                                          
                                                                                          
                                                                                          AWARDS
                                                                                          
                                                                                          
                                                                                          AWARDS
                                                                                          
                                                                                          
                                                                                          UNDERLYING
                                                                                          
                                                                                          
                                                                                          COMPENSATION
                                                                                          
                                                                                          
                                                                                          COMPENSATIONPRINCIPALPOSITION
                                                                                          
                                                                                          YEAR
                                                                                          
                                                                                          SALARY($)
                                                                                          
                                                                                          
                                                                                          ($)
                                                                                          
                                                                                          
                                                                                          ($)
                                                                                          
                                                                                          
                                                                                          ($)
                                                                                          
                                                                                          
                                                                                          OPTIONS(#)
                                                                                          
                                                                                          
                                                                                          ($)(14)
                                                                                          
                                                                                          
                                                                                          ($)(15)Randy
      S. Selman
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          $
                                                                                          287,687
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          225,226
                                                                                          (11)(12)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          55,421
                                                                                          (1)
                                                                                          
                                                                                          $
                                                                                          568,334President,
      Chief
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          $
                                                                                          263,695
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          51,502
                                                                                          (2)
                                                                                          
                                                                                          $
                                                                                          456,614Executive
      Officerand
      DirectorAlan
      Saperstein
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          $
                                                                                          261,534
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          225,226
                                                                                          (11)(12)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          59,591
                                                                                          (3)
                                                                                          
                                                                                          $
                                                                                          546,351Chief
      Operating
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          $
                                                                                          238,695
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          56,942
                                                                                          (4)
                                                                                          
                                                                                          $
                                                                                          437,054Officer,
      Treasurerand
      DirectorClifford
      Friedland
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          $
                                                                                          232,410
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          62,934
                                                                                          (5)
                                                                                          
                                                                                          $
                                                                                          436,761Senior
      VP - Busi-
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          $
                                                                                          212,358
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          59,050
                                                                                          (6)
                                                                                          
                                                                                          $
                                                                                          412,825ness
      Developmentand
      DirectorDavid
      Glassman
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          $
                                                                                          232,410
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          55,722
                                                                                          (7)
                                                                                          
                                                                                          $
                                                                                          429,549Senior
      VP -
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          $
                                                                                          212,358
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          52,155
                                                                                          (8)
                                                                                          
                                                                                          $
                                                                                          405,930MarketingRobert
      Tomlinson
                                                                                          
                                                                                          2009
                                                                                          
                                                                                          $
                                                                                          244,194
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          169,579
                                                                                          (11)(13)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          62,642
                                                                                          (9)
                                                                                          
                                                                                          $
                                                                                          476,415Chief
      Financial
                                                                                          
                                                                                          2008
                                                                                          
                                                                                          $
                                                                                          223,125
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          141,417
                                                                                          (11)
                                                                                          
                                                                                          
                                                                                          -0-
                                                                                          
                                                                                          
                                                                                          $
                                                                                          63,742
                                                                                          (10)
                                                                                          
                                                                                          $
                                                                                          428,284Officer





(1)
              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.
  41
  (2)
              Includes
      $15,046 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $19,456 for retirement savings and
      401(k) match.
  (3)
              Includes
      $24,591 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $18,000 for retirement
    savings.
  (4)
              Includes
      $21,942 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $18,000 for retirement
    savings.
  (5)
              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.
  (6)
              Includes
      $21,939 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $20,111 for retirement savings and
      401(k) match.
  (7)
              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.
  (8)
              Includes
      $15,044 for medical and other insurance; $12,000 for automobile allowance;
      $5,000 for dues allowance and $20,111 for retirement savings and
      401(k) match.
  (9)
              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.
  (10)
              Includes
      $21,941 for medical and other insurance; $12,000 for automobile
      allowance; $8,125 for dues allowance and $21,676 for retirement
      savings and 401(k) match.


(11)
              During
      the year ended September 30, 2007, each of the Named Executive Officers
      was issued options to purchase 620,000 common shares at $1.73 per share,
      which was the fair value at date of grant. However, the quoted market
      value of an ONSM share was $0.41 and $0.30 per share as of September 30,
      2009 and 2008, respectively.


220,000
of the above options vest based on performance over the two year period from
October 1, 2007 through September 30, 2009 and since that service period started
after September 30, 2007, there was no related compensation expense for the year
then ended. Therefore, the entire non-cash compensation expense for the vested
portion of these options was recognized over the two years
ending September 30, 2009, using the Black-Scholes model.
  The
remaining 400,000 of those options vest based on service over a four year period
that starts on September 27, 2007.  The four days from the vesting
period start date through September 30, 2007 represent approximately one quarter
of one percent of an approximately 1,460 day total service period, which was
considered immaterial for inclusion of compensation expense for the year ended
September 30, 2007. Therefore, the entire non-cash compensation expense for
these options is being recognized over the four years
ending September 30, 2011, using the Black-Scholes
model.


We have
determined that the performance objectives (as set forth in Employment
Agreements below) were met for the quarter ended June 30, 2009, but that they
were not met for the remaining three quarters of fiscal 2009 nor were they met
for the year ended September 30, 2009. Therefore, 13,750 options out of a
potential 110,000 performance options vested for each executive during fiscal
2009. An additional 100,000 service options vested during fiscal 2009, for total
vested options of 113,750 for each of the Named Executive Officers during fiscal
2009.


We have
determined that the performance objectives (as set forth in Employment
Agreements below) were met for the quarter ended December 31, 2007, but that
they were not met for the remaining three quarters of fiscal 2008 nor were they
met for the year ended September 30, 2008. Therefore, 13,750 options out of a
potential 110,000 performance options vested for each executive during fiscal
2008. An additional 100,000 service options vested during fiscal 2008, for total
vested options of 113,750 for each of the Named Executive Officers during fiscal
2008.


42
  (12)
              On
      August 11, 2009, our Compensation Committee granted 800,000 fully vested
      five-year Plan Options (400,000 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 $2.50 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 $0.41 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, using the Black-Scholes
  model.


On August
11, 2009, our Compensation Committee granted 360,500 fully vested five-year Plan
Options (180,250 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 $1.57 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 $0.41 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, using the Black-Scholes
model.
  On
December 17, 2009, our Compensation Committee granted 539,500 fully vested
five-year Plan Options (269,750 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 $1.57
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 expect to recognize non-cash compensation expense of approximately $91,472
($45,736 each) for the three months ended December 31, 2009, using the
Black-Scholes model.




(13)
              On
      August 11, 2009, our Compensation Committee granted 150,000 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 $1.21 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 $0.41 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, 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.
  (15)
              Total
      compensation includes cash and non-cash elements. The most significant
      non-cash element is the value assigned to the options based on the
      Black-Scholes model, which options as discussed in footnotes 11, 12 and 13
      above had strike prices that significantly exceeded the fair value of our
      shares as of September 30, 2009 and 2008, respectively and thus at those
      dates were what is commonly described as “under water”. Below is a table
      that presents the cash and non-cash elements of compensation for the years
      ended September 30, 2009 and 2008:
  For the Year ended September
30, 2009:





TotalCompensation
                  
                  
                  Non-CashCompensation
                  
                  
                  CashCompensation(includingnon-cash)Randy
      S. Selman
                  
                  $
                  568,334
                  
                  
                  $
                  225,226
                  
                  
                  $
                  343,108Alan
      Saperstein
                  
                  $
                  546,351
                  
                  
                  $
                  225,226
                  
                  
                  $
                  321,125Clifford
      Friedland
                  
                  $
                  436,761
                  
                  
                  $
                  141,417
                  
                  
                  $
                  295,344David
      Glassman
                  
                  $
                  429,549
                  
                  
                  $
                  141,417
                  
                  
                  $
                  288,132Robert
      Tomlinson
                  
                  $
                  476,415
                  
                  
                  $
                  169,579
                  
                  
                  $
                  306,836


43
  For the Year ended September
30, 2008:





TotalCompensation
                  
                  
                  Non-CashCompensation
                  
                  
                  CashCompensation(including non-cash)Randy
      S. Selman
                  
                  $
                  456,614
                  
                  
                  $
                  141,417
                  
                  
                  $
                  315,197Alan
      Saperstein
                  
                  $
                  437,054
                  
                  
                  $
                  141,417
                  
                  
                  $
                  295,637Clifford
      Friedland
                  
                  $
                  412,825
                  
                  
                  $
                  141,417
                  
                  
                  $
                  271,408David
      Glassman
                  
                  $
                  405,930
                  
                  
                  $
                  141,417
                  
                  
                  $
                  264,513Robert
      Tomlinson
                  
                  $
                  428,284
                  
                  
                  $
                  141,417
                  
                  
                  $
                  286,867





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 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 $5,000 allowance for the reimbursement of dues
or charitable donations.  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.





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 400,000 shares of ONSM common stock at an exercise price of $1.73
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 100,000 per year, starting on September 27, 2008, and
they automatically vest upon the happening of the following events on a date
more than six (6) months after the date of the agreement: (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.


44


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 220,000 shares of ONSM common stock at an exercise price of $1.73
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. Up to
one-half of these shares were eligible for vesting on a quarterly basis and the
rest annually, with the total grant allocable over a two-year period ending
September 30, 2009. Vesting of the quarterly portion was 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. Vesting of the annual portion was subject to meeting the above cash
flow requirements on a year-over-year basis, plus a revenue growth rate of at
least 30% for the fiscal year over the prior year. In the event of quarter to
quarter decreases in revenues and or cash flow, the options did not vest for
that quarter but the unvested quarterly options were added to the available
options for the year, vested subject to achievement of the applicable annual
goal. In the event options did not vest based on the quarterly or annual goals,
they immediately expired. 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.




We have
determined that the above performance objectives were met for the quarter ended
December 31, 2007 but that they were not met for the remaining three quarters of
fiscal 2008 nor were they met for the fiscal year ended September 30, 2008. We
have also determined that the performance objectives were met for the quarter
ended June 30, 2009 but that 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, 13,750 options out of a potential 110,000 performance options vested
for each executive during each fiscal year 2008 and 2009 and as a result we
recognized total aggregate compensation expense of approximately $80,000 for
each fiscal year, related to the vested portion of these options.





On August
11, 2009, our Compensation Committee agreed to extend the above bonus program
for two years under substantially the same terms, except that the annual revenue
growth rate will be 20%, we will negotiate with the Executives in good faith as
to how revenue increases from specific acquisitions are measured, and 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. Implementation of
this program is subject only to the approval by our shareholders of a sufficient
increase in the number of authorized 2007 Plan options, at which time the
performance bonus options will be granted and priced – it is anticipated that
the request for shareholder authorization will be submitted at time of the next
annual Shareholder Meeting, expected to be held in February or March 2010. We
have also agreed that this bonus program will continue after this additional
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.





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 $1.00 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 $1.00 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.




45




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 $1.00 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 $1.00. 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.





Outstanding
Equity Awards at Fiscal Year-End Table


The
following table sets forth certain information regarding stock options held as
of September 30, 2009 by the Named Executive Officers. There were no outstanding
stock awards held by them as of that date:




46




NUMBER OF SECURITIES
                                                                          UNDERLYING UNEXERCISED
                                                                          OPTIONS (#)
                                                                        
                                                                        EQUITY
                                                                          INCENTIVE
                                                                          PLAN
                                                                          AWARDS:
                                                                          NUMBER OF
                                                                          SECURITIES
                                                                          UNDERLYING
                                                                          UNEXERCISED
                                                                          UNEARNED
                                                                        
                                                                        OPTION
                                                                          EXERCISE
                                                                        
                                                                        OPTION EXPIRATIONNAME
                                                                        
                                                                        EXERCISABLE
                                                                        
                                                                        
                                                                        UNEXERCISABLE
                                                                        
                                                                        OPTIONS (#)
                                                                        
                                                                        PRICE ($)
                                                                        
                                                                        DATERandy
      Selman (6)
                                                                        
                                                                        
                                                                        100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.71
                                                                        
                                                                        9/29/2011450,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.12
                                                                        
                                                                        7/6/2010269,750
                                                                        (5)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.57
                                                                        
                                                                        12/27/2009180,250
                                                                        (3)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.57
                                                                        
                                                                        8/11/2014400,000
                                                                        (3)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        2.50
                                                                        
                                                                        8/11/2014200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        9/28/2012–
      9/28/201527,500
                                                                        (2)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        12/31/2011–6/30/2013Alan
      Saperstein (6)
                                                                        
                                                                        
                                                                        100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.71
                                                                        
                                                                        9/29/2011450,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.12
                                                                        
                                                                        7/6/2010269,750
                                                                        (5)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.57
                                                                        
                                                                        12/27/2009180,250
                                                                        (3)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.57
                                                                        
                                                                        8/11/2014400,000
                                                                        (3)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        2.50
                                                                        
                                                                        8/11/2014200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        9/28/2012–
      9/28/201527,500
                                                                        (2)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        12/31/2011–6/30/2013Cliff
      Friedland (6)
                                                                        
                                                                        
                                                                        100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.71
                                                                        
                                                                        9/29/201188,860
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        3.376
                                                                        
                                                                        7/1/2012200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        9/28/2012–
      9/28/201527,500
                                                                        (2)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        12/31/2011–6/30/2013David
      Glassman (6)
                                                                        
                                                                        
                                                                        100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.71
                                                                        
                                                                        9/29/201188,860
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        3.376
                                                                        
                                                                        7/1/2012200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        9/28/2012–
      9/28/201527,500
                                                                        (2)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        12/31/2011–6/30/2013Robert
      Tomlinson (6)
                                                                        
                                                                        
                                                                        100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        0.71
                                                                        
                                                                        9/29/2011100,000
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.12
                                                                        
                                                                        7/6/2010150,000
                                                                        (4)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.21
                                                                        
                                                                        8/11/2014200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        200,000
                                                                        (1)
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        9/28/2012–
      9/28/201527,500
                                                                        (2)
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        
                                                                        $
                                                                        1.73
                                                                        
                                                                        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)
              In
      December 2009, fully vested five-year Plan options were issued in exchange
      for cancellation of these expiring Non-Plan options – see discussion in
      footnotes to Summary Compensation table
above.
 (6)
              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.


47
 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 4,500,000
shares of common stock for issuance pursuant to options granted under the 1996
Plan ("Plan Options") and 2,000,000 shares for restricted stock grants (“Stock
Grants”) made under the 1996 Plan.  At September 30, 2009, there were
unexercised options to purchase 3,740,000 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 $0.71 to $2.50 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 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 6,000,000 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. At September 30, 2009,
there were unexercised options to purchase 5,298,750 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 $0.50 to
$3.376 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.
  48
  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 24, 2009, the closing price of our common stock as
reported on the NASDAQ Capital Market was $0.28 per share.


49


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
11, 2009 held by:





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


·
            our
      directors,


·
            named
      executive officers, and


·
            all
      of our directors and officers as a
group.





Unless otherwise indicated, the address
of each of the listed beneficial owners identified is c/o Onstream Media
Corporation, 1291 Southwest 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 11, 2009 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 as of December 11, 2009. At that date, approximately 81% 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.





SharesofCommonStockBeneficiallyOwnedNameandAddressofBeneficialOwner
                  
                  Number
                  
                  
                  PercentageRandy
      S. Selman (1)
                  
                  
                  1,637,452
                  
                  
                  
                  3.5
                  %Alan
      M. Saperstein (2)
                  
                  
                  1,639,320
                  
                  
                  
                  3.5
                  %Clifford
      Friedland (3)
                  
                  
                  1,159,776
                  
                  
                  
                  2.6
                  %David
      Glassman (4)
                  
                  
                  1,159,609
                  
                  
                  
                  2.6
                  %Robert
      E. Tomlinson (5)
                  
                  
                  577,500
                  
                  
                  
                  1.3
                  %Robert
      Wussler (6)
                  
                  
                  256,171
                  
                  
                  
                  0.6
                  %Charles
      C. Johnston (7)
                  
                  
                  698,828
                  
                  
                  
                  1.6
                  %Carl
      L. Silva (8)
                  
                  
                  50,000
                  
                  
                  
                  0.1
                  %Leon
      Nowalsky (9)
                  
                  
                  50,000
                  
                  
                  
                  0.1
                  %All
      directors and officers as a group (nine persons) (10)
                  
                  
                  7,228,656
                  
                  
                  
                  14.5
                  %Austin
      Lewis (11)
                  
                  
                  5,694,799
                  
                  
                  
                  12.7
                  %





(1)           Includes
9,952 shares of our common stock presently outstanding, options to acquire
100,000 common shares at $0.71 per share, options to acquire 450,000 common
shares at $1.12 per share, options to acquire 450,000 common shares at $1.57 per
share, options to acquire 227,500 common shares at $1.73 per share and options
to acquire 400,000 common shares at $2.50 per share.





(2)           Includes
11,820 shares of our common stock presently outstanding, options to acquire
100,000 common shares at $0.71 per share, options to acquire 450,000 common
shares at $1.12 per share, options to acquire 450,000 common shares at $1.57 per
share, options to acquire 227,500 common shares at $1.73 per share and options
to acquire 400,000 common shares at $2.50 per share.




50




(3)           Includes
447,216 shares of our common stock presently outstanding, 148,100 shares of our
common stock held by Titan Trust, 148,100 shares of our common stock held by
Dorado Trust, options to acquire 100,000 common shares at $0.71 per share,
options to acquire 227,500 common shares at $1.73 per share and options to
acquire 88,860 common shares at $3.376 per share. Mr. Friedland is the control
person and beneficial owner of both Titan Trust and Dorado Trust and exercises
sole voting and dispositive powers over these shares.





(4)           Includes
447,049 shares of our common stock presently outstanding, 148,100 shares of our
common stock held by JMI Trust, 148,100 shares of our common stock held by
Europa Trust, options to acquire 100,000 common shares at $0.71 per share,
options to acquire 227,500 common shares at $1.73 per share and options to
acquire 88,860 common shares at $3.376 per share. Mr. Glassman is the control
person and beneficial owner of both JMI Trust and Europa Trust and exercises
sole voting and dispositive powers over these shares.





(5)           Includes
options to acquire 100,000 common shares at $0.71 per share, options to acquire
100,000 common shares at $1.12 per share, options to acquire 150,000 common
shares at $1.21 per share and options to acquire 227,500 common shares at $1.73
per share.





(6)           Includes
616 shares of our common stock presently outstanding, options to acquire 50,000
ONSM common shares at $0.71 per share, options to acquire 100,000 ONSM common
shares at $1.12 per share, options to acquire 100,000 ONSM common shares at
$1.57 per share and options to purchase 5,555 ONSM common shares at
$3.376 per share.





(7)           Includes
439,214 shares of our common stock held by J&C Resources, LLC, 9,614 shares
of our common stock held by Asset Factoring, Ltd., options to acquire 50,000
ONSM common shares at $0.71 per share, options to acquire 100,000 ONSM common
shares at $1.12 per share and options to acquire 100,000 ONSM common shares at
$1.57 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.





(8)           Includes
options to acquire 50,000 ONSM common shares at $0.88 per share.





(9)           Includes
options to acquire 50,000 ONSM common shares at $1.00 per share.





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





(11)         Includes
5,668,549 shares of our common stock presently outstanding and warrants to
acquire 26,250 common shares at $1.50 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 4,665,046 shares to Lewis
Opportunity Fund and beneficial ownership of 1,003,503 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 1,454,545 shares as of December 7, 2009,
which includes the 1,250,000 shares of our common stock issuable upon conversion
of a portion of a note (the “Rockridge Note”) held by Rockridge Capital
Holdings, LLC (“Rockridge”), warrants to acquire 21,212 ONSM common shares at
$1.65 per share, warrants to acquire 83,333 ONSM common shares at $1.50 per
share and options to acquire 100,000 ONSM common shares at $2.46 per share. Mr.
Deluca is the control person and beneficial owner of Rockridge and exercises
sole voting and dispositive powers over these shares These 1,454,545 shares
represent approximately 3.2% 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 2,200,000 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 11, 2009. However, if these 2,200,000 shares were added to the
1,454,545 which are considered beneficially owned by Mr. Deluca as of that date,
the combined total of 3,654,545 shares would represent 7.6% beneficial
ownership.




51




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) 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 $0.40 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 $0.40 per share would result in the issuance of 1,250,000 common shares
upon the conversion of the $500,000 balloon payment.





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 60,000 restricted common shares in advance every six months. The
first two tranches under this contract (60,000 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 15,000 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
240,000 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.




52




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 $0.40 per share) and the Note and Stock Purchase
Agreement also provides that Rockridge may receive an origination fee of
2,200,000 restricted ONSM common shares.




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 will
receive an aggregate of seventy-five thousand (75,000) unregistered shares. One
of these funding commitment letters, for $250,000, was executed by Mr. Charles
Johnston, one of our directors.


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.





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. Wussler, Johnston, Silva
and Nowalsky.





ITEM
14.          PRINCIPAL
ACCOUNTING FEES AND SERVICES


Audit
Fees


The
aggregate audit fees billed to us by Goldstein Lewin & Co. 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.





The
aggregate audit fees billed to us by Goldstein Lewin & Co. for professional
services rendered during the fiscal year ended September 30, 2008 were
$240,632, for the audit of our annual financial statements included in our
Annual Report on Form 10-KSB for the fiscal year ended September 30, 2007 and
for the review of our quarterly financial statements included in our quarterly
reports on Form 10-QSB for the quarters ended December 31, 2007, and March 31
and June 30, 2008.





53




Audit
Related Fees





The
aggregate fees billed to us by Goldstein, Lewin & Co. for assurance and
related services relating to the performance of the audit of our financial
statements which are not reported under the caption "Audit Fees" above were
$6,903 and $85,757 for the fiscal years ended September 30, 2009 and 2008,
respectively. These amounts include $6,599 and $71,104, respectively, for their
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 & Co. were $13,590 and
$15,737 for the fiscal years ended September 30, 2009 and 2008, respectively.
Tax fees include the preparation of federal and state corporate income tax
returns as well as tax compliance, tax advice and tax planning.





All
Other Fees





Other than fees relating to the
services described above under “Audit Fees,” “Audit-Related Fees” and “Tax
Fees,” there were no additional fees billed to us by Goldstein Lewin & Co.
for services rendered for the fiscal years ended September 30, 2009 or
2008.





Audit
Committee Policies


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





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


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


54




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 (16)3.1.15
              
              Articles
      of Amendment dated December 30, 2004, with regard to corporate name change
      (15)3.1.16
              
              Articles
      of Amendment dated February 7, 2005 with regard to the designations for
      Series A-10 Convertible Preferred Stock (17)3.1.17
              
              Articles
      of Amendment dated January 7, 2009 with regard to the designations for
      Series A-12 Redeemable Convertible Preferred Stock (24)3.1.18
              
              Articles
      of Amendment dated December 23, 2009 with regard to the designations for
      Series A-13 Convertible Preferred Stock3.2
              
              By-laws
      (1)4.1
              
              Specimen
      Common Stock Certificate (1)4.2
              
              Form
      of 8% Senior Secured Convertible Notes (16)4.3
              
              Form
      of $1.65 Warrant (16)4.4
              
              Form
      of $1.50 Warrant (16)4.5
              
              Form
      of $1.00 Warrant (20)




55




4.6
              
              Form
      of $1.65 Warrant issuable upon exercise of $1.00 Warrant
    (20)4.7
              
              Form
      of Subordinated Secured Convertible Note (21)4.8
              
              Form
      of $1.50 Warrant for Subordinated Secured Convertible Notes
      (21)4.9
              
              Form
      of 12% Convertible Secured Note (26)4.10
              
              12%
      Convertible Secured Note - Rockridge (19)4.11
              
              Allonge
      to 12% Convertible Secured Note – Rockridge (30)4.12
              
              Form
      of Promissory Note – Thermo Credit10.1
              
              Form
      of 1996 Stock Option Plan and Amendment thereto (1)(3)10.2
              
              Form
      of 2007 Equity Incentive Plan (24)10.3
              
              Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Randy S. Selman10.4
              
              Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Alan Saperstein10.5
              
              Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Clifford Friedland10.6
              
              Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and David Glassman10.7
              
              Employment
      Agreement (Amended) dated August 11, 2009 between Onstream Media
      Corporation and Robert Tomlinson10.8
              
              Form
      of Subscription Agreement used for sale of $11.0 million common shares -
      March 2007 (22)10.9
              
              Form
      of Securities Purchase Agreement for 8% Senior Secured Convertible Notes
      (16)10.10
              
              Form
      of Additional Investment Right (16)10.11
              
              Form
      of Pledge Agreement (16)10.12
              
              Form
      of Security Agreement (16)10.13
              
              Form
      of Letter Agreement with Additional Investment Right holders
      (18)10.14
              
              Deposit
      Control Agreement dated October 2004 (14)10.15
              
              Form
      of Subscription Agreement for Subordinated Secured Convertible Notes
      (21)10.16
              
              Form
      of Subordination Agreement for Subordinated Secured Convertible Notes
      (21)10.17
              
              Form
      of Security Agreement for Subordinated Secured Convertible Notes
      (21)10.18
              
              Amendment
      and Waiver Agreement, dated as of May 29, 2008, among Narrowstep Inc. and
      the investors party thereto (25)10.19
              
              Form
      of Narrowstep Voting Agreement, dated as of May 29, 2008
    (25)10.20
              
              Form
      of Onstream Voting Agreement, dated as of May 29, 2008
  (25)10.21
              
              Form
      of Subscription Agreement, dated as of May 29, 2008, by and between
      Narrowstep Inc. and the investors party thereto (25)10.22
              
              Form
      of Subscription Agreement, dated as of August 13, 2008, by and between
      Narrowstep Inc. and the investors party thereto (27)10.23
              
              Form
      of Subscription Agreement for 12% Convertible Secured Notes
      (26)10.24
              
              Form
      of Security Agreement for 12% Convertible Secured Notes
    (26)10.25
              
              Note
      and Stock Purchase Agreement for 12% Convertible Secured Note - Rockridge
      (19)10.26
              
              Security
      Agreement for 12% Convertible Secured Note - Rockridge
  (19)10.27
              
              First
      Amendment to Note and Stock Purchase Agreement for 12% Convertible Secured
      Note - Rockridge (30)10.28
              
              Commercial
      Business Loan Agreement – Thermo Credit10.29
              
              Amendment
      to Agreements – Thermo Credit10.30
              
              Second
      Amendment to Commercial Business Loan Agreement – Thermo
      Credit10.31
              
              Security
      Agreement – Thermo Credit14.1
              
              Code
      of Business Conduct and Ethics (12)14.2
              
              Corporate
      Governance and Nominating Committee Principles (30)14.3
              
              Audit
      Committee Charter (23)21.1
              
              Subsidiaries
      of the registrant23.1
              
              Consent
      of Independent Registered Public Accounting
Firm




56




31.1
              
              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 November
      4, 2004.


(15)
            Incorporated
      by reference to the registrant’s current report on Form 8-K filed on
      January 4, 2005.


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


(17)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed February
      11, 2005.


(18)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed February
      17, 2005.


(19)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed April
      20, 2009.


(20)
            Incorporated
      by reference to the registrant's Proxy Statement for the 2005 Annual
      Shareholder’s Meeting filed on August 1,
2005.


(21)
            Incorporated
      by reference to the registrant's current report on Form 8-K/A filed April
      3, 2006.


(22)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed March
      28, 2007.


(23)
            Incorporated
      by reference to the registrant’s proxy statement for the 2007 Annual
      Meeting filed with the SEC on July 31,
2007.


(24)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed January
      7, 2009.


(25)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed June 2,
      2008.


(26)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed June 6,
      2008.


(27)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed August
      15, 2008.


(28)
            Incorporated
      by reference to the registrant's current report on Form 8-K/A filed
      September 19, 2008.


(29)
            Incorporated
      by reference to the registrant's Proxy Statement for the 2008 and 2009
      Annual Shareholders Meeting filed on January 28,
  2009.


(30)
            Incorporated
      by reference to the registrant's current report on Form 8-K filed
      September 18, 2009.


57


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:
      December 29, 2009By:
                /s/ Robert E. TomlinsonRobert
      E. TomlinsonChief
      Financial OfficerDate:
      December 29, 2009





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,
              
              December
      29, 2009Randy
      S. Selman
              
              Chief
      Executive OfficerBy: /s/ Robert E. Tomlinson
              
              Chief
      Financial Officer andRobert
      E. Tomlinson
              
              Principal
      Accounting Officer
              
              December
      29, 2009By: /s/ Alan Saperstein
              
              Director
      and Chief
              
              December
      29, 2009Alan
      Saperstein
              
              Operating
      OfficerBy: /s/ Clifford Friedland
              
              Director
      and Senior VP
              
              December
      29, 2009Clifford
      Friedland
              
              Business
      DevelopmentBy: /s/ Charles C. Johnston
              
              Director
              
              December
      29, 2009Charles
      C. JohnstonBy: /s/ Robert J. Wussler
              
              Director
              
              December
      29, 2009Robert
      J. WusslerBy: /s/ Carl Silva
              
              Director
              
              December
      29, 2009Carl
      SilvaBy: /s/ Leon Nowalsky
              
              Director
              
              December
      29, 2009Leon
      Nowalsky


58




REPORT OF INDEPENDENT
REGISTERED PUBLIC ACCOUNTING FIRM





To the
Shareholders of Onstream Media Corporation


Pompano
Beach, Florida





We have
audited the accompanying consolidated balance sheets of Onstream Media
Corporation and subsidiaries as of September 30, 2009 and 2008, and the related
consolidated statements of operations, stockholders' equity and cash flows for
the years then ended.  These financial statements are the
responsibility of the Company's management.  Our responsibility is to
express an opinion on these financial statements based on our
audits.





We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States).  Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement.  An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.  An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Onstream Media Corporation
and subsidiaries as of September 30, 2009 and 2008, and the results of their
operations and their cash flows for the years then ended in conformity with
generally accepted accounting principles in the United States of
America.





/s/
Goldstein Lewin & Co.





GOLDSTEIN
LEWIN & CO.


Certified
Public Accountants





Boca
Raton, Florida


December
29, 2009


F-1


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS




September
      30,
                      2009
                  
                  
                  September
      30,
                      2008ASSETSCURRENT
      ASSETS:Cash and cash
      equivalents
                  
                  $
                  541,206
                  
                  
                  $
                  674,492Accounts receivable, net of
      allowance fordoubtful
      accounts of $241,298 and $30,492, respectively
                  
                  
                  2,189,252
                  
                  
                  
                  2,545,450Prepaid expenses
                  
                  
                  356,963
                  
                  
                  
                  328,090Inventories and other current
      assets
                  
                  
                  198,960
                  
                  
                  
                  172,111Total
      current assets
                  
                  
                  3,286,381
                  
                  
                  
                  3,720,143PROPERTY
      AND EQUIPMENT, net
                  
                  
                  3,083,096
                  
                  
                  
                  4,056,770INTANGIBLE
      ASSETS, net
                  
                  
                  2,499,150
                  
                  
                  
                  3,731,586GOODWILL,
      net
                  
                  
                  16,496,948
                  
                  
                  
                  21,696,948OTHER
      NON-CURRENT ASSETS
                  
                  
                  118,398
                  
                  
                  
                  639,101Total
      assets
                  
                  $
                  25,483,973
                  
                  
                  $
                  33,844,548


LIABILITIES AND STOCKHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Accounts payable and accrued
      liabilities
                          
                          $
                          3,704,676
                          
                          
                          $
                          3,059,376Amounts
      due to shareholders and officers
                          
                          
                          109,419
                          
                          
                          
                          109,419Deferred revenue
                          
                          
                          163,198
                          
                          
                          
                          128,715Notes and leases payable
      –  current portion, net of discount
                          
                          
                          1,615,891
                          
                          
                          
                          1,774,264Series
      A-12 Redeemable Convertible Preferred stock – redeemableportion,
      net of discount
                          
                          
                          98,000
                          
                          
                          
                          -Total
      current liabilities
                          
                          
                          5,691,184
                          
                          
                          
                          5,071,774Notes
      and leases payable, net of current portion and discount
                          
                          
                          505,061
                          
                          
                          
                          109,151Convertible
      debentures, net of discount
                          
                          
                          1,109,583
                          
                          
                          
                          795,931Total
      liabilities
                          
                          
                          7,305,828
                          
                          
                          
                          5,976,856COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Series
      A-10 Convertible Preferred stock, par value $.0001 per share,authorized700,000
      shares,-0- and 74,841 issued and outstanding,
    respectively
                          
                          
                          -
                          
                          
                          
                          8Series
      A-12 Redeemable Convertible Preferred stock, par value $.0001per
      share, authorized100,000 shares, 70,000 and -0- issued and
      outstanding, respectively
                          
                          
                          7
                          
                          
                          
                          -Common
      stock, par value $.0001 per share; authorized 75,000,000 shares,
      44,332,699 and42,625,627 issued and outstanding,
      respectively
                          
                          
                          4,433
                          
                          
                          
                          4,262Additional
      paid-in capital
                          
                          
                          132,295,895
                          
                          
                          
                          130,078,354Unamortized
      discount
                          
                          
                          (12,000
                          )
                          
                          
                          (20,292
                          )Accumulated
      deficit
                          
                          
                          (114,110,190
                          )
                          
                          
                          (102,194,640
                          )Total
      stockholders’ equity
                          
                          
                          18,178,145
                          
                          
                          
                          27,867,692Total
      liabilities and stockholders’ equity
                          
                          $
                          25,483,973
                          
                          
                          $
                          33,844,548








F-2





ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS





Years
      Ended
                  September 30,2009
              
              
              2008REVENUE:DMSP
      and hosting
              
              $
              1,705,697
              
              
              $
              1,440,584Webcasting
              
              
              5,670,364
              
              
              
              5,924,507Audio
      and web conferencing
              
              
              7,098,993
              
              
              
              7,262,685Network
      usage
              
              
              1,992,935
              
              
              
              2,235,078Other
              
              
              458,964
              
              
              
              724,369Total
      revenue
              
              
              16,926,953
              
              
              
              17,587,223COSTS
      OF REVENUE:DMSP
      and hosting
              
              
              557,652
              
              
              
              606,947Webcasting
              
              
              1,676,937
              
              
              
              2,134,765Audio
      and web conferencing
              
              
              1,928,103
              
              
              
              1,476,575Network
      usage
              
              
              863,621
              
              
              
              938,487Other
              
              
              467,220
              
              
              
              654,251Total
      costs of revenue
              
              
              5,493,533
              
              
              
              5,811,025GROSS
      MARGIN
              
              
              11,433,420
              
              
              
              11,776,198OPERATING
      EXPENSES:General and
      administrative:Compensation
              
              
              9,803,158
              
              
              
              9,257,629Professional
      fees
              
              
              1,268,608
              
              
              
              1,970,007Write
      off deferred acquisition costs
              
              
              504,738
              
              
              
              -Impairment
      loss on goodwill and other intangible assets
              
              
              5,500,000
              
              
              
              -Other
      general and administrative
              
              
              2,436,101
              
              
              
              2,735,816Depreciation
      and amortization
              
              
              3,195,291
              
              
              
              4,215,669Total
      operating expenses
              
              
              22,707,896
              
              
              
              18,179,121Loss
      from operations
              
              
              (11,274,476
              )
              
              
              (6,402,923
              )OTHER
      EXPENSE, NET:Interest
      income
              
              
              -
              
              
              
              1,781Interest
      expense
              
              
              (651,464
              )
              
              
              (244,678
              )Other
      income, net
              
              
              95,155
              
              
              
              84,362Total
      other expense, net
              
              
              (556,309
              )
              
              
              (158,535
              )Net
      loss
              
              $
              (11,830,785
              )
              
              $
              (6,561,458
              )Loss
      per share – basic and diluted:Net
      loss per share
              
              $
              (0.27
              )
              
              $
              (0.16
              )Weighted
      average shares of common stock outstanding – basic and
    diluted
              
              
              43,476,478
              
              
              
              42,329,391





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


F-3


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY


YEARS
ENDED SEPTEMBER 30, 2008 AND 2009




Series A-
      10
                            Preferred
      Stock
                          
                          
                          Common
      Stock
                          
                          
                          Additional
      Paid-in Capital
                          
                          
                          AccumulatedShares
                          
                          
                          Amount
                          
                          
                          Shares
                          
                          
                          Amount
                          
                          
                          Gross
                          
                          
                          Discount
                          
                          
                          Deficit
                          
                          
                          TotalBalance,
      September 30, 2007
                          
                          
                          69,196
                          
                          
                          $
                          7
                          
                          
                          
                          41,880,707
                          
                          
                          $
                          4,188
                          
                          
                          $
                          129,090,403
                          
                          
                          $
                          (98,491
                          )
                          
                          $
                          (95,497,362
                          )
                          
                          $
                          33,498,745Issuance
      of shares, warrants and options for consultant services
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          543,670
                          
                          
                          
                          54
                          
                          
                          
                          821,151
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          821,205Issuance
      of shares and options for employee services
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          882,242
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          882,242Common
      shares issued for interest andfeeson
      convertible debentures
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          201,250
                          
                          
                          
                          20
                          
                          
                          
                          186,492
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          186,512Obligation
      for shortfall in proceeds from sales of common shares issued for
      acquisition of Infinite Conferencing
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (958,399
                          )
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (958,399
                          )Dividends
      accrued or paid on Series A-10 preferred
                          
                          
                          5,645
                          
                          
                          
                          1
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          56,465
                          
                          
                          
                          78,199
                          
                          
                          
                          (135,820
                          )
                          
                          
                          (1,155
                          )Net
      loss
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          (6,561,458
                          )
                          
                          
                          (6,561,458
                          )Balance,
      September 30, 2008
                          
                          
                          74,841
                          
                          
                          $
                          8
                          
                          
                          
                          42,625,627
                          
                          
                          $
                          4,262
                          
                          
                          $
                          130,078,354
                          
                          
                          $
                          (20,292
                          )
                          
                          $
                          (102,194,640
                          )
                          
                          $
                          27,867,692





(Continued)


F-4


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY


YEARS
ENDED SEPTEMBER 30, 2008 AND 2009





(Continued)





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
                      
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      42,625,627
                      
                      
                      $
                      4,262
                      
                      
                      $
                      130,078,354
                      
                      
                      $
                      (20,292
                      )
                      
                      $
                      (102,194,640
                      )
                      
                      $
                      27,867,692Issuance
      of shares, warrants and options for consultant services
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      832,871
                      
                      
                      
                      83
                      
                      
                      
                      319,639
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      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 redeemable portion of Series A-12 preferred as a
    liability
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (100,000
                      )
                      
                      
                      16,000
                      
                      
                      
                      (14,000
                      )
                      
                      
                      (98,000
                      )Common
      shares issued for interest and fees on convertible
    debentures
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      452,589
                      
                      
                      
                      45
                      
                      
                      
                      137,230
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      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
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      7,957
                      
                      
                      
                      1
                      
                      
                      
                      37,894
                      
                      
                      
                      20,292
                      
                      
                      
                      (34,765
                      )
                      
                      
                      23,422Conversion
      of Series A-10 preferred to common shares
                      
                      
                      (17,835
                      )
                      
                      
                      (2
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      178,361
                      
                      
                      
                      18
                      
                      
                      
                      (16
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Dividends
      accrued or paid on Series A-12 preferred
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      235,294
                      
                      
                      
                      24
                      
                      
                      
                      63,976
                      
                      
                      
                      (28,000
                      )
                      
                      
                      (36,000
                      )
                      
                      
                      -Net
      loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (11,830,785
                      )
                      
                      
                      (11,830,785
                      )Balance,
      September 30, 2009
                      
                      
                      -
                      
                      
                      $
                      -
                      
                      
                      
                      70,000
                      
                      
                      $
                      7
                      
                      
                      
                      44,332,699
                      
                      
                      $
                      4,433
                      
                      
                      $
                      132,295,895
                      
                      
                      $
                      (12,000
                      )
                      
                      $
                      (114,110,190
                      )
                      
                      $
                      18,178,145





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


F-5


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





Years Ended
                  September 30,2009
              
              
              2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net loss
              
              $
              (11,830,785
              )
              
              $
              (6,561,458
              )Adjustments
      to reconcile net loss to net cash provided by operating
      activities:Depreciation
      and amortization
              
              
              3,195,291
              
              
              
              4,215,669Impairment
      loss on goodwill and other intangible assets
              
              
              5,500,000
              
              
              
              -Write
      off deferred acquisition costs
              
              
              504,738
              
              
              
              -Compensation
      expenses paid with equity
              
              
              1,127,606
              
              
              
              882,242Amortization
      of deferred professional fee expenses paid with equity
              
              
              383,375
              
              
              
              1,079,073Amortization
      of discount on convertible debentures
              
              
              73,462
              
              
              
              23,104Amortization
      of discount on notes payable
              
              
              113,631
              
              
              
              15,227Interest
      expense paid in common shares and options
              
              
              98,858
              
              
              
              -Bad
      debt expense
              
              
              228,943
              
              
              
              16,843Gain
      from settlements of obligations and sales of equipment
              
              
              (85,009
              )
              
              
              (16,199
              )Net
      cash (used in) operating activities, before changes in current assets
      and liabilities
              
              
              (689,890
              )
              
              
              (345,499
              )Changes
      in current assets and liabilities, net of effect of
      acquisitions:Decrease in accounts
      receivable
              
              
              139,932
              
              
              
              57,884(Increase) in prepaid
      expenses
              
              
              (9,947
              )
              
              
              (22,208
              )(Increase) in other current
      assets
              
              
              (76,742
              )
              
              
              (2,290
              )(Increase)
      in inventories
              
              
              (15,520
              )
              
              
              (9,230
              )Increase
      in accounts payable and accrued liabilities
              
              
              940,027
              
              
              
              476,777Increase
      (Decrease) in deferred revenue
              
              
              34,483
              
              
              
              (86,686
              )Net
      cash provided by operating activities
              
              
              322,343
              
              
              
              68,748CASH
      FLOWS FROM INVESTING ACTIVITIES:Acquisition
      of property and equipment
              
              
              (1,225,447
              )
              
              
              (1,429,656
              )Narrowstep
      acquisition costs (written off to expense in March 2009)
              
              
              (187,614
              )
              
              
              -Net
      cash (used in) investing activities
              
              
              (1,413,061
              )
              
              
              (1,429,656
              )





(Continued)


F-6


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS





(Continued)




Years
      Ended
                  September 30,2009
              
              
              2008CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from loans and notes payable, net of expenses
              
              $
              1,553,194
              
              
              $
              1,160,980Proceeds
      from convertible debentures, net of expenses
              
              
              375,000
              
              
              
              959,339Proceeds
      from sale of A-12 preferred shares, net of redemptions
              
              
              100,000
              
              
              
              -Repayment
      of loans, notes and leases payable
              
              
              (1,070,762
              )
              
              
              (645,149
              )Net
      cash provided by financing activities
              
              
              957,432
              
              
              
              1,475,170NET
      (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
              
              
              (133,286
              )
              
              
              114,262CASH
      AND CASH EQUIVALENTS, beginning of period
              
              
              674,492
              
              
              
              560,230CASH
      AND CASH EQUIVALENTS, end of period
              
              $
              541,206
              
              
              $
              674,492SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Cash
      payments for interest
              
              $
              351,776
              
              
              $
              225,481SUPPLEMENTAL
      SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:Obligation
      arising for shortfall in proceeds from sales of common shares issued
      for acquisition of Infinite Conferencing – see note 2 for assets
      acquired and liabilities assumed
              
              $
              -
              
              
              $
              958,399Issuance
      of shares, warrants and options for consultant services
              
              $
              306,305
              
              
              $
              821,205Issuance
      of shares and options for employee services
              
              $
              1,141,236
              
              
              $
              882,242Issuance
      of A-10 preferred shares for A-10 dividends
              
              $
              29,938
              
              
              $
              56,466Issuance
      of common shares for A-12 dividends
              
              $
              64,000
              
              
              $
              -Issuance
      of common shares for interest
              
              $
              137,275
              
              
              $
              186,512Issuance
      of right to obtain common shares for financing fees
              
              $
              531,000
              
              
              $
              -Issuance
      of common shares for A-10 preferred shares and dividends
              
              $
              186,318
              
              
              $
              -Issuance
      of A-12 preferred shares for A-10 preferred shares
              
              $
              600,000
              
              
              $
              -Equipment
      obtained under capital lease
              
              $
              37,664
              
              
              $
              -Payment
      of Narrowstep acquisition costs to vendor deferred past established trade
      terms, pending us obtaining financing
              
              $
              119,000
              
              
              $
              -Purchase
      of software and equipment with payment to vendor deferred past established
      trade terms, pending us obtaining financing
              
              $
              -
              
              
              $
              315,000





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


F-7


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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


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


The DMSP
division, which operates primarily from facilities in Colorado Springs,
Colorado, provides an online, subscription based service that includes access to
enabling technologies and features for our clients to acquire, store, index,
secure, manage, distribute and transform these digital assets into saleable
commodities.The UGC division, which
operates primarily from facilities in Colorado Springs, Colorado and also
operates as Auction Video (see note 2), provides a video ingestion and flash
encoder that can be used by our clients on a stand-alone basis or in conjunction
with the DMSP.
 
 The Smart
Encoding division, which operates primarily from facilities in San Francisco,
California, provides both automated and manual encoding and editorial services
for processing digital media, using a set of coordinated technologies and
processes that allow the quick and efficient online search, retrieval, and
streaming of this media, which can include photos, videos, audio, engineering
specs, architectural plans, web pages, and many other pieces of business
collateral. This division also provides hosting, storage and streaming services
for digital media, which are provided via the DMSP.


The
Travel division, which operates primarily from facilities in Pompano Beach,
Florida, produces Internet-based multi-media streaming videos related to hotels,
resorts, time-shares, golf facilities, and other travel destinations. We
warehouse this travel content on our own online travel portal –
www.travelago.com ("Travelago"). The Travel division generates revenue
through production and distribution fees.





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.


F-8


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Nature of
Business (continued)





Our EDNet
division, which operates primarily from facilities in San Francisco, California,
provides connectivity within the entertainment and advertising industries
through its managed network, which encompasses production and post-production
companies, advertisers, producers, directors, and talent. The global network,
with clients in cities throughout the United States, Canada, Mexico, Europe, and
the Pacific Rim, enables high-speed exchange of high quality audio, compressed
video and multimedia data communications, utilizing long distance carriers,
regional phone companies, satellite operators, and major internet service
providers. EDNet also provides systems integration and engineering services,
application-specific technical advice, audio equipment, proprietary and
off-the-shelf codecs, teleconferencing equipment, and other innovative products
to facilitate its broadcast and production applications. EDNet generates
revenues from network usage, sale, rental and installation of equipment, and
other related fees.





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
$114.1 million as of September 30, 2009. Our operations have been financed
primarily through the issuance of equity and debt. For the year ended September
30, 2009, we had a net loss of approximately $11.8 million, although cash
provided by operations for that period was approximately $322,000. Although we
had cash of approximately $541,000 at September 30, 2009, working capital was a
deficit of approximately $2.4 million at that date.





We are
constantly evaluating our cash needs, in order to make appropriate adjustments
to operating expenses. Depending on our actual future cash needs, we may need to
raise additional debt or equity capital to provide funding for ongoing future
operations, or to refinance existing indebtedness. No assurances can be given
that we will be successful in obtaining additional capital, or that such capital
will be available on terms acceptable to us. Our continued existence is
dependent upon our ability to raise capital and to market and sell our services
successfully. The financial statements do not include any adjustments to reflect
future effects on the recoverability and classification of assets or amounts and
classification of liabilities that may result if we are
unsuccessful.





During
February 2009, we took actions to reduce our operating costs, primarily
personnel related, by approximately $65,000 per month. During October 2009, we
took additional actions to reduce our operating costs, primarily personnel
related, by another approximately $62,000 per month. We recently began to
identify and implement certain infrastructure related cost savings, which
actions we expect will reduce our costs of revenue by approximately $45,000 per
month, once fully implemented by the end of fiscal 2010.





We have
estimated that, based on the above reductions in our expenditure levels,
we will require an approximately 2% increase in our consolidated
revenues in fiscal 2010, as compared to fiscal 2009, in order to adequately fund
our minimum anticipated expenditures (including debt service and a basic
level of capital expenditures) through September 30, 2010.  We have
estimated that, in addition to this ongoing revenue increase, we will also
require aggregate financing of approximately $500,000, (funded over several
months starting in January 2010 and in addition to the $500,000 loan proceeds
received from Rockridge in October 2009 – see note 4) to adequately address our
current working capital deficit, to the extent past due vendor and other
payments are believed by us to be necessary for us to continue our
operations.


F-9


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Liquidity
(continued)





We have
implemented specific actions, including hiring additional sales personnel,
developing new products and initiating new marketing programs, geared towards
achieving the above revenue increases. The costs associated with these actions
were contemplated in the above calculations.  However, in the event we
are unable to achieve these revenue increases, we believe that a
combination of identified decreases in our current level of expenditures that we
would implement and the raising of additional capital in the form of debt and/or
equity that we believe we could obtain from identified sources would be
sufficient to allow us to operate through September 30, 2010. We will closely
monitor our revenue and other business activity through the remainder of fiscal
2010 to determine if further cost reductions, the raising of additional capital
or other activity is considered necessary. See note 9 with respect to funding
commitment letters we received in December 2009 that would provide us with
$750,000 cash under certain conditions.





Accounting
Standards Codification





In July
2009, the Financial Accounting Standards Board (“FASB”) issued Statement of
Financial Accounting Standards Number 168, “TheFASB Accounting
Standards Codification and the Hierarchy of Generally Accepted Accounting
Principles”, which identified the FASB’s Accounting Standards Codification
(“ASC”) as the single source of authoritative nongovernmental U.S. generally
accepted accounting principles (“GAAP”). The ASC reorganized the thousands of
U.S. GAAP pronouncements into roughly 90 accounting topics and displays all
topics using a consistent structure. It also includes relevant Securities and
Exchange Commission (“SEC”) guidance that follows the same topical structure in
separate sections in the ASC. All previously existing accounting standards
documents were superseded by the ASC, which was effective for interim and annual
periods ending after September 15, 2009.All other accounting
literature not included in the ASC is nonauthoritative. We believe that our
adoption of this standard on its effective date (September 15, 2009) did not
have a material effect on our consolidated financial statements.





Basis of
Consolidation





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





Cash and
cash equivalents





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


Concentration
of Credit Risk





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


F-10


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009




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





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. Bad debt reserves were
approximately $241,000 and $30,000, at September 30, 2009 and 2008,
respectively.





Fair
Value Measurements





The
carrying amounts of cash and cash equivalents, accounts receivable, accounts
payable and accrued liabilities approximate fair value due to the short maturity
of the instruments. The carrying amounts of the current portion of notes 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 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 Rockridge 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-11


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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 Rockridge Note, the Equipment Notes or the redeemable portion of the Series
A-12. However, we have determined that the fair value of the Rockridge 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
Rockridge 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
Rockridge Note, the Equipment Notes and the redeemable portion of the Series
A-12 as of October 1, 2008 or as of September 30, 2009 and therefore no
adjustment with respect to fair value was made to our financial statements as of
September 30, 2009 or for the year then ended.





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.





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.


F-12


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Goodwill
and other intangible assets





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





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





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





Revenue
Recognition





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





The
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.


F-13


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Revenue
Recognition (continued)





Based on
our review of the above data, we have determined that the material portion of
our revenues for on-demand webcasting services are recognized during the period
in which those services are provided, which complies with the provisions of the
Revenue Recognition topic of the ASC. Furthermore, we have determined that the
maximum potentially deferrable revenue from on-demand webcasting services
charged for but not provided as of September 30, 2008 and as of September 30,
2009 was immaterial in relation to our recorded liabilities at those
dates.





The
Travel division of the Digital Media Services Group recognizes a portion of its
contract revenue at the time of completion of video production services with the
remaining revenue recognized over the term of the contract. Per hit charges are
recognized when users watch a video on the Internet.  Fixed monthly
fees are recognized on a monthly basis consistent with the terms of the
contract.  Commissions on bookings are recognized when the stays are
completed.





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 Travel division revenues, 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 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. 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.





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.


F-14


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Revenue
Recognition (continued)





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





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





Comprehensive
Income or Loss





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





Advertising
and marketing





Advertising
and marketing costs, which are charged to operations as incurred and included in
Professional Fees and Other General and Administrative Operating Expenses, were
approximately $299,000 and $554,000 for the years ended September 30, 2009 and
2008, respectively.





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 $90 million in Federal net operating loss carryforwards
as of September 30, 2009, approximately $8 million which expire in fiscal years
2010 through 2012 and approximately $82 million which expire in fiscal
years 2018 through 2029.  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 $90
million total, against future taxable income may be limited as a result of
ownership changes and other limitations.


F-15


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Income
Taxes (continued)





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 million as
of September 30, 2009, 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, 2008 and
September 30, 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. We adopted this
requirement as of the beginning of our fiscal year beginning October 1, 2007.
However, as of the date of such adoption and as of 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, 2009 or 2008.
The tax years ending September 30, 2006 and thereafter remain subject to
examination by Federal and various state tax jurisdictions.





Net Loss
Per Share





For the
years ended September 30, 2009 and 2008, net loss per share is based on the net
loss divided by the weighted average number of shares of common stock
outstanding.  Since the effect of common stock equivalents was
anti-dilutive, all such equivalents were excluded from the calculation of
weighted average shares outstanding. The total outstanding options and warrants,
which have been excluded from the calculation of weighted average shares
outstanding, were 14,544,509 and 15,155,731 at September 30, 2009 and 2008,
respectively.


In
addition, 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 Redeemable
Convertible Preferred Stock (“Series A-12”) which could potentially convert into
700,000 shares of ONSM common stock, (ii) $1,000,000 of convertible notes which
in aggregate could potentially convert into up to 1,250,000 shares of ONSM
common stock (excluding interest), (iii) 1,950,000 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 $375,000
convertible portion of the Rockridge Note which could potentially convert into a
minimum of 937,500 shares of ONSM common stock.


F-16


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Net Loss
Per Share (continued)





Furthermore,
if we sell all or substantially all of our assets prior to the repayment of the
Rockridge Note, the remaining outstanding principalamountof the Rockridge Note
may be converted into restricted shares of our common stock, which would have
been 2,472,965 shares as of September 30, 2009 (in addition to the 937,500
shares noted above).





The
potential dilutive effects of the following convertible securities previously
outstanding at September 30, 2008 were excluded from the calculation of weighted
average shares outstanding: (i) 74,841 shares of Series A-10 Convertible
Preferred Stock (“Series A-10”) which could have potentially converted into
748,410 shares of ONSM common stock and (ii) $1,000,000 of convertible notes
which in aggregate could have potentially converted into up to 1,250,000 shares
of ONSM common stock (excluding interest).





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. Accounts payable and accrued liabilities
includes approximately $661,000 and $555,000 as of September 30, 2009 and 2008,
respectively, related to salaries, commissions, taxes, vacation and other
benefits earned but not paid as of those dates.





Equity
Compensation to Employees and Consultants





We have a
stock based compensation plan (the “Plan”) for our employees. 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, 2009 and 2008 includes compensation
cost for all share-based payments granted subsequent to September 30, 2006,
based on the estimated grant-date fair value. As of October 1, 2006, there were
no outstanding share-based payments granted prior to that date, but not yet
vested. For Plan options that were granted (or extended) and thus valued under
the Black-Scholes model during the three months ended September 30, 2009, the
expected volatility rate was 88%, the risk-free interest rate was 2.5%, expected
dividends were $0 and the expected term was 4 to 5 years, 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 Plan options that were granted and thus valued under the
Black-Scholes model during the three months ended June 30, 2009, the expected
volatility rate was 96%, the risk-free interest rate was 1.1%, expected
dividends were $0 and the expected term was 4 years, the full term of the
related options. There were no Plan options granted during the six months ended
March 31, 2009 requiring our valuation using the Black-Scholes
model.


F-17


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Equity
Compensation to Employees and Consultants (continued)





For Plan
options that were granted and thus valued under the Black-Scholes model during
the three months ended September 30, 2008, the expected volatility rate was 81%,
the risk-free interest rate was 2.9%, expected dividends were $0 and the
expected term was 4 years, the full term of the related options. For Plan
options that were granted and thus valued under the Black-Scholes model during
the three months ended June 30, 2008, the expected volatility rate was 77% to
81%, the risk-free interest rate was 3.0% to 3.4%, expected dividends were $0
and the expected term was 4 to 6.5 years, the full term of the related options.
There were no Plan options granted during the three months ended March 31, 2008
requiring our valuation using the Black-Scholes model. For Plan options that
were granted and thus valued under the Black-Scholes model during the three
months ended December 31, 2007, the expected volatility rate was 78% to 79%, the
risk-free interest rate was 4.1% to 4.3%, expected dividends were $0 and the
expected term was 4 to 6.5 years, the full term of the related
options.





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 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 three
months ended September 30, 2009, the expected volatility rate was 99%, the
risk-free interest rate was 2.11%, expected dividends were $0 and the expected
term was 4 years, the full term of the related options. There were no Non-Plan
options granted during the nine months ended September 30, 2009 requiring our
valuation using the Black-Scholes model. There were no Non-Plan options granted
during the nine months ended September 30, 2008 requiring our valuation using
the Black-Scholes model. For Non-Plan options that were granted and thus valued
under the Black-Scholes model during the three months ended December 31, 2007,
the expected volatility rate was 79%, the risk-free interest rate was 6.25%,
expected dividends were $0 and the expected term was 4 years, the full term of
the related options.





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


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 $52,000 and $46,000
for the years ended September 30, 2009 and 2008, respectively. We expensed
approximately $52,000 and $41,000 in those fiscal years, respectively, with the
remaining amount of $5,000 in fiscal 2008 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,
2009.


F-18


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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





Accounting
Estimates





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


Reclassifications


Certain
prior year amounts have been reclassified to conform to the current year
presentation, including inventories and other current asset balance sheet
groupings and property and equipment footnote category
classifications.





Effects
of Recent Accounting Pronouncements





The Fair
Value Measurements and Disclosures topic of the ASC includes certain concepts
first set forth in September 2006, which define the use of fair value measures
in financial statements, establish a framework for measuring fair value and
expand disclosure related to the use of fair value measures. In February 2008,
the FASB provided a one-year deferral of the effective date of those concepts
for non-financial assets and non-financial liabilities, except those that are
recognized or disclosed in the financial statements at fair value at least
annually. The application of these concepts was effective for our fiscal year
beginning October 1, 2008, excluding the effect of the one-year deferral noted
above. See “Fair Value Measurements” above. We are currently evaluating the
impact of adopting these concepts with respect to non-financial assets and
non-financial liabilities on our consolidated financial statements, which will
be effective beginning October 1, 2009.





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


F-19


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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 will be first effective for our fiscal year beginning October 1, 2009
and early adoption is prohibited. Under these provisions, we would have recorded
the $418,058 of acquisition-related costs included in other non-current assets
on our September 30, 2008 balance sheet as expense during the year then ended.
Accordingly, the $504,738 write off of deferred acquisition costs reflected in
our results of operations for the year ended September 30, 2009 would have been
replaced by an expense of $86,680. We are currently evaluating any additional
impact these provisions may have on our financial statements.





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 shall be
effective for our fiscal year beginning October 1, 2009 and early adoption
is prohibited. 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 should be
applied prospectively to intangible assets acquired after the effective date. We
are currently evaluating the impact these requirements may have on our financial
statements.





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 will be effective for our
fiscal year beginning October 1, 2009, including interim periods within that
fiscal year. We are currently evaluating the impact these
requirements may have on our financial statements.





The
Subsequent Events topic of the ASC establishes general standards of accounting
for and disclosure of events that occur after the balance sheet date but before
financial statements are issued or are available to be issued. Certain of these
requirements, which were first effective for interim or annual financial periods
ending after June 15, 2009, relate to the concept of financial statements being
“available to be issued” andrequire the disclosure
of the date through which an entity has evaluated subsequent events and the
basis for that date (i.e., whether that date represents the date the financial
statements were issued or were available to be issued). Other than providing
this disclosure, our adoption of these requirements as of and for the period
ended September 30, 2009 did not have a significant impact on our consolidated
financial statements.


F-20


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





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, 2009
              
              
              September
      30, 2008Gross
                Carrying
                Amount
              
              
              Accumulated
                Amortization
              
              
              Net
      Book
                Value
              
              
              Gross
                Carrying
                Amount
              
              
              Accumulated
                Amortization
              
              
              Net
      Book
                ValueGoodwill:Infinite
      Conferencing
              
              $
              11,100,887
              
              
              $
              -
              
              
              $
              11,100,887
              
              
              $
              12,000,887
              
              
              $
              -
              
              
              $
              12,000,887Acquired
      Onstream
              
              
              4,121,401
              
              
              
              -
              
              
              
              4,121,401
              
              
              
              8,421,401
              
              
              
              -
              
              
              
              8,421,401EDNet
              
              
              1,271,444
              
              
              
              -
              
              
              
              1,271,444
              
              
              
              1,271,444
              
              
              
              -
              
              
              
              1,271,444Auction
      Video
              
              
              3,216
              
              
              
              -
              
              
              
              3,216
              
              
              
              3,216
              
              
              
              -
              
              
              
              3,216Total
      goodwill
              
              
              16,496,948
              
              
              
              -
              
              
              
              16,496,948
              
              
              
              21,696,948
              
              
              
              -
              
              
              
              21,696,948Acquisition-related
      intangible assets:Infinite  Conferencing  -customer
      lists,  trademarks,URLs,
      supplier terms andconsulting/non-
      competes
              
              
              4,383,604
              
              
              
              (2,061,105
              )
              
              
              2,322,499
              
              
              
              4,583,604
              
              
              
              (1,275,000
              )
              
              
              3,308,604Auction
      Video - customerlists,
      patent pending andconsulting/non-
      competes
              
              
              1,110,671
              
              
              
              (934,020
              )
              
              
              176,651
              
              
              
              1,174,827
              
              
              
              (751,845
              )
              
              
              422,982Total
      intangible assets
              
              
              5,494,275
              
              
              
              (2,995,125
              )
              
              
              2,499,150
              
              
              
              5,758,431
              
              
              
              (2,026,845
              )
              
              
              3,731,586Total
      goodwill and other acquisition-related intangible assets
              
              $
              21,991,223
              
              
              $
              (2,995,125
              )
              
              $
              18,996,098
              
              
              $
              27,455,379
              
              
              $
              (2,026,845
              )
              
              $
              25,428,534





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 business 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 operations of Infinite are part of
the Audio and Web Conferencing Services Group.





The
consideration for the Infinite Merger was a combination of $14 million in cash
and 1,376,622 shares of our restricted common stock (valued at approximately
$4.0 million, or $2.906 per share), for an aggregate purchase price of
approximately $18 million, before transaction costs. We arranged a private
equity financing for net proceeds totaling approximately $10.2 million, to
partially fund the cash portion of the transaction.


F-21


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 
 Infinite Conferencing –
April 27, 2007 (continued)
 
 At the
closing of the Infinite Merger, we entered into a lock-up agreement with the
former Infinite shareholders that limited the extent and timing of their sale of
the 1,376,622 ONSM shares issued to them and also provided that in the event
that the accumulated gross proceeds of the sale of first 50% of those shares was
less than $2.0 million, we would pay the difference in registrable ONSM common
shares, or cash to the extent required by certain restrictions. On December 27,
2007, the former Infinite shareholders notified us that the first 688,311 shares
had been sold by them for $1,041,601, which would have required an additional
payment by us in cash or shares of approximately $958,399. We recorded the
liability on our financial statements as of that date, which was offset by a
reduction in additional paid-in capital, and on March 12, 2008 executed
collateralized promissory notes payable to the former Infinite shareholders in
final settlement of this obligation – see note 4.
 
 In
connection with the Infinite Merger, we entered into two employment contracts
and one consulting contract with three key Infinite executives. The employment
contracts included five-year option grants for the purchase of up to 200,000
common shares with an exercise price of $2.50 per share (fair market value at
the date of closing) and vesting over two years – see Note 8. As a result of the
April 2008 expiration and non-renewal of one of the employment contracts, 50,000
of these options were forfeited. The employment and consulting contracts, all of
which had either expired or been terminated at various dates through June 19,
2009, contain non-compete provisions with a minimum term of three years from the
merger closing.
 The
summarized balance sheet of Infinite as of the April 27, 2007 closing of the
Infinite Merger is as follows, showing the fair values we assigned to Infinite’s
assets and liabilities in accordance with the Business Combinations
topic of the ASC and recorded by us at that time.
 
 Accounts
      receivable
                      
                      $
                      893,228Property
      and equipment
                      
                      
                      894,388Other
      tangible assets (includes $14,861 cash)
                      
                      
                      48,817Identifiable
      intangible assets
                      
                      
                      4,583,604Total
      assets
                      
                      $
                      6,420,037Accounts
      payable and accrued liabilities
                      
                      $
                      204,395Shareholder’s
      equity
                      
                      
                      6,215,642Total
      liabilities and shareholder’s equity
                      
                      $
                      6,420,037
 
 Infinite’s
accounts receivable, net of reserves, were considered to be reasonably
collectible and were generally due within thirty days of the closing of the
Infinite Merger and therefore their book carrying value as of the date of
acquisition was considered to be a reasonable estimate of their fair
value.
 
 Infinite’s
management estimated the fair value of their property and equipment, primarily
phone switch equipment and related internally developed billing and management
reporting software, based on information regarding third-party sales of similar
equipment and the estimated cost to recreate the customized
software.  We are amortizing these assets over useful lives ranging
from 3 to 5 years.
  F-22
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 
 Infinite Conferencing –
April 27, 2007 (continued)
 
 The fair
value of certain intangible assets (internally developed software, customer
lists, trademarks, URLs (internet domain names), favorable contractual terms and
employment and non-compete agreements) acquired as part of the Infinite Merger
was determined by our management at the time of the merger. This fair value was
primarily based on the discounted projected cash flows related to these assets
for the next three to six years immediately following the merger on a
stand-alone basis without regard to the Infinite Merger, as projected by our
management and Infinite’s management. The discount rate utilized considered
equity risk factors (including small stock risk) as well as risks associated
with profitability and working capital, competition, and intellectual property.
The projections were adjusted for charges related to fixed assets, working
capital and workforce retraining. We are amortizing these assets over useful
lives ranging from 3 to 6 years.
 
 Infinite’s
accounts payable and accrued liabilities were generally due within thirty days
of the closing of the Infinite Merger and therefore their book carrying value as
of the date of acquisition was considered to be a reasonable estimate of their
fair value.
 
 We
purchased Infinite for $18,216,529 in cash and stock. In conjunction with the
acquisition, liabilities were assumed as follows:
 
 Identifiable
      tangible and intangible assets
                    
                    $
                    6,420,037Goodwill
                    
                    
                    12,000,887Acquired
      assets (at fair value)
                    
                    
                    18,420,924Less:
      Cash paid for non-cash assets
                    
                    
                    (14,201,668
                    )Less:
      Cash acquired for cash
                    
                    
                    (14,861
                    )Less:
      Shares issued for non-cash assets
                    
                    
                    (4,000,000
                    )Assumed
      liabilities
                    
                    $
                    204,395
 
 The
$12,000,887 excess included in the $18,216,529 we paid for 100% of Infinite over
$6,215,642 (the fair values assigned to the tangible and intangible assets, net
of liabilities at fair value) was recorded by us as goodwill, subject to regular
future valuations and adjustments as required by the Intangibles – Goodwill and
Other topic of the ASC. The other intangible assets are being amortized to
expense over their estimated useful lives, although the unamortized balances are
still subject to review and adjustment for impairment. 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.
 
 As
discussed in “Testing for Impairment” below, the initially recorded goodwill for
Infinite Conferencing of approximately $12.0 million was determined to be
impaired as of December 31, 2008 and a $900,000 adjustment was made to reduce
the carrying value of that goodwill to approximately $11.1 million as of that
date.  A similar adjustment of $200,000 was made to reduce the
carrying value of certain intangible assets acquired as part of the Infinite
Merger. These adjustments, totaling $1.1 million, were included in the aggregate
$5.5 million charge for impairment of goodwill and other intangible assets as
reflected in our results of operations for the year ended September 30,
2009.
  F-23
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 
 Auction Video – March 27,
2007
 
 On March
27, 2007 we completed the acquisition of the assets, technology and patents
pending of privately owned Auction Video, Inc., a Utah corporation, and Auction
Video Japan, Inc., a Tokyo-Japan corporation (collectively, “Auction Video”).
The 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
467,290 shares of restricted ONSM common stock (valued at approximately $1.5
million, or $3.21 per share) 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,
before transaction costs. The operations of Auction Video are part of the
Digital Media Services Group.
 
 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 - see note 5.
 
 We
allocated $2,046,996 of 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. $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. The technology and patent pending related
to the video ingestion and flash transcoder, the Auction Video customer lists
and the consulting and non-compete agreements entered into with the former
executives and owners of Auction Video were valued in aggregate at $1,150,000
and are being amortized over various lives between two to five years commencing
April 2007. Other tangible assets acquired were valued at $46,996.
 
 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”). In August 2008,
February 2009 and May 2009, the USPO issued non-final rejections of the claims
pending in the first of the two applications. In October 2009 we submitted an
amendment to the first of the two applications, which amendment we expect the
USPO to respond to within ninety days after the date of our submission.
Regardless of this, 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.
  F-24
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 
 Auction Video – March 27,
2007 (continued)
 
 We
purchased Auction Video for $2,023,963 in cash and stock. In conjunction with
the acquisition, liabilities were assumed as follows:
 
 Identifiable
      tangible and intangible assets
                    
                    $
                    2,046,996Goodwill
                    
                    
                    3,216Acquired
      assets (at fair value)
                    
                    
                    2,050,212Less:
      Cash paid for non-cash assets
                    
                    
                    (523,066
                    )Less:
      Cash acquired for cash
                    
                    
                    (897
                    )Less:
      Shares issued for non-cash assets
                    
                    
                    (1,500,000
                    )Assumed
      liabilities
                    
                    $
                    26,249
 
 In
connection with the acquisition, we entered into three consulting contracts with
three key Auction Video employees, two of which expired as of February 28, 2008
and the third which expired as of February 28, 2009. The third contract included
a two-year option grant to one of the consultants for the purchase of up to
35,000 common shares with an exercise price of $2.98 per share (fair market
value at the date of closing) and vesting over two years, which options expired
as of February 28, 2009. The consulting contracts contain non-compete provisions
with a minimum term of two years from the acquisition closing.
 
 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 a
$100,000 adjustment was made to reduce the carrying value of those intangible
assets to approximately $200,000 as of that date.  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, after approval by a majority of our shareholders in a duly
constituted meeting, 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 2,207,966 shares of
the ONSM restricted common stock and 463,554 options and warrants to purchase
ONSM common stock at an exercise price of $3.376 per share. We also issued
common stock options to directors and management as additional compensation at
the time of and for the Onstream Merger, accounted for in accordance with
Accounting Principles Board Opinion Number 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.
  F-25
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 Acquired Onstream – December
23, 2004 (continued)
 
 The
summarized balance sheet of Acquired Onstream as of the December 23, 2004
closing of the Onstream Merger is as follows, showing the fair values we
assigned to Acquired Onstream’s assets and liabilities in accordance with the
Business Combinations topic of the ASC and recorded by us at that
time.
 
 Cash
      and other current assets
                    
                    $
                    36,059Property
      and equipment
                    
                    
                    2,667,417Total
      assets
                    
                    $
                    2,703,476Accounts
      payable and accrued liabilities
                    
                    $
                    814,739Notes
      payable and capitalized lease
                    
                    
                    335,179Total
      liabilities
                    
                    
                    1,149,918Shareholder’s
      equity
                    
                    
                    1,553,558Total
      liabilities and shareholder’s equity
                    
                    $
                    2,703,476
 
 Property
and equipment in the above table represents the partially (at the time)
completed DMSP, primarily Acquired Onstream’s payments to its vendors SAIC,
Virage, North Plains and Nine Systems. This was the primary asset included in
the purchase of Acquired Onstream, and was recorded at fair value as of the
December 23, 2004 closing, in accordance with the Business Combinations topic of
the ASC – see note 3. 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) as well as
risks associated with profitability and working capital, competition, and
intellectual property. The projections were adjusted for charges related to
fixed assets, working capital and workforce retraining.
 
 The
$8,421,401 excess included in the $9,974,959 we paid for 100% of Acquired
Onstream over $1,553,558 (the fair values assigned to the tangible and
intangible assets, net of liabilities at fair value) was recorded by us as
goodwill, subject to regular future valuations and adjustments as required by
the Intangibles – Goodwill and Other topic of the ASC.
 
 As
discussed in “Testing for Impairment” below, the initially recorded goodwill for
Acquired Onstream of approximately $8.4 million 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-26
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 2:
GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS
(Continued)
 
 Testing forImpairment
  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. 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 Conferencing as of April 27, 2008, on
EDNet as of September 30, 2008 and on 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 Infinite Conferencing’s
net assets as of April 27, 2008 nor of EDNet’s net assets as of September 30.
2008. Although the first step of the two step testing process of Acquired
Onstream’s net assets (which include the DMSP) 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 three
months ended December 31, 2008. As discussed above, this $5.5 million adjustment
was determined to relate to $1.1 million of goodwill and intangible assets of
Infinite Conferencing, $100,000 of intangible assets of Auction Video and $4.3
million of goodwill of Acquired Onstream.
  As part
of the second step of the two step process for testing impairment as of December
31, 2008, the April 27, 2008 testing of Infinite Conferencing and the September
30, 2008 testing of EDNet were updated through December 31, 2008. Accordingly,
none of our reporting units with significant goodwill or intangible assets were
scheduled for a recurring annual impairment review during the September 30, 2009
quarter and as of September 30, 2009, we had noted no business or other
conditions that would indicate the necessity for interim “step one” testing of
individual reporting units for impairment. Therefore, the comparison of our
market capitalization to its net book value as of September 30, 2009 was not
considered to be relevant at that date. However, if the price of our common
stock and our market value continue at the December 24, 2009 levels ($0.28 per
share) or decline further, such condition may result in future non-cash
impairment charges to our results of operations related to our goodwill and
other intangible assets arising from our next scheduled recurring annual
impairment review, which will be as of December 31, 2009.
 
 The
valuations of Infinite Conferencing, EDNet and Acquired Onstream incorporate our
management’s estimates of future sales and operating income, which estimates in
the cases of Infinite Conferencing and Acquired Onstream are dependent on
products (audio and web conferencing and the DMSP, respectively) from which
significant sales increases may be required to support that valuation. We are
required to perform reviews for impairment in future periods, at least annually,
that may result in future periodic write-downs.  Tests for impairment
between annual tests may be required if events occur or circumstances change
that would more likely than not reduce the fair value of the net carrying
amount.
  F-27
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
3:  PROPERTY AND EQUIPMENT
 
 Property
and equipment, including equipment acquired under capital leases, consists
of:
 September 30, 2009
                  
                  
                  September 30, 2008Historical
                      Cost
                  
                  
                  Accumulated
                      Depreciation
                      and
                      Amortization
                  
                  
                  Net Book
                      Value
                  
                  
                  Historical
                      Cost
                  
                  
                  Accumulated
                      Depreciation
                      and
                      Amortization
                  
                  
                  Net Book
                      Value
                  
                  
                  Useful
                      Lives
                      (Yrs)Equipment
      and software
                  
                  $
                  10,442,539
                  
                  
                  $
                  (9,079,681
                  )
                  
                  $
                  1,362,858
                  
                  
                  $
                  10,096,433
                  
                  
                  $
                  (8,022,265
                  )
                  
                  $
                  2,074,168
                  
                  
                  
                  1-5DMSP
                  
                  
                  5,719,979
                  
                  
                  
                  (4,791,517
                  )
                  
                  
                  928,462
                  
                  
                  
                  5,256,575
                  
                  
                  
                  (3,918,607
                  )
                  
                  
                  1,337,968
                  
                  
                  
                  3-5Travel video
      library
                  
                  
                  1,368,112
                  
                  
                  
                  (1,368,112
                  )
                  
                  
                  -
                  
                  
                  
                  1,368,112
                  
                  
                  
                  (1,368,112
                  )
                  
                  
                  -
                  
                  
                  
                  N/AOther
      capitalized internal use software
                  
                  
                  1,215,401
                  
                  
                  
                  (448,218
                  )
                  
                  
                  767,183
                  
                  
                  
                  771,485
                  
                  
                  
                  (177,544
                  )
                  
                  
                  593,941
                  
                  
                  
                  3-5Furniture,
      fixtures and leasehold improvements
                  
                  
                  475,857
                  
                  
                  
                  (451,264
                  )
                  
                  
                  24,593
                  
                  
                  
                  475,857
                  
                  
                  
                  (425,164
                  )
                  
                  
                  50,693
                  
                  
                  
                  2-7Totals
                  
                  $
                  19,221,888
                  
                  
                  $
                  (16,138,792
                  )
                  
                  $
                  3,083,096
                  
                  
                  $
                  17,968,462
                  
                  
                  $
                  (13,911,692
                  )
                  
                  $
                  4,056,770
 Depreciation
and amortization expense for property and equipment was approximately $2,227,000
and $2,816,000 for the years ended September 30, 2009 and 2008,
respectively.
 The DMSP
is comprised of four separate “products”, which are transcoding, storage,
search/retrieval and distribution. A limited version of the DMSP, with three of
the four products, was first placed in service with third-party customers in
November 2005.  This initial version of the DMSP offered for sale to
the general public since October 2006 is known as the “Store and Stream”
version. In connection with the development of a second version of the DMSP with
additional functionality known as “Streaming Publisher”, we have capitalized as
part of the DMSP’s carrying cost approximately $608,000 of employee
compensation, payments to contract programmers and related costs as of September
30, 2009, including $422,000 capitalized during the year then ended and the
remainder capitalized in the previous year.
 
 On March
27, 2007 we completed the acquisition of Auction Video – see note 2. The assets
acquired included a video ingestion and flash transcoder, which was already
integrated into the DMSP as of the date of the acquisition. Based on our
determination of the fair value of that transcoder at the date of the
acquisition, $600,000 was added to the DMSP’s carrying cost as reflected above,
which additional cost is being depreciated over a three-year life commencing
April 2007.
  F-28
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
3:  PROPERTY AND EQUIPMENT (Continued)
 
 On March
31, 2008 we agreed to pay $300,000 for a perpetual license for certain digital
asset management software, which we currently utilize to provide our automatic
meta-tagging services, in addition to and in accordance with a limited term
license that we purchased in 2007 for $281,250 - see note 5 for additional terms
of this perpetual license and possible limits on its future use. Although we
continue to use this software to provide our automatic meta-tagging services, we
recently expanded our use of this software in providing our core DMSP services.
Therefore,  we recorded a portion of this 2008 purchase, as well as a
portion of the remaining unamortized amount of the 2007 purchase, as an
aggregate $243,750 increase in the DMSP’s carrying cost as reflected above,
which additional cost is being depreciated over a five-year life commencing
April 2008.
 
 Other
capitalized internal use software as of September 30, 2009 includes (i)
approximately $501,000 of employee compensation and other costs related to the
development of iEncode webcasting software, including $288,000 capitalized
during the year then ended and the remainder capitalized in the previous year
and (ii) approximately $156,000 of employee compensation, payments to
contract programmers and other costs related to the development of the
MarketPlace365 (MP365) platform, all capitalized during the year then
ended. iEncode is a self-administered, webcasting appliance that can be
used anywhere to produce a live video webcast. The MP365 platform will enable
the creation of on-line virtual marketplaces, trade shows and social communities
utilizing almost all of our other technologies including DMSP, webcasting, UGC
and conferencing.
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE
 
 Convertible
Debentures
 
 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. 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 10,000 restricted ONSM common shares for each $100,000 lent
to us, and also receive interest at 12% per annum. Interest is payable every 6
months in cash or, at our option, in restricted ONSM common shares, based on a
conversion price equal to seventy-five percent (75%) of the average ONSM closing
price for the thirty (30) trading days prior to the date the applicable payment
is due. On November 11, 2008, we elected to issue 158,000 unregistered shares of
our common stock to the Investors in lieu of $48,740 cash interest on these
Equipment Notes for the period from June 2008 through October 2008,
which was recorded as interest expense of $69,520 on our books, based on
the fair value of those shares on the issuance date. On May 21, 2009, we elected
to issue 294,589 unregistered shares of our common stock to the Investors in
lieu of $60,000 cash interest on these Equipment Notes for the period from
November 2008 through April 2009, which was recorded as interest expense of
$67,756 on our books, based on the fair value of those shares on the issuance
date. On November 11, 2009, we elected to issue 209,500 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 $77,515 on our books, based on
the fair value of those shares on the issuance date. The next interest due
date is April 30, 2010.
  F-29
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Convertible
Debentures (continued)
 
 We may
prepay the Equipment Notes, which mature June 3, 2011, at any time upon ten (10)
days' prior written notice to the Investors during which time any or all of the
Investors may choose to convert the Equipment Notes held by them.  In
the event of such repayment, all interest accrued and due for the remaining
unexpired loan period is due and payable and may be paid in cash or restricted
ONSM common shares in accordance with the above formula.
 
 The
outstanding principal is due on demand in the event a payment default is uncured
ten (10) business days after written notice. Investors holding in excess of 50%
of the outstanding principal amount of the Equipment Notes may declare a default
and may take steps to amend or otherwise modify the terms of the Equipment Notes
and related security agreement.
 
 The
Equipment Notes may be converted to restricted ONSM common shares at any time
prior to their maturity date, at the Investors’ option, based on a conversion
price equal to seventy-five percent (75%) of the average ONSM closing price for
the thirty (30) trading days prior to the date of conversion, but in no event
may the conversion price be less than $0.80 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 101,250 restricted ONSM common shares and
$31,500 paid in cash. These 101,250 shares, plus the 100,000 shares issued to
the investors (as discussed above) had a fair market value of approximately
$186,513. The value of these 201,250 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 is made in common shares instead of cash. The unamortized portion of
this discount was $130,607 and $204,069 at September 30, 2009 and 2008,
respectively.
 
 Although
the minimum conversion price was established in the Equipment Notes at $0.80 per
ONSM share, the quoted market price was approximately $0.93 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 $0.81 on April 30, 2008, $0.84 on May 20,
2008 and back to $0.80 by June 27, 2008, less than one month after the issuance
of the related Equipment Notes. Therefore, we have determined that the $0.80 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.
 
 A portion
of the Rockridge Note ($375,000 face value, which is $240,190 net, after
deducting the applicable discount) is also convertible into ONSM common shares,
as discussed below, and classified under Convertible Debentures, net of
discount, on our September 30, 2009 balance sheet.
  F-30
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes
Payable
 
 Notes
payable consist of the following as of September 30, 2009 and 2008:
 
 September 30,
                    2009
                
                
                September30,
                    2008Note
      payable to a financial institution, collateralized by
      accounts    receivable and certain other related
      assets, interest payable monthly at 13.5% per annum.  Revolving
      line of credit expiring December 2011.
                
                $
                1,382,015
                
                
                $
                1,200,000Note
      payable to an entity controlled by a major shareholder, collateralized by
      first priority lien on all our assets, subordinated only to extent of
      higher priority liens on certain receivables and equipment, principal and
      interest (at 12% per annum) payable in equal monthly installments through
      August 2013. Balance shown excludes $375,000 balloon payment, which is due
      on maturity but also convertible into ONSM common shares at holder’s
      option.
                
                
                989,187
                
                
                
                -Notes
      payable to former Infinite shareholders
                
                
                -
                
                
                
                458,399Capitalized
      software and equipment leases
                
                
                142,924
                
                
                
                248,809Total
      notes payable
                
                
                2,514,126
                
                
                
                1,907,208Less:
      discount on notes payable
                
                
                (393,174
                )
                
                
                (23,793
                )Notes
      payable, net of discount
                
                
                2,120,952
                
                
                
                1,883,415Less:
      current portion, net of discount
                
                
                (1,615,891
                )
                
                
                (1,774,264
                )Long
      term notes payable, net of current portion
                
                $
                505,061
                
                
                $
                109,151
 
 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 $37,082 and $19,954 as of September
30, 2009 and 2008, respectively.
 
 Mr. Leon
Nowalsky, a member of our Board of Directors, is also a founder and board member
of the Lender.
  F-31
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes Payable
(continued)
 
 Line
of Credit Arrangement (continued)
 
 The
outstanding principal balance due under the Line may be repaid by us at any
time, but no later than December 28, 2011, which may be extended by us for an
extra year, subject to compliance with all loan terms, including no material
adverse change, as well as concurrence of the Lender. We will incur a charge
equal to 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, starting with the quarter ending
September 30, 2010, with a quarterly debt service coverage covenant. We were
also subject to compliance with the debt service coverage covenant up to and
including the June 30, 2009 quarter as well as compliance with a minimum
tangible net worth covenant through June 30, 2009. We received waivers from the
Lender with respect to lack of compliance with the tangible net worth covenant
from March 31, 2008 through June 30, 2009, as well as with respect to lack of
compliance with the debt service to cash flow covenant from the quarter ended
June 30, 2008 through the quarter ended June 30, 2009. Although the balance
outstanding under the Line was in excess of the allowable borrowing amount from
time to time during 2009 based on the formulas discussed above, subsequent
principal payments reduced the outstanding balance so that it no longer exceeded
the allowable borrowing amount. Prior to December 7, 2009, the terms of the Line
did not specify the allowable time period to repay borrowings in excess of the
allowable borrowing amount, but the Lender has waived any breach related to
these past overages.
 
 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 Infinite Notes issued by us in March
2008 with an initial amount of $858,399 as discussed below, the $1.0 million
aggregate debt for Equipment Notes we issued in June and July 2008, as discussed
above, our December 2008 issuance of the Series A-12 Redeemable Convertible
Preferred Stock with a stated value of $800,000, as discussed in note 6, our
April 2009 issuance of the Rockridge Note, as well as its September 2009
amendment, for a face value of up to $2.0 million, as discussed below and our
December 2009 issuance of the CCJ Note for a face value of $200,000, as
discussed in note 9.
 
 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.
  F-32
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes Payable
(continued)
 
 Rockridge
Note (continued)
 
 In
connection with this transaction, we issued a Note (the “Rockridge Note”), which
is collateralized by a first priority lien on all of our assets, such lien
subordinated only to the extent higher priority liens on assets, primarily
accounts receivable and certain designated software and equipment, are held by
certain of our other lenders. We also entered into a Security Agreement with
Rockridge that contains certain covenants and other restrictions with respect to
the collateral.
 
 The
Rockridge Note, after giving effect to all borrowings under the Amendment and
the Allonge, is repayable in equal monthly installments of $45,202 extending
through August 14, 2013 (the “Maturity Date”), which installments include
principal (except for a $500,000 balloon payable on the Maturity Date) plus
interest (at 12% per annum) on the remaining unpaid balance. The Rockridge
Agreement, as amended, also provides that Rockridge may receive an origination
fee upon not less than sixty-one (61) days written notice to us, payable by our
issuance of 2,200,000 restricted ONSM common shares (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 $0.20 (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 $0.28 per
share on December 24, 2009.
 
 Legal
fees totaling $46,929 were paid or accrued by us as of September 30, 2009
in connection with the Rockridge Agreement. 1,950,000 of the 2,200,000
Shares discussed above were earned by Rockridge as of September 30, 2009 and had
a fair market value of approximately $531,000 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 $577,929 discount against the
Rockridge Note (as well as a corresponding increase in additional paid-in
capital for the value of the Shares) and are being amortized as interest expense
over the term of the Rockridge Note. The effective interest rate of the
Rockridge Note was approximately 44.3% per annum, until the September 2009
amendment, at which time it was reduced to approximately 28.0% per annum. These
rates exclude the potential effect of a premium to market prices if the balloon
payment is satisfied in common shares instead of cash as well as the potential
effect of any appreciation in the value of the Shares at the time of issuance
beyond their value at the date of the Rockridge Agreement or the Amendment, as
applicable. The unamortized portion of this discount was $490,902 as of
September 30, 2009.
  F-33
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes Payable
(continued)
 
 Rockridge
Note (continued)
 
 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 ONSM common stock. Upon notice from Rockridge at any time after
September 4, 2010and 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 $0.40 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 $0.23 as of the date of the Rockridge Agreement and
$0.39 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.
 
 Infinite
Notes
 
 At the
time of the April 27, 2007 Infinite Merger (see note 2), we entered into a
lock-up agreement with the former Infinite shareholders (the "Infinite
Shareholders") that provided that in the event the accumulated gross proceeds of
the sale of certain shares issued to them in connection with that merger were
less than a contractually defined amount, we would pay the
difference.  On December 27, 2007, the Infinite Shareholders notified
us that those shares had been sold by them for proceeds which under the lock-up
agreement would require us to pay an additional $958,399.
  F-34
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE 4:
CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued)
 
 Notes Payable
(continued)
 
 Infinite
Notes (continued)
 
 On
February 14, 2008, we paid $100,000 against the above obligation. On March 12,
2008, we executed promissory notes (the “Infinite Notes”) payable to the
Infinite Shareholders for the remaining aggregate balance due of $858,399 plus
interest accruing at 12% per annum on the outstanding balance from February 15,
2008 until the July 10, 2009 maturity. Note payments were made of (i) $100,000
(one hundred thousand dollars) on March 15, 2008, (ii) $50,000 (fifty thousand
dollars) per month from April 2008 through June 2009 and (iii) $8,399 during
July 2009.
 
 Capitalized
Software and Equipment Leases
 
 During
July 2007, we entered into a capital lease for audio conferencing equipment,
which had an outstanding principal balance of $109,151 and $222,688 as of
September 30, 2009 and 2008, respectively. The balance is payable in equal
monthly payments of $10,172 through August 2010, which includes interest at
approximately 5% per annum, plus an optional final payment based on fair value,
but not to exceed $16,974.
 
 During
January 2009, we entered into a capital lease for telephone equipment, which had
an outstanding principal balance of $33,773 as of September 30, 2009. The
balance is payable in equal monthly payments of $828 through January 2014, which
includes interest at approximately 11% per annum.
 As part
of the Onstream Merger, we assumed a capital lease for software, which had no
outstanding balance included in notes payable as of September 30, 2009 and a
$26,121 notes payable balance as of September 30, 2008. However, accounts
payable includes $109,674 and $79,692 of past due payments related to this lease
at September 30, 2009 and 2008, respectively. See note 2.
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES
 
 Narrowstep acquisition
termination and litigation – On May 29, 2008, we entered into an
Agreement and Plan of Merger (the “Merger Agreement”) to acquire Narrowstep,
Inc. (“Narrowstep”), which Merger Agreement was amended twice (on August 13,
2008 and on September 15, 2008). The terms of the Merger Agreement, as amended,
allowed that if the acquisition did not close on or prior to November 30, 2008,
the Merger Agreement could be terminated by either us or Narrowstep at any time
after that date provided that the terminating party was not responsible for the
delay. On March 18, 2009, we terminated the Merger Agreement and the acquisition
of Narrowstep.
 
 As a
result of this termination, we recorded the write-off of certain
acquisition-related costs in our operating results for the year ended September
30, 2009 (see note 1 – Effects of Recent Accounting Pronouncements). In
addition, we may incur additional future costs and expenses not included in this
write-off, as follows: (i) satisfaction of a claim by Narrowstep for certain
equipment alleged to be in our custody and (ii) satisfaction of certain other
damages asserted by Narrowstep. These items are discussed
below.
  F-35
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (continued)
 
 Narrowstep acquisition
termination and litigation (continued) - In November 2008 Narrowstep
invoiced us approximately $372,000 for their equipment alleged to be in our
custody as of that date and in June 2009 a letter issued by their counsel
demanded that we pay $400,000 related to this matter. Although we acknowledged
possession of at least some of this equipment, we have not agreed to a payment
for that equipment and believe that if a payment were made it would be
substantially less than the Narrowstep demand. Accordingly, this matter is not
reflected as a liability on our financial statements, nor have we included any
related assets on our financial statements. However, we received approximately
$32,000 in merchandise credit for certain of this equipment, which was recorded
as a reduction of our acquisition cost write-off for the year ended September
30, 2009 and is considered to be a valid offset to amounts included in that
write-off but that we believe should have been paid by Narrowstep. In addition
to these costs, we believe that we could seek reimbursement from Narrowstep of
certain general and administrative costs reflected in our operating expenses for
the years ended September 30, 2009 and 2008 (i.e., not segregated as part of the
specific write-off of acquisition costs), since they were incurred in direct
support of Narrowstep operations.
 
 On April
16, 2009 Narrowstep issued a press release announcing that it was seeking $14
million and other damages (including the above matter) from us, as a result of
our alleged actions in connection with the termination of the agreement to
acquire Narrowstep. This demand was made in the form of a letter issued at about
the same time by Narrowstep’s counsel. After reviewing the demand letter issued
by Narrowstep’s counsel, 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 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
again determined that Narrowstep has no basis in fact or in law for any claim
and accordingly, this matter has not been reflected as a liability on our
financial statements. On December 18, 2009, we were served with a summons and we
intend to file the required response on or before the required deadline and to
vigorously defend against all claims. Furthermore, we do not expect the ultimate
resolution of this matter to have a material impact on our financial position or
results of operations.
 
 Other legal
proceedings – On May 26, 2009, we were served with a summons and
complaint filed in Broward County, Florida, containing a breach of contract
claim against us by a firm seeking compensation for legal services allegedly
rendered to us, plus court costs, in the amount of approximately $383,000. We
have accrued approximately $115,000 related to this matter on our financial
statements as of September 30, 2009, which was included in the write-off of
certain acquisition-related costs included in our operating results for the year
then ended (see note 1 – Effects of Recent Accounting Pronouncements). Certain
discovery activities by the parties are in process, mediation has been set for
January 26, 2010 and trial has been set for March 8, 2010. We believe that the
ultimate resolution of the matter will not have a material adverse effect on our
financial position or results of operations.
  F-36
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 
 Other legal
proceedings (continued) – 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 letter regarding
minimum share price listing requirement – We received a letter from
NASDAQ dated January 4, 2008 indicating that we had 180 calendar days, or until
July 2, 2008, to regain compliance with what is now Listing Rule 5550(a)(2) –
formerly Marketplace Rule 4310(c)(4) (the “Rule”), which is necessary in order
to be eligible for continued listing on the NASDAQ Capital Market. The NASDAQ
letter indicated that our non-compliance with the Rule was as a result of the
bid price of ONSM common stock closing below $1.00 per share for the preceding
thirty consecutive business days.  On July 3, 2008, we received a
letter from NASDAQ stating that we were not considered compliant with the Rule
as of that date, but because we met all other initial NASDAQ listing criteria,
we were granted an additional 180 calendar days, or until December 30, 2008, to
regain compliance with the Rule. On October 22, 2008, we received a letter from
NASDAQ stating that NASDAQ had suspended enforcement of the bid price listing
requirement through January 19, 2009, which suspension NASDAQ extended several
more times. Since we were in a bid price compliance period at the time of the
initial suspension, we remained at the same stage of the process we were in when
the NASDAQ first announced the suspension until that suspension was terminated
on July 31, 2009. Accordingly, we were subsequently notified by NASDAQ that as a
result of the termination of the suspension, we had until October 16, 2009 to
regain compliance with the Rule. On October 19, 2009, we received a letter from
NASDAQ stating that since we had not regained compliance with the Rule as of
October 16, 2009, our common stock was subject to delisting. However, such
delisting would not occur if we requested a hearing with the NASDAQ Listing
Qualifications Panel (“the “Panel”) and pending the Panel’s decision subsequent
to that hearing.
  We
requested such a hearing with the Panel, which we attended on December 3, 2009,
and at which time we presented our plan for regaining compliance with the Rule
and requested that our securities be allowed to remain listed pending the
completion of that plan. Based on the Panel’s consideration of that plan, as
well as any other relevant factors, the Panel has the ability to grant us a
period of up to 180 days (counting from the date of the October 19, 2009 letter)
to regain compliance with the Rule. As of December 29, 2009, the Panel had not
informed us of their decision and there can be no assurance that the Panel will
grant our request for continued listing.
  We might
be considered compliant with the Rule, subject to the NASDAQ staff’s discretion,
our common stock closes at $1.00 per share or more for a minimum of ten
consecutive business days.  The closing ONSM share price was $0.28 per
share on December 24, 2009. Although we have not decided on such action, we have
been advised that as a Florida corporation we may implement a reverse split of
our common shares without shareholder approval, provided a proportionate
reduction is made in the number of our authorized common shares and we provide
appropriate advance notice to NASDAQ and other applicable
authorities.
 
 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 the common shares we issued in connection with
the April 2007 Infinite Merger, contain penalty clauses if our common stock is
not traded on NASDAQ or a similar national exchange – see further discussion
below.
  F-37
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 Registration payment
arrangements – We included the 8% Subordinated Convertible Debentures and
the related $1.50 warrants on a registration statement which was declared
effective by the SEC on July 26, 2006. We are only required to expend
commercially reasonable efforts to keep the registration statement continuously
effective. However, in the event the registration statement or the ability to
sell shares thereunder lapses for any reason for 30 or more consecutive days in
any 12 month period or more than twice in any 12 month period, the purchasers of
the 8% Subordinated Convertible Debentures may require us to redeem any shares
obtained from the conversion of those notes and still held, for 115% of the
market value for the previous five days. The same penalty provisions apply if
our common stock is not listed or quoted, or is suspended from trading on an
eligible market for a period of 20 or more trading days (which need not be
consecutive). Due to the fact that that there is no established mechanism for
reporting to us changes in the ownership of these shares after  they
are originally issued, we are unable to quantify how many of these shares
are still held by the original recipient and thus subject to the above
provisions. Regardless of the above, we believe that the applicability of these
provisions would be limited by equity and/or by statute to a certain timeframe
after the original security purchase. All of these debentures were converted to
common shares on or before March 31, 2007.
 The $1.50warrants provide that,
starting one year after issuance, in the event the shares are not subject to an
effective registration statement at the time of exercise, the holder could elect
a “cashless exercise” whereby we would issue shares equal in value to the excess
of the market price at the time of the exercise over the warrant exercise
price.403,650 of
these warrants were still outstanding as of September 30, 2009, and will expire
in March and April of 2011 – see note 8.
 We
included the common shares underlying the 8% Senior Convertible Debentures,
including the Additional 8% Convertible Debentures (AIR), and the related $1.65
warrants, on a registration statement declared effective by the SEC on June 29,
2005. These debentures provide cash penalties of 1% of the original
purchase price for each month that (a) our common shares are not listed on the
NASDAQ Capital Market for a period of 3 trading days (which need not be
consecutive) or (b) the common shares underlying those securities and the
related warrants are not saleable subject to an S-3 or other registration
statement then effective with the SEC. The latter penalty only applies for a
five-year period beginning with the June 29, 2005 registration statement
effective date and does not apply to shares saleable under Rule 144(k).
Regardless of the above, we believe that the applicability of these provisions
would be limited by equity and/or by statute to a certain timeframe after the
original security purchase - all of these debentures were converted to common
shares on or before March 31, 2007.
 
 The $1.65
warrants provide that if the shares are not subject to an effective registration
statement on the date required in relation to the initial and/or subsequent
issuance of shares under the related transactions and at the time of warrant
exercise, the holder could elect a “cashless exercise” whereby we would issue
shares equal in value to the excess of the market price at the time of the
exercise over the warrant exercise price. Although 1,128,530 of these warrants
were still outstanding as of September 30, 2009, 737,114 of that total expired
on December 23, 2009 and the remainder will expire on February 15, 2010 – see
note 8.
  F-38
 
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 Registration payment
arrangements (continued) –During March and April
2007, we sold an aggregate of 4,888,889 restricted common shares at $2.25 per
share for total gross proceeds of approximately $11.0 million. This private
equity financing was arranged by us to partially fund the Infinite Merger – see
note 2. 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 five paragraphs are
registration payment arrangements, as that term is defined in the Derivatives
and Hedging topic (Contracts in Entity’s own Entity 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, 2009, 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. However, the $0.28 quoted
market price price of our common shares was below the $1.00 NASDAQ requirement
as of December 24, 2009, which condition could eventually affect our NASDAQ
listing status, as discussed above.
 
 Registration rights -
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. 784,592 of the
2,789,592 shares issued in March 2007 and subject to these rights were included
in a registration statement declared effective by the SEC on June 15, 2007 and
as of December 24, 2009 we have not received any demand for the registration of
the balance. As the note does 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. Furthermore, since
the unregistered shares were originally issued in March 2007, they may be
saleable, in whole or in part, under Rule 144. In any event, we have determined
that material payments in relation to these rights are not probable and
therefore no accrual related to them is necessary under the requirements of the
Contingencies topic of the ASC.
  F-39
  ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 Registration rights
(continued) – 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. 1,000,000 of the 1,694,495 total
principal and interest shares subject to these rights were included in a
registration statement declared effective by the SEC on June 15, 2007 and as of
December 24, 2009 we have not received any demand for the registration of the
balance.  As the note does 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. Furthermore,
since the unregistered shares were originally issued in November and December
2006, they may be saleable, in whole or in part, under Rule 144. In any event,
we have determined that material payments in relation to these rights are not
probable and therefore no accrual related to them is necessary under the
requirements of the Contingencies topic of the ASC.
 We
granted piggyback registration rights in connection with 100,000 shares and
220,000 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. 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 285,000 shares and
350,000 options issued to consultants subsequent to June 15, 2007. We have not
filed a registration statement with the SEC since that date. As the 285,000
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. Although 150,000 of the 350,000
options include cashless exercise rights until they are registered, and
therefore do constitute registration payment arrangements, since the exercise
price of $1.73 per share is significantly in excess of the market price of $0.41
per share as of September 30, 2009, 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. Although 200,000 of the 350,000 options include
cashless exercise rights starting one year after issuance until they are
registered, and therefore do constitute registration payment arrangements, since
the exercise prices of $0.50, $0.75 and $1.00 per share are significantly in
excess of the market price of $0.41 per share as of September 30, 2009, we have
concluded that no accrual related to these rights is necessary as of that date
under the requirements of the Contingencies topic of the ASC.
 Employment contracts and
severance – On September 27, 2007, our Compensation Committee and Board
of Directors approved three-year employment agreements with Messrs. Randy Selman
(President and CEO), Alan Saperstein (COO and Treasurer), Robert Tomlinson
(Chief Financial Officer), Clifford Friedland (Senior Vice President Business
Development) and David Glassman (Senior Vice President Marketing), collectively
referred to as “the Executives”. On May 15, 2008 and August 11, 2009 our
Compensation Committee and Board approved certain corrections and
modifications to those agreements, which are reflected in the discussion of
the terms of those agreements below.
  F-40
 ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES
 NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009
 
 NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 
 Employment contracts and
severance (continued) – The agreements provide initial annual base
salaries of $253,000 for Mr. Selman, $230,000 for Mr. Saperstein, $207,230 for
Mr. Tomlinson and $197,230 for Messrs. Friedland and Glassman, 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
$5,000 allowance for the reimbursement of dues or charitable
donations.  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.
 
 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 400,000
shares of ONSM common stock at an exercise price of $1.73 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
100,000 per year, starting on September 27, 2008, and they automatically vest
upon the happening of the following events on a date more than six (6) months
after the date of the agreement: (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 220,000 shares of ONSM common stock at an exercise price of $1.73
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. Up to
one-half of these shares were eligible for vesting on a quarterly basis and the
rest annually, with the total grant allocable over a two-year period ending
September 30, 2009. Vesting of the quarterly portion was 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. Vesting of the annual portion was subject to meeting the above cash
flow requirements on a year-over-year basis, plus a revenue growth rate of at
least 30% for the fiscal year over the prior year. In the event of quarter to
quarter decreases in revenues and or cash flow, the options did not vest for
that quarter but the unvested quarterly options were added to the available
options for the year, vested subject to achievement of the applicable annual
goal. In the event options did not vest based on the quarterly or annual goals,
they immediately expired. 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.
  F-41


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





Employment contracts and
severance (continued) – We have determined that the above performance
objectives were met for the quarter ended December 31, 2007 but that they were
not met for the remaining three quarters of fiscal 2008 nor were they met for
the fiscal year ended September 30, 2008. We have also determined that the
performance objectives were met for the quarter ended June 30, 2009 but that
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, 13,750 options out
of a potential 110,000 performance options vested for each executive during each
fiscal year 2008 and 2009 and as a result we recognized total aggregate
compensation expense of approximately $80,000 for each fiscal year, related to
the vested portion of these options.





On August
11, 2009, our Compensation Committee agreed to extend the above bonus program
for two years under substantially the same terms, except that the annual revenue
growth rate will be 20%, we will negotiate with the Executives in good faith as
to how revenue increases from specific acquisitions are measured, and 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. Implementation of
this program is subject only to the approval by our shareholders of a sufficient
increase in the number of authorized 2007 Plan options, at which time the
performance bonus options will be granted and priced – it is anticipated that
the request for shareholder authorization will be submitted at time of the next
annual Shareholder Meeting, expected to be held in February or March 2010. We
have also agreed that this bonus program will continue after this additional
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.





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 $1.00 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 $1.00 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.


F-42


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)
 
 Employment contracts and
severance (continued) – 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 $1.00 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 $1.00. The 12.0% is
allocated in the employment agreements as two and one-half percent (2.5%) each
to Messrs. Selman, Saperstein, Friedland and Glassman and two percent (2.0%) to
Mr. Tomlinson.
 
 Our
general policy is to not include severance or minimum employment periods in
employment contracts, with the exception of the above employment contracts with
the Executives. However, as of September 30, 2009, we have entered into
arrangements with three (3) employees that would require minimum payments of
approximately $320,000 for wages, taxes and benefits over the approximately
fourteen month period after that date.
 
 Other compensation –
In addition to the 12% allocation of the Company Sale Price to the Executives,
as discussed above, on August 11, 2009 our Compensation Committee determined
that an additional three percent (3.0%) of the Company Sale Price would be
allocated, on the same terms, with two percent (2.0%) allocated to the four
outside Directors (0.5% each), as a supplement to provide appropriate
compensation for ongoing services as a director and as a termination fee,
one-half percent (0.5%) allocated to one additional executive-level employee and
the remaining one-half percent (0.5%) to be allocated by the Board and our
management at a later date, which will be primarily to compensate other
executives not having employment contracts, but may also include additional
allocation to some or all of these five senior Executives.


Consultant
contracts – We have entered into a consulting contract,
effective June 1, 2009, with an individual for executive management services to
be performed for our Infinite division. This contract calls for base
compensation of $175,000 per year, plus $25,000 commission per year provided
certain current revenue levels are maintained. In addition we have agreed to pay
a travel allowance of $3,000 to $5,000 per month for up to the first thirteen
months of the contract, plus a one-time $15,000 moving expenses reimbursement.
Termination of the contract without cause before 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. The contract is renewable by mutual agreement of the parties with six
months notice to the other. As part of the contract, a new four-year term (from
vesting) option grant was made for the purchase of 400,000 common ONSM shares,
vesting over four years at 100,000 per year, exercisable at the fair market
value at the date of grant, but no less than $0.50 per share. See notes 6 and
8.




F-43


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





Consultant
contracts (continued) – 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,
2009 of approximately 110,000 unregistered shares and 800,000 options to
purchase common shares at exercise prices from $0.50 to $1.00 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. The
services related to these shares and options will be provided over a 12 month
period, and will result in a professional fees expense of approximately $145,000
over that service period, based on the current $0.28 market value of an ONSM
common share as of December 24, 2009 – see notes 6 and 8.


Bandwidth and co-location
facilities purchase commitments - Effective July 1, 2008, we entered into
a two-year long distance bandwidth rate agreement with a national CDN (content
delivery network) company, which includes a minimum purchase commitment of
approximately $200,000 per year. We are in compliance with this agreement, based
on comparing our purchases through September 30, 2009 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 $570,000, such agreements
expiring at various times through December 2011.
 
 Long distance purchase
commitment - Effective January 15, 2006, our EDNet division entered into
a two-year long distance telephone rate agreement with a national
telecommunications company, which included a telephone services purchase
commitment of approximately $120,000 per year. On September 13, 2007, this
agreement was extended to add another two years, for a total term of four years.
We are in compliance with this agreement, based on comparing our purchases
through September 30, 2009 to the corresponding pro-rata share of that
commitment.


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 $57,500. The leases have expiration dates ranging from 2010 to
2012 (after considering our rights of termination) and in most cases provide for
renewal options. Most of the leases have annual rent escalation provisions.
Future minimum lease payments required under these non-cancelable leases as of
September 30, 2009, excluding the capital lease obligations discussed in note 4,
total approximately $968,000.





The
three-year operating lease for our principal executive offices in Pompano Beach,
Florida expires September 15, 2010. The monthly base rental is currently
approximately $22,500 (including our share of property taxes and common area
expenses) with annual five percent (5%) increases. The lease provides for one
two-year renewal option with 5% annual increases.





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




F-44


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)


Lease commitments
(continued) – The three-year operating lease for our Infinite Conferencing
location in New Jersey expires October 31, 2012. The monthly base rental is
approximately $10,800 with five percent (5%) annual increases. The lease
provides one two-year renewal option, with no rent increase.
 
 Our
operating lease for office space in New York City expires January 31,
2010.   The monthly base rental is approximately
$6,600.  During the second quarter of fiscal 2010, we expect to
replace this month-to-month lease with a multi-year lease commitment at another
location for no more than the monthly rental amount being incurred at the
current location.


The
future minimum lease payments required under the non-cancelable leases, 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
                
                
                Leases2010
                
                $
                616,093
                
                
                $
                121,825
                
                
                $
                737,9182011
                
                
                197,715
                
                
                
                9,938
                
                
                
                207,6532012
                
                
                142,615
                
                
                
                9,938
                
                
                
                152,5532013
                
                
                11,932
                
                
                
                9,938
                
                
                
                21,8702014
                
                
                -
                
                
                
                3,313
                
                
                
                3,313Total
      minimum lease payments
                
                $
                968,355
                
                
                $
                154,952
                
                
                $
                1,123,307Less:
      amount representing interest
                
                
                
                
                
                
                (12,028
                )Present
      value of net minimum lease payments
                
                
                
                
                
                $
                142,924Less:
      current portion
                
                
                
                
                
                
                (115,635
                )Long-term
      portion
                
                
                
                
                
                $
                27,289





Total
rental expense (including executory costs) for all operating leases was
approximately $849,000 and $776,000 for the years ended September 30, 2009 and
2008, respectively.





Software purchase and
royalty commitment – On March 31, 2008 we agreed to pay $300,000 (plus a
$37,500 annual support fee) for a perpetual license for software we utilize to
provide automatic meta-tagging and other DMSP services. An initial $56,250
payment was paid in July 2008 with the $281,250 balance included in payables at
September 30, 2009 and 2008. In connection with this license, we agreed to pay a
1% royalty on revenues from the use, licensing or offering of the functionality
of this software to our customers, if such revenue exceeds certain levels,
subject to a minimum amount per transaction and to the extent the calculated
royalty exceeds the license payment. We are not yet liable for payments under
this agreement.





On August
5, 2009, the vendor of the above software stated that the license would be
terminated if $305,718.75 (balance plus interest) was not paid by September 4,
2009 and that our obligation to pay would not be affected by such termination.
We believe that this termination would not have a material effect on our ongoing
operations, since the licenses are the basis for new products being developed
for which there are not yet significant revenues, are being used to provide
excess capacity over our current operational needs or are being used to provide
non-core services with an insignificant net contribution to our operating
results. Furthermore, we believe that we have meritorious defenses supporting
our lack of payment to date, including product performance and integration
issues.


F-45


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
5:  COMMITMENTS AND CONTINGENCIES (Continued)





SAIC contract - As
part of the Onstream Merger, we became obligated under a contract with SAIC,
under which SAIC would build a platform that eventually, after further design
and re-engineering by the Company, became the DMSP. The contract terminated by
mutual agreement of the parties on June 30, 2008. Although cancellation of the
contract among other things releases SAIC to offer what is identified as the
“Onstream Media Solution” directly or indirectly to third parties, our
management does not expect this right to result in a material adverse impact on
future DMSP sales.





Auction Video Japan
office - 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. See note 2.





NOTE
6:  CAPITAL STOCK





Common
Stock





During
the year ended September 30, 2008, we issued 453,670 unregistered shares valued
at approximately $541,000 (including the 240,000 shares issued in connection
with the October 2007 amendment and one-year extension of a three-year
consulting contract first entered into in November 2006, but excluding the
90,000 shares recorded in fiscal 2008 but reversed upon cancellation of the
contract in fiscal 2009, both as discussed below) and recognized as professional
fees expense for financial consulting and advisory services over various service
periods of up to 36 months. Except for 25,000 shares issued to Mr. Charles
Johnston, director, as compensation for services to be rendered by him for
fiscal year 2008 in connection with his appointment as Audit Committee chairman,
none of the other shares were issued to our directors or
officers.





In
November 2006, we entered into a three-year consulting contract with the
principal and beneficial owner of an entity which loaned us funds under a
convertible note in October 2006. The contract, for the provision of
international business development and financial advice, is cancellable upon
thirty days notice and originally called for the issuance of 60,000 restricted
common shares in advance every six months. The first two tranches under this
contract (60,000 shares each) were issued in January and May 2007, valued based
on fair market value as of the date of issuance and expensed as professional
fees expense. This contract was amended in July 2007 for some additional
short-term services, resulting in issuance of an additional 15,000 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
240,000 restricted common shares, in exchange for the extension of the remaining
term of the contract from two years to three years. These shares were valued
based on fair market value as of the date of issuance and are being expensed
ratably over the remaining contract term as professional fees
expense.
 F-46




ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
6:  CAPITAL STOCK (Continued)





Common Stock
(continued)


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
240,000 unregistered shares for financial consulting and advisory services, of
which we recorded the issuance of 90,000 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, 2008, we issued options to purchase our common
shares, in exchange for financial consulting and advisory services, such options
valued at approximately $210,000. Except for options to purchase 41,667 shares
valued at approximately $23,000 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 options were issued to our directors
or officers.





During
the year ended September 30, 2008, we issued 201,250 shares in connection with
the Equipment Notes – 101,250 shares issued as fees to placement agents and
finders and 100,000 shares issued to the Investors. See note 4.





During
the year ended September 30, 2009, we issued 922,871 unregistered shares valued
at approximately $294,000 and recognized as professional fees expense for
financial consulting and advisory services over various service periods of up to
12 months. These amounts exclude the reduction for the cancellation of 90,000
previously recorded consulting shares as discussed above. None of the shares
were issued to our directors or officers, although 120,000 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 options to purchase our common
shares, in exchange for financial consulting and advisory services, such options
valued at approximately $82,000. Except for options to purchase 8,333 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 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 $383,000 and $1,079,000 for the years ended September 30, 2009 and
2008, respectively.





As a
result of previously issued shares and options for financial consulting and
advisory services, we have recorded approximately $165,000 in deferred equity
compensation expense at September 30, 2009, to be amortized over the remaining
periods of service of up to 13 months. The deferred equity compensation expense
is included in the balance sheet captions prepaid expenses and other non-current
assets.




F-47


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
6:  CAPITAL STOCK (Continued)





Common Stock
(continued)





We
recognized compensation expense (and a corresponding increase in additional paid
in capital) of approximately $1,127,000 and $882,000 for the years ended
September 30, 2009 and 2008, respectively, in connection with options issued to
our employees to purchase our common shares. See note 5 (employment contracts
and severance) and note 8.





During
the year ended September 30, 2009, we issued 452,589 shares valued at $137,275
in connection with interest on the Equipment Notes – see note 4.





During
the year ended September 30, 2009, we issued 178,361 shares in connection with
the conversion of Series A-10 preferred as well as 243,251 shares in payment of
dividends on Series A-10 and Series A-12 preferred, both issuances discussed in
more detail below.





Preferred
Stock





As of
September 30, 2008, the only preferred stock outstanding was Series A-10
Convertible Preferred Stock (“Series A-10”). As of September 30, 2009, the only
preferred stock outstanding was Series A-12 Redeemable Convertible Preferred
Stock (“Series A-12”).





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.





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.




F-48


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
6:  CAPITAL STOCK (Continued)





Preferred Stock
(continued)





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 has a coupon of 8% per annum, a stated value of $10.00 per preferred
share and a conversion rate of $1.00 per common share. Series A-12 dividends are
cumulative and must be fully paid by us prior to the payment of any dividend on
our common shares. Dividends are payable in advance, in the form of ONSM common
shares. The holders of Series A-12 may require redemption by us under certain
circumstances, as outlined below, but any shares of Series A-12 that are still
outstanding as of December 31, 2009 will automatically convert into ONSM common
shares. Series A-12 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-12 shall not be entitled to vote on any matters as to which holders of
ONSM common shares are entitled to vote. Holders of Series A-12 are 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”). $100,000 of
this cash was received on December 31, 2008 and the remaining $100,000 was
received on January 2, 2009.





In
accordance with the terms of the Series A-12, dividends are 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 235,294 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, which is being
amortized as a dividend over the one-year term of the Series A-12.




In
accordance with the terms of the Series A-12, after six months the holders may
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 have no redemption rights. On April 14, 2009, we entered into a
Redemption Agreement with one of the holders of the Series A-12, under which the
holder redeemed 10,000 shares of Series A-12 in exchange for our payment of
$100,000 on April 16, 2009. Furthermore, we have reflected $98,000 of the Series
A-12 as a current liability on our September 30, 2009 balance sheet, which is
the remaining $100,000 redeemable portion of the Series A-12, net of a pro-rata
share of the total unamortized discount.





See note
9 - Subsequent Events with respect to our authorization and issuance of Series
A-13 Convertible Preferred Stock (“Series A-13”) during December 2009, which
included the conversion of certain Series A-12 shares to Series
A-13.


F-49


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
7:  SEGMENT INFORMATION


Our
operations are currently comprised of two groups, Digital Media Services and
Audio and Web Conferencing Services. 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 Infinite division of the
Audio and Web Conferencing Services Group are in the New York City metropolitan
area. The primary operating activities of the Webcasting and Travel divisions of
the Digital Media Services Group, as well as our headquarters, are in Pompano
Beach, Florida. The primary operating activities of the DMSP and UGC divisions
of the Digital Media Services Group are in Colorado Springs, Colorado. All
material sales, as well as the location of our property and equipment, are
within the United States. Detailed below are the results of operations by
segment for the years ended September 30, 2009 and 2008, and total assets by
segment as of the years then ended.





For the years ended September
      30,2009
                    
                    
                    2008Revenue:Digital
      Media Services Group
                    
                    $
                    7,740,355
                    
                    
                    $
                    7,851,243Audio
      and Web Conferencing Services Group
                    
                    
                    9,186,598
                    
                    
                    
                    9,735,980Total
      consolidated revenue
                    
                    $
                    16,926,953
                    
                    
                    $
                    17,587,223Segment
      operating income (loss):Digital
      Media Services Group
                    
                    
                    1,155,918
                    
                    
                    
                    (82,455
                    )Audio
      and Web Conferencing Services Group
                    
                    
                    2,535,433
                    
                    
                    
                    3,675,654Total
      segment operating income
                    
                    
                    3,691,351
                    
                    
                    
                    3,593,199Depreciation
      and amortization
                    
                    
                    (3,195,291
                    )
                    
                    
                    (4,215,669
                    )Corporate
      and unallocated shared expenses
                    
                    
                    (5,765,798
                    )
                    
                    
                    (5,780,453
                    )Write
      off deferred acquisition costs
                    
                    
                    (504,738
                    )
                    
                    
                    -Impairment
      loss on goodwill and other intangible assets
                    
                    
                    (5,500,000
                    )
                    
                    
                    -Other
      expense, net
                    
                    
                    (556,309
                    )
                    
                    
                    (158,535
                    )Net
      loss
                    
                    $
                    (11,830,785
                    )
                    
                    $
                    (6,561,458
                    )





September 30,2009
                    
                    
                    2008Assets:Digital
      Media Services Group
                    
                    $
                    7,747,921
                    
                    
                    $
                    13,215,981Audio
      and Web Conferencing Services Group
                    
                    
                    16,796,925
                    
                    
                    
                    18,986,117Corporate
      and unallocated
                    
                    
                    939,127
                    
                    
                    
                    1,642,450Total
      assets
                    
                    $
                    25,483,973
                    
                    
                    $
                    33,844,548


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


F-50


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009


NOTE
8:  STOCK OPTIONS AND WARRANTS


As of
September 30, 2009, we had issued options and warrants still outstanding to
purchase up to 14,544,509 ONSM common shares, including 9,038,750 Plan Options;
1,102,928 Non-Plan Options to employees and directors; 1,619,346 Non-Plan
Options to financial consultants; and 2,783,485 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 4,500,000
shares available for issuance as options and up to another 2,000,000 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 6,000,000 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.





Detail of
Plan Option activity under the 1996 Plan and the 2007 Plan for the years
ended September 30, 2009 and 2008 is as follows:


September 30, 2009
                
                
                September 30, 2008Number of
                    Shares
                
                
                Weighted
                    Average
                    Exercise Price
                
                
                Number of
                    Shares
                
                
                Weighted
                    Average
                    Exercise PriceBalance,
      beginning of period
                
                
                8,103,000
                
                
                $1.31
                
                
                
                7,471,332
                
                
                $1.43Granted
      during the period
                
                
                2,781,250
                
                
                $1.42
                
                
                
                960,000
                
                
                $1.00Expired
      or forfeited during the period
                
                
                (1,845,500
                )
                
                $1.46
                
                
                
                ( 328,332
                )
                
                $3.37Balance,
      end of the period
                
                
                9,038,750
                
                
                $1.32
                
                
                
                8,103,000
                
                
                $1.31Exercisable
      at end of the period
                
                
                6,852,083
                
                
                $1.36
                
                
                
                4,544,250
                
                
                $1.11





We
recorded total compensation expense of approximately $1,127,000 and $882,000 for
the years ended September 30, 2009 and 2008, respectively, related to Plan
Options granted to employees and vesting during those periods. The unvested
portion of Plan Options outstanding as of September 30, 2009 (and granted on or
after our October 1, 2006 adoption of the requirements of the Compensation -
Stock Compensation topic of the ASC) represents approximately $1,407,000 of
potential future compensation expense, which excludes approximately $27,000
related to the ratable portion of those unvested options allocable to past
service periods and recognized as compensation expense as of September 30,
2009.




F-51


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)


The 9,038,750
outstanding Plan Options 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
                  options
                  outstanding
              
              
              Vested
                portion
      of
                options
                outstanding
              
              
              Exercise
                  price
                  per
                  share
              
              Expiration
                dateDec
      2004
              
              Senior
      management
              
              
              150,000
              
              
              
              150,000
              
              
              $1.21
              
              Aug
      2014July
      2005
              
              Directors
      and senior management
              
              
              1,400,000
              
              
              
              1,400,000
              
              
              $1.12
              
              July
      2010July
      2005
              
              Employees
      excluding senior management
              
              
              884,000
              
              
              
              884,000
              
              
              $1.12
              
              July
      2010July
      2006
              
              Carl
      Silva – new director
              
              
              50,000
              
              
              
              50,000
              
              
              $0.88
              
              July
      2010Sept
      2006
              
              Directors
      and senior management
              
              
              650,000
              
              
              
              650,000
              
              
              $0.71
              
              Sept
      2011Sept
      2006
              
              Employees
      excluding senior management
              
              
              606,000
              
              
              
              606,000
              
              
              $0.71
              
              Sept
      2011March
      2007
              
              Employees
      excluding senior management
              
              
              25,000
              
              
              
              25,000
              
              
              $2.28
              
              March
      2011April
      2007
              
              Infinite
      Merger – see note 2
              
              
              150,000
              
              
              
              150,000
              
              
              $2.50
              
              April
      2012Sept
      2007
              
              Senior
      management employment contracts – see note 5
              
              
              2,137,500
              
              
              
              1,137,500
              
              
              $1.73
              
              Sept 2012 – Sept 2016Dec
      2007
              
              Leon
      Nowalsky – new director
              
              
              50,000
              
              
              
              50,000
              
              
              $1.00
              
              Dec
      2011Dec
      2007
              
              Employees
      excluding senior management
              
              
              10,000
              
              
              
              3,333
              
              
              $1.00
              
              Dec
      2011April
      2008
              
              Employees
      excluding senior management
              
              
              15,000
              
              
              
              5,000
              
              
              $1.00
              
              April
      2012May
      2008
              
              Infinite
      management consultant – see note 5
              
              
              100,000
              
              
              
              100,000
              
              
              $1.00
              
              May
      2013Aug
      2008
              
              Employees
      excluding senior management
              
              
              405,000
              
              
              
              235,000
              
              
              $1.00
              
              Aug
      2012Dec
      2008
              
              Employees
      excluding senior management
              
              
              300,000
              
              
              None
              
              
              $1.00
              
              Dec
      2012May
      2009
              
              Infinite
      management consultant – see note 5
              
              
              400,000
              
              
              None
              
              
              $0.50
              
              Jun
      2014 – Jun 2018May
      2009
              
              Employees
      excluding senior management
              
              
              400,000
              
              
              
              100,000
              
              
              $0.50
              
              May 2013 – Jul 2015Aug
      2009
              
              Directors
      and senior management
              
              
              800,000
              
              
              
              800,000
              
              
              $2.50
              
              Aug
      2014Aug
      2009
              
              Directors
      and senior management
              
              
              500,695
              
              
              
              500,695
              
              
              $1.57
              
              Aug
      2014Aug
      2009
              
              Director
              
              
              5,555
              
              
              
              5,555
              
              
              $3.376
              
              Aug
      2014Total
      Plan Options as of September 30, 2009
              
              
              9,038,750
              
              
              
              6,852,083




F-52


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)


On August
11, 2009, our Compensation Committee granted 1,306,250 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 are all in excess of the market
value of an ONSM share as of August 11, 2009. The cancelled Non-Plan Options
were the two items discussed below, as well as five-year fully vested Non-Plan
Options we granted to certain executives during the year ended September 30,
2005, for the purchase of 800,000 shares of ONSM common stock at $2.50 per
share. 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 $1,127,000 discussed above and the remainder
recognized as professional fees expense.
 
 As of
September 30, 2009, there were 1,102,928 outstanding Non-Plan Options issued to
employees and directors, which were all issued during the year ended September
30, 2005, as follows:
 
 i)
Immediately exercisable five-year options issued to certain executives,
directors and other management issued in conjunction with the Onstream Merger
for the purchase of 849,305 shares of ONSM common stock at $1.57 per share (fair
market value at date of grant) and expiring in December 2009, which is the
1,350,000 options originally issued less 500,695 of those options cancelled on
August 11, 2009 in exchange for the issuance of an equivalent number of Plan
Options, as discussed above, and
 
 ii)
Immediately exercisable options issued in conjunction with the Onstream Merger
for the purchase of 253,623 shares of ONSM common stock at $3.376 per share,
which is the 270,284 options originally issued less 11,106 of those options
which have expired as of September 30, 2009 and less 5,555 of those options
cancelled on August 11, 2009 in exchange for the issuance of an equivalent
number of Plan Options, as discussed above. 1,853 of the 253,623 options
outstanding as of September 30, 2009 expired in December 2009. The remaining
options expire in July 2012 and May 2013.
 
 On
December 17, 2009, our Compensation Committee granted 749,305 five-year Plan
Options in exchange for the cancellation of an equivalent number of Non-Plan
Options expiring in December 2009, with no change in the $1.57 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 corresponding issuance, we expect to
recognize non-cash compensation and professional fee expense of approximately
$127,000 for the three months ended December 31, 2009. The remaining 100,000
Non-Plan Options not replaced expired in December 2009.
 F-53


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)


As of
September 30, 2009, there were 1,619,346 outstanding and fully vested Non-Plan
Options issued to financial consultants, as follows:


Issuance period
                        
                        Number
                            of options
                        
                        
                        Exercise price
                            per share
                        
                        Expiration
                            DateAugust
      2009
                        
                        
                        100,000
                        
                        
                        $0.50
                        
                        Aug
      2013September
      2009
                        
                        
                        100,000
                        
                        
                        $0.50
                        
                        Sept
      2013September
      2009
                        
                        
                        50,000
                        
                        
                        $0.75
                        
                        Sept
      2013September
      2009
                        
                        
                        100,000
                        
                        
                        $1.00
                        
                        Sept
      2013Year
      ended September 30, 2009
                        
                        
                        350,000October
      2007
                        
                        
                        150,000
                        
                        
                        $1.73
                        
                        Oct
      2011October
      2007
                        
                        
                        100,000
                        
                        
                        $1.83
                        
                        Oct
      2011Year
      ended September 30, 2008
                        
                        
                        250,000October
      - December 2006
                        
                        
                        75,000
                        
                        
                        $1.00
                        
                        Oct
      - Dec 2010December
      2006
                        
                        
                        40,000
                        
                        
                        $1.50
                        
                        December
      2010January
      – December 2007
                        
                        
                        490,000
                        
                        
                        $2.46
                        
                        Oct
      2010 - Dec 2011March
      2007
                        
                        
                        21,184
                        
                        
                        $2.48
                        
                        March
      2012Year
      ended September 30, 2007
                        
                        
                        626,184October
      2005 – August 2006
                        
                        
                        295,000
                        
                        
                        $1.00
                        
                        Oct 2009 – Aug 2010March
      – September 2006
                        
                        
                        85,750
                        
                        
                        $1.05
                        
                        March
      2011Year
      ended September 30, 2006
                        
                        
                        380,750March
      2005
                        
                        
                        5,000
                        
                        
                        $1.65
                        
                        March
      2010December
      2004
                        
                        
                        7,412
                        
                        
                        $3.376
                        
                        Dec
      2009Year
      ended September 30, 2005
                        
                        
                        12,412Total
      Non-Plan consultant optionsas
      of September 30, 2009
                        
                        
                        1,619,346





See the
discussion of consultant contracts in note 5 for details with respect to
commitments to issue up to 800,000 options after September 30, 2009, not
reflected in the above table.


F-54


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE
8:  STOCK OPTIONS AND WARRANTS (Continued)
 
 As of
September 30, 2009, there were outstanding vested warrants, primarily issued in
connection with various financings, to purchase an aggregate of 2,783,485 shares
of common stock, as follows:


Description
      of transaction
                  
                  Number
      of
                      warrants
                  
                  
                  Exercise
      price
                      per
      share
                  
                  Expiration
                      DatePlacement
      fees – common share offering – March and April 2007
                  
                  
                  342,222
                  
                  
                  $2.70
                  
                  March and
      April 20128%
      Subordinated Convertible Debentures –  March and April
      2006
                  
                  
                  403,650
                  
                  
                  $1.50
                  
                  March
      and April 2011Additional
      8%  Convertible Debentures - February and April
      2005
                  
                  
                  391,416
                  
                  
                  $1.65
                  
                  February and April 20108%
      Convertible Debentures – December 2004
                  
                  
                  737,114
                  
                  
                  $1.65
                  
                  December
      2009Series
      A-10 Preferred – December 2004
                  
                  
                  909,083
                  
                  
                  $1.50
                  
                  December
      2009Total
      warrants as of September 30, 2009
                  
                  
                  2,783,485


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 $1.50 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.


With
respect to the warrants issued in connection with the sale of 8% Convertible
Debentures and Additional 8% Convertible Debentures, the number of shares of
ONSM common stock that can be issued upon the exercise of these $1.65 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 9.999% 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-55




ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE 9:
SUBSEQUENT EVENTS





Our
September 30, 2009 financial statements were available to be issued on or about
December 29, 2009 and we have evaluated all events occurring through that date
for disclosure therein. Notes 1 (Liquidity, Effects of Recent Accounting
Pronouncements), 3 (Auction Video patent application), 4 (Convertible Debenture
interest payment, Line of Credit Arrangement renewal and modifications,
Rockridge Note borrowing), 5 (Narrowstep acquisition termination and litigation,
NASDAQ letter regarding minimum share price listing requirement, Lease
commitments) and 6 (Non Plan Option cancellations, Plan Option grants) contain
disclosure with respect to transactions occurring after September 30,
2009.





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 $0.50 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
ONSM common shares, using the greater of (i) $0.50 per share or (ii) the average
closing bid price of a common share for the five trading days immediately
preceding the conversion.




Any
shares of Series A-13 that are still outstanding as of December 31, 2011 will
automatically convert into ONSM 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 $1.50 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 ONSM common shares are
entitled to vote. Holders of Series A-13 are not entitled to registration
rights.





During
August 2009, CCJ Trust remitted $200,000 to us as a short term advance bearing
interest at .022% per day (equivalent to approximately 8% per annum) until the
date of repayment or unless the parties mutually agreed to another financing
transaction(s) prior to repayment. This advance was included in accounts payable
and accrued liabilities on our September 30, 2009 balance sheet. On December 29,
2009, we entered into an agreement with CCJ Trust 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 (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. 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) $0.50 per
share. In conjunction with and in consideration of this note transaction, 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 plus four-year warrants for the purchase of 175,000
ONSM common shares at $0.50 per share.




During
the period from October 1, 2009 through December 24, 2009, we recorded the
issuance of 147,500 unregistered shares of common stock for financial consulting
and advisory services. The services will be provided over a period of three to
twelve months, and will result in a professional fees expense of approximately
$41,000 over the service period. None of these shares were issued to our
directors or officers.




F-56


ONSTREAM
MEDIA CORPORATION AND SUBSIDIARIES


NOTES TO
THE CONSOLIDATED FINANCIAL STATEMENTS


SEPTEMBER
30, 2009





NOTE 9:
SUBSEQUENT EVENTS (Continued)





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 the debt (i) would be unsecured and
subordinated to the Company’s other debts, (ii) would be subject to approval by
our other creditors having the right of such pre-approval, (iii) would provide
for no principal or interest payments in cash prior to December 31, 2010,
although, at our option, consideration may be given in the form of equity issued
before that date and (iv) would provide that any cash repayment of principal
after that date would be in equal monthly installments over at least one year
but no greater than four years. The rate of return on such debt, including cash
and equity consideration given, would be negotiable based on market values at
the time of funding but in any event would be not be greater than (i) a cash
coupon rate of fifteen percent (15%) per annum and a (ii) total effective
interest rate of thirty percent (30%) per annum (such rate including the cash
coupon rate plus the fair value of our shares given and/or the Black-Scholes
valuation of debt conversion features and/or issuance of options and/or
warrants).  As consideration for these commitment letters, the issuing
entities will receive an aggregate of seventy-five thousand (75,000)
unregistered shares. One of these funding commitment letters, for $250,000, was
executed by Mr. Charles Johnston, one of our directors.




F-57