-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, L8xDFUUqHaPNBzkUoP6yf29TYa1CTSBR0HO2LjXQ142kBPgdYvm8MJWeY6xuOtXY HuPdTB8pvxSvOM8suaX58w== 0001144204-06-001513.txt : 20060113 0001144204-06-001513.hdr.sgml : 20060113 20060113171323 ACCESSION NUMBER: 0001144204-06-001513 CONFORMED SUBMISSION TYPE: 10KSB PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050930 FILED AS OF DATE: 20060113 DATE AS OF CHANGE: 20060113 FILER: COMPANY DATA: COMPANY CONFORMED NAME: Onstream Media CORP CENTRAL INDEX KEY: 0000919130 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 650420146 STATE OF INCORPORATION: FL FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10KSB SEC ACT: 1934 Act SEC FILE NUMBER: 000-22849 FILM NUMBER: 06530648 BUSINESS ADDRESS: STREET 1: 1291 SW 29 AVE STREET 2: STE 3A CITY: POMPANO BEACH STATE: FL ZIP: 33069 BUSINESS PHONE: 9549176655 MAIL ADDRESS: STREET 1: 1600 S DIXIE HIGHWAY STREET 2: SUITE 3A CITY: BOCA RATON STATE: FL ZIP: 33432 FORMER COMPANY: FORMER CONFORMED NAME: VISUAL DATA CORP DATE OF NAME CHANGE: 19961025 10KSB 1 v033164_10ksb.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-KSB (Mark One) [x] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended September 30, 2005 [_] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to ------- -------- Commission file number 000-22849 Onstream Media Corporation -------------------------- (Name of small business issuer in its charter) Florida 65-0420146 - --------------------------------- ------------------------------------ (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 1291 SW 29 Avenue Pompano Beach, Florida 33069 ---------------------- --------------------------- (Address of principal executive offices) (Zip Code) Issuer's telephone number 954-917-6655 ------------ Securities registered under Section 12(b) of the Exchange Act: Title of each class Name of each exchange on which registered None not applicable - --------------------- ----------------------------------------- (Title of each class) Securities registered under Section 12(g) of the Exchange Act: common stock - --------------------- (Title of class) Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act [_] Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [x] No [_] Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. [_] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yes [_] No [X] State issuer's revenues for its most recent fiscal year. $ 8,156,394 for the 12 months ended September 30, 2005. State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was sold, or the average bid and asked prices of such common equity, as of a specified date within the past 60 days. The aggregate market value of the common equity held by non-affiliates computed at the closing price of the registrant's common stock on January 11, 2006 is approximately $10.3 million. State the number of shares outstanding of each of the issuer's class of common equity, as of the latest practicable date. As of January 11, 2006, 12,891,716 shares of common stock are issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE If the following documents are incorporated by reference, briefly describe them and identify the part of the Form 10-KSB (e.g., Part I, Part II, etc.) into which the document is incorporated: (1) any annual report to security holders; (2) any proxy or information statement; and (3) any prospectus filed pursuant to Rule 424(b) of the Securities Act of 1933 ("Securities Act"). Not Applicable. Transitional Small Business Disclosure Form (check one): Yes [_] No [X] CERTAIN CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION Certain statements in this annual report on Form 10-KSB contain or may contain forward-looking statements that are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, the potential rescission rights of the holders of the Company's 8% Convertible Debentures, Additional 8% Convertible Debentures and Series A-10 Preferred Stock, our ability to implement our strategic initiatives (including our ability to successfully complete, produce, market and/or sell the DMSP and/or our ability to eliminate cash flow deficits by increasing our sales), economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk, U.S. and global competition, and other factors affecting the Company's operations and the fluctuation of the Company's common stock price, and other factors discussed elsewhere in this report and in other documents filed by the Company with the Securities and Exchange Commission from time to time.. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of September 30, 2005. Readers should carefully review this Form 10-KSB in its entirety, including but not limited to our financial statements and the notes thereto and the risks described in "Item 1. Business--Risk Factors." Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. Actual results could differ materially from the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will, in fact, occur. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. When used in this Annual Report, the terms "we", "our", and "us" refers to Onstream Media Corporation, formerly known as Visual Data Corporation, a Florida corporation, and its subsidiaries. All share and per share data contained herein gives proforma effect to the one for 15 reverse stock split of our common stock effected on June 24, 2003. PART I ITEM 1. DESCRIPTION OF BUSINESS Our Business, Products and Services We are an online service provider of live and on-demand media communication, including webcasting, webconferencing, digital asset management and web publishing services. Our objective is to provide these services via a fully robust, comprehensive digital media services platform (DMSP) that virtually any company, government agency or other enterprise having a need to manage rich media content will be able to utilize in an affordable and highly secure environment. Our operations are organized in two main operating groups: o Digital Asset Management Group o Webcasting Group Products and services provided by each of the groups are: Digital Asset Management Group Our Digital Asset Management Group, which operates primarily from facilities in San Francisco, California, provides digital asset management and audio and video networking services that represented approximately 54.9% and 52.2% of our revenues for the years ended September 30, 2005 and 2004, respectively. These revenues are comprised primarily of network access and usage fees, the sale and rental of communication equipment, and fees for encoding, storage, search and retrieval and distribution of digital assets. Digital asset management is a set of coordinated technologies and processes that allow the quick and efficient storage, retrieval, and reuse of the digital files that are essential to most businesses. These digital files include photos, videos, audio files, engineering specs, architectural plans, web pages, and many other pieces of business collateral. Digital asset management provides the business rules and processes needed to acquire, store, index, secure, search, export and transform these assets and their descriptive information. In addition, the Digital Asset Management Group services include, through its operation Entertainment Digital Network, Inc. ("EDNET"), providing connectivity within the entertainment and advertising industries through a private wide-area network (WAN) managed by it, which encompasses production and post-production companies, advertisers, producers, directors, and talent. The network enables high-speed exchange of high quality audio, compressed video and multimedia data communications, utilizing long distance carriers, regional phone companies, satellite operators, and major Internet service providers. EDNET also provides systems integration and engineering services, application-specific technical advice, audio equipment, proprietary and off-the-shelf codecs, video compression and transport equipment, teleconferencing equipment, and other innovative products to facilitate our broadcast and production applications. EDNET's global network, with approximately 500 active access locations in cities throughout the United States, Canada, Mexico, Europe, and the Pacific Rim, is the product of strategic alliances with long distance carriers, regional telephone companies, satellite operators and independent fiber optic telecommunication providers, which enables the collaborative exchange of high quality audio, or for compressed video and multimedia data communications. In December 2004 we completed our acquisition of the remaining approximately 74% of Acquired Onstream not previously owned by us (the "Onstream Merger"). Acquired Onstream was a development stage company founded in 2001 with the business objective of developing a feature rich digital asset management service and offering the service on an application service provider (ASP) basis to exploit the confluence of trends in broadband access and the cost of digital storage media. This product, the Digital Media Services Platform ("DMSP"), will allow corporations to better manage their digital rich media without the major capital expense for the hardware, software and additional staff necessary to build their own digital asset management solution. The DMSP was designed and is being managed by Science Applications International Corporation ("SAIC") (one of the country's foremost IT security firms providing services to all branches of the federal government as well as leading corporations) and is actually comprised of four separate "products", only two of which were available on an individual basis at the time of the Onstream Merger. The four separate products are transcoding, storage, search and retrieval and distribution. A limited version of the DMSP, with three of the four products accessible via an integrated interface using North Plains technology and incorporating important security and other design features available through SAIC, was first placed in service with third-party customers in November 2005. The fourth product will be available to our DMSP customers in the near future. We believe that the DMSP expands our product offering by providing our Fortune 1000 and media and entertainment customers a low cost monthly service for the storage, streaming, encoding, collaboration and distribution of digital rich media. The closing of the Onstream Merger brings new target markets for our webcasting services that include government, healthcare, education, telecommunications and international sectors. We believe that these verticals also have strong requirements for digital asset management services and are the primary business sectors for SAIC. We also believe the availability of the DMSP will expose our company to incremental revenue opportunities in our webcasting and EDNET businesses. We believe that being able to offer our clients such integrated product and services is a critical element to differentiating our company from our competitors in the marketplace. Acquired Onstream entered into a Basic Ordering Agreement for Professional Solutions ("BOA") with SAIC, with an original term expiring December 31, 2006 which we may, at our option, extend for up to an additional 48 months by executing up to four one-year renewal options. Pursuant to the BOA, SAIC agreed to design, host and manage the DMSP, including the addition and customization of applications to fit the specific needs of customers. SAIC also agreed to provide certain hosting and back-office services directly to us and in support of our customers. The amount we have expended to complete the working platform is approximately $3.5 million which includes approximately $1.8 million in cash or ONSM common stock paid to SAIC to date plus the cost of licensed technology, software, custom programming and equipment from Virage, Nine Systems, North Plains and other vendors, as discussed below. Upon payment of all amounts due SAIC for each software module described in the BOA (exclusive of third party software), SAIC will grant us, as Acquired Onstream's successor, a royalty-free, worldwide, perpetual non-transferable license to operate the software created by SAIC for our internal business purposes, by our customers on an ASP basis so long as hosting and OSS/BSS (operating support systems/business support systems) services are provided exclusive by SAIC, and for back-up hosting and disaster recovery purposes. In addition, upon payment to SAIC of 20% of the original total development costs (excluding third party software) for any particular software which SAIC has developed under the BOA, SAIC will grant us, as Acquired Onstream's successor, a royalty-free, perpetual, world wide license to such software which includes the right to distribute the software on an ASP basis to our customers, to a third party hosting the software on behalf of us and our customers as end users on an ASP basis, and to end users under an enterprise license for the end user's internal business purposes only. In addition, we, as Acquired Onstream's successor, will have the right to create extensions and enhancements to the software which will be owned by us, and we will grant SAIC a royalty free, world wide, perpetual, non-exclusive license, sublicense and transferable license to operate and modify the extensions and enhancements for itself and its clients. In addition, the agreement with SAIC restricts SAIC from offering an outsourced solution that allows for the management and use of digital rich media with 2 flexible applications such as collaboration and re-purposing to any third party during the term of the agreement. In February 2004 we acquired certain assets from Virage, Inc. The assets acquired included the assignment of customer contracts for the performance of digital asset management services as well as assistance in the integration of those activities into our operations. Also in February 2004, Acquired Onstream entered into a license agreement whereby it licensed certain software from Virage, Inc. This software is being integrated into the DMSP. In May 2004 Acquired Onstream entered into a license agreement with Nine Systems, a software vendor of Internet protocol-based billing and provisioning solutions. Under this agreement, we, as Acquired Onstream's successor, licensed on a perpetual basis the Nine Systems billing and provisioning software including systems integration support. In December 2004 North Plains, a software developer of digital asset management repositories and work flow engines, entered into an agreement with us, as Acquired Onstream's successor, to provide its software for use in our digital asset management services platform. Webcasting Group The Webcasting Group provides corporate-oriented, web-based media services including live audio and video webcasting and on-demand audio and video streaming and represented approximately 45.1% and 47.8% of our revenues for the years ended September 30, 2005 and 2004, respectively. These revenues are comprised primarily of production and distribution fees. Our Webcasting Group, which operates primarily from facilities in Pompano Beach, Florida and a sales office in New York City, provides online webcasting services, a cost effective means for corporations to broadcast conference calls live, making them available to the investing public, the media and to anyone worldwide with Internet access. We market the webcasting services through a direct sales force and through channel partners, also known as resellers. Each webcast can be heard and/or viewed live, and then archived for replay for an additional fee with an option for accessing the archived material through a company's own web site. These webcasts primarily communicate corporate earnings and other financial information; product launches and other marketing information; training, emergency or other information directed to employees; and corporate or other special events. We provide our webcasting customers with vertically integrated streaming media solutions, from onsite production through delivery to end-users. These solutions included original production, editing, and digital encoding of audio and video content, Internet website design and development, and Internet distribution and hosting. Our Webcasting Group also includes our travel production and distribution operations. These operations primarily include the production, storage and Internet streaming of two to four minute multi-media videos for clients such as hotel, resort, golf facility, travel destination and time-shares. We store and make available all such content on our website www.travelago.com. In May 2005 the Company agreed to sell its travel production and distribution operations and the related assets. However, in September 2005 the buyer filed a legal action against the Company alleging that the Company did not deliver these assets as agreed. The Company believes that the ultimate resolution of this legal action will not have a material impact on its financial condition or results of operations and, pending such resolution, the Company continues these travel production and distribution operations. 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 3 to take advantage of the particular distributors' existing marketing programs, sales forces and business relationships. Contracts with these distributors generally range from one to two years. We have expanded our marketing efforts during the past year through the use of public relations and telemarketing firms. We intend to continue these actions during the coming year, as well as the introduction of targeted television and radio advertising, as well as direct mail. See Item 6 - Liquidity and Capital Resources. In March 2004, Thomson Financial Group completed the acquisition of CCBN. As a result, we have combined revenues from both of these companies for disclosure purposes. For the years ended September 30, 2005 and 2004, we provided webcasting services to one significant customer, Thomson Financial Group, under a contract that can be terminated upon a 30-day notification. Revenues from sales to this customer were approximately $1.4 million, or approximately 17%, and approximately $1.8 million, or approximately 24%, of total consolidated revenue for the years ended September 30, 2005 and 2004, respectively. These revenues represented approximately 38% and 50% of Webcasting Group revenues for the same periods. For the year ended September 30, 2005 the Company provided digital asset management services to another significant customer, America Online, Inc., under a contract which can be terminated upon a 30-day notification. Revenues from sales to this customer were approximately $1.2 million, or approximately 15%, of total consolidated revenue for the year ended September 30, 2005. These revenues represented approximately 26% of Digital Asset Management Group revenues for the same period. Other than these agreements, no other agreement with a customer has represented more than 10% of our revenues during these periods. See Risk Factors below. Competition We operate in highly competitive and rapidly changing business segments. We expect our competition to intensify. We compete with: - - other web sites, Internet portals and Internet broadcasters to acquire and provide content to attract users; - - video and audio conferencing companies and Internet business service broadcasters; - - online services, other web site operators and advertising networks; - - traditional media, such as television, radio and print; and - - end-user software products. Our webcasting products and services fall into two competitive areas: live or archived financial and fair-disclosure related conferences, and all other live or archived webcast productions for the corporate, financial, educational and government segments. In the financial conferences area, we compete with Akamai, ON24, IVT, WILink, Talkpoint, Wall Street Transcripts, Netbriefings, PTEK Holdings, Shareholder.com, Thomson Financial Group, Media Link Worldwide and others that offer live webcasts of quarterly earnings conference calls. For other webcast production, we compete with other smaller geographically local entities. Our production services, however, have been in demand by some of our competitors, and from time to time we have provided services to these companies. The nature of the streaming media sector of the Internet market is highly interdependent while being competitive. 4 During fiscal 2005, our Webcasting Group experienced a revenue increase of approximately 1.5%, or approximately 2.9% before considering a decline in travel production and distribution revenues. Although the competitive pressures that reduced the number of audio-only webcasts in fiscal 2004 continued in fiscal 2005, this declining trend was offset during fiscal 2005 by sales growth from higher priced video webcasts. Competition for the audio and video networking services provided by the EDNet division of our Digital Asset Management Group is based upon the ability to provide systems compatibility and proprietary off-the-shelf codecs. Due to the difficulty and expense of developing and maintaining private digital networks, bridging services, engineering availability and service quality, we believe that the number of audio networking competitors are, and will remain small. Our primary video networking competitors are video appliance dealers that source video transport hardware. This group's advantage is one that provides a total solution including system design, broadband sourcing, and custom software connectivity applications that include a comprehensive digital path for television commercial transport. However, companies that compete in some portion of the audio and video networking services market targeted by us include Telestream, Globix, Acceris, Media Link, Savvis, and Digital Generation (DG) Systems. While there is competition for the provision of digital asset management services by our Digital Asset Management Group, this is a relatively new product with few established providers. We believe that our approach of partnering with established providers such as SAIC, Virage Application Services and North Plains reduces the competition in this area. We also believe that our ability to offer integrated webcasting, networking and other services as part of "full service" digital asset management limits direct competition. However, companies that compete in some portion of the digital asset management market targeted by us include MerlinOne, Clear Sky, eMotion, Aquant, Getty Images, Quebecor, American Color, Ascent Media, Wam!Net, Interchange Digital and Publicis. Government Regulation Although there are currently few laws and regulations directly applicable to the Internet, it is likely that new laws and regulations will be adopted in the United States and elsewhere covering issues such as broadcast license fees, copyrights, privacy, pricing, sales taxes and characteristics and quality of Internet services. It is possible that governments will enact legislation that may be applicable to us in areas such as content, network security, encryption and the use of key escrow, data and privacy protection, electronic authentication or "digital" signatures, illegal and harmful content, access charges and retransmission activities. Moreover, the applicability to the Internet of existing laws governing issues such as property ownership, content, taxation, defamation and personal privacy is uncertain. The majority of such laws were adopted before the widespread use and commercialization of the Internet and, as a result, do not contemplate or address the unique issues of the Internet and related technologies. Any such export or import restrictions, new legislation or regulation or governmental enforcement of existing regulations may limit the growth of the Internet, increase our cost of doing business or increase our legal exposure, which could have a material adverse effect on our business, financial condition and results of operations. By distributing content over the Internet, we face potential liability for claims based on the nature and content of the materials that we distribute, including claims for defamation, negligence or copyright, patent or trademark infringement, which claims have been brought, and sometimes successfully litigated, against Internet companies. To protect our company from such claims, we maintain general liability insurance (including umbrella coverage) of approximately $3.0 million. The general liability insurance may not cover all potential claims of this type or may not be adequate to indemnify us for any liability to which we may be exposed. Any liability not covered by insurance or in excess of insurance coverage could have a material adverse effect on our business, results of operations and financial condition. 5 Our audio and video networking services are conducted primarily over telephone lines, which are heavily regulated by the various Federal and other agencies. However, we believe that the responsibility for compliance with those regulations primarily falls on the local and long distance telephone service providers and not the Company. Intellectual Property Our success depends in part on our ability to protect our intellectual property. To protect our proprietary rights, we rely generally on copyright, trademark and trade secret laws, confidentiality agreements with employees and third parties, and agreements with consultants, vendors and customers, although we have not signed such agreements in every case. Despite such protections, a third party could, without authorization, copy or otherwise obtain and use our content. We can give no assurance that our agreements with employees, consultants and others who participate in development activities will not be breached, or that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or independently developed by competitors. We may pursue the registration of certain of our trademarks and service marks in the United States, although we have not secured registration of all our marks. In addition, the laws of some foreign countries do not protect our proprietary rights to the same extent as do the laws of the United States, and effective copyright, trademark and trade secret protection may not be available in such jurisdictions. In general, there can be no assurance that our efforts to protect our intellectual property rights through copyright, trademark and trade secret laws will be effective to prevent misappropriation of our content. Our failure or inability to protect our proprietary rights could materially adversely affect our business, financial condition and results of operations. Employees At December 31, 2005 we had 61 full time employees, of whom 30 were design, production and technical personnel, 12 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. 6 RISK FACTORS Before you invest in our securities, you should be aware that there are various risks. Additional risks and uncertainties not presently known to us or that we currently believe to be immaterial may also adversely affect our business. You should consider carefully these risk factors, together with all of the other information included in or incorporated by reference into this prospectus before you decide to purchase our securities. If any of the following risks and uncertainties develop into actual events, our business, financial condition or results of operations could be materially adversely affected. There is significant doubt about our ability to continue as a going concern. Our financial statements have been prepared assuming that we will continue as a going concern. The independent auditor's report on our current financial statements states that we have suffered significant recurring losses from operations since inception that raise substantial doubt about our ability to continue as a going concern. We continue to explore the possibility of raising funds through available sources, which include equity and debt markets, although there is no assurance that we will be able to raise such funds. In the event we are unable to raise these funds, we cannot be certain how long, or if, we will be able to maintain operations. We have an accumulated deficit and we anticipate continuing losses that will result in significant liquidity and cash flow problems absent a material increase in our revenues. We have incurred losses since our inception, and have an accumulated deficit of approximately $70.4 million as of September 30, 2005. For the year ended September 30, 2005, we had a net loss of approximately $9.6 million and cash used in operations was approximately $1.9 million. We had approximately $4,000 of cash as of September 30, 2005. We have projected capital expenditures for the next twelve months of $900,000, which includes the further development of the recently completed DMSP as well as an upgrade to the webcasting software and hardware infrastructure, now in process. We also anticipate additional operating expenses in the coming year related to the continuation of our marketing program expansion that began in the year ended September 30, 2005, although we cannot guarantee that this expansion will be implemented or that our marketing efforts will be successful. Although we may experience increases in our operating expenses during the next year arising from our program for compliance with Section 404 of the Sarbanes-Oxley Act of 2002, we may defer these expenses based on the status of regulatory changes in this area. Our operations have historically been financed primarily through the issuance of equity and debt. We cannot assure that our revenues will continue to increase, nor can we assure that they will not decrease. We recently completed the Digital Services Media Platform ("DMSP") and it was first placed in service with third-party customers in November 2005, but we cannot assure what the sales activity will be. As long as our cash flow from operations remains insufficient to completely fund operations, we will continue depleting our cash and other financial resources. As a result of the uncertainty as to 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 which could adversely affect our ability to expand our business and operations during fiscal 2006. 7 The original offer and sale of our 8% Convertible Debentures and Series A-10 Preferred Stock may be deemed to be in violation of federal securities laws and as a result the investors in those securities may have the right to rescind their original purchase of those securities. On December 23, 2004, we completed a private placement of our 8% Convertible Debentures and Series A-10 Preferred Stock. In February and April 2005, additional investment rights granted as part of the 8% Convertible Debentures were exercised. Interest and dividends accrued on these securities since their issuance have been paid with A-10 Preferred or common shares. The gross proceeds from these transactions (the "Financing Transactions"), plus dividends and interest paid in kind through September 30, 2005, were approximately $11.6 million. The resale registration statement of shares of common stock underlying the 8% Convertible Debentures, the Series A-10 Preferred Stock, the additional investment rights and the warrants was originally filed by us on February 23, 2005. This original registration was subsequently withdrawn and a resale registration statement was filed on April 11, 2005. Pursuant to the Securities Act of 1933 and the related rules and regulations, as interpreted by the Securities and Exchange Commission, as a result of a portion of the additional investment rights being unexercised at the time the resale registration statement was originally filed, the private offerings have not been completed and accordingly, the public and private offerings would be integrated and result in a violation of Section 5 of the Securities Act. Accordingly, the investors who purchased the private placement securities may have a number of remedies available to them, including the potential right to rescind the purchase of those securities plus, potentially, any amount representing damage to such investors. As of September 30, 2005, and prior to giving effect to the accounting for this potential rescission, our balance sheet reflected a liability, net of discount, of approximately $1.2 million associated with these securities. The remainder of the proceeds arising from the 8% Convertible Debentures, including the portion of the additional investment rights exercised through that date, and the Series A-10 Preferred Stock, including dividends and interest paid in kind, was approximately $10.4 million and was classified as part of stockholders' equity at that date. After giving effect to the accounting for this potential rescission, approximately $7.4 million of the $10.4 million was reclassified under the caption "Equity Securities Subject to Potential Rescission", which is located on the balance sheet directly above the stockholders' equity section, but not included in it and the remaining approximately $3.0 million related to detachable warrants and embedded conversion features was classifed as a liability pursuant to EITF 00-19. We are unable to predict if the investors would attempt to exercise such potential rescission rights. Each investor's decision would be based upon, among other things, a decline in the price of our common stock and other factors. These potential rescission rights would require us to refund at least the gross proceeds of these private offerings to the investors. In order to satisfy such potential obligations, we would be required to utilize our available capital resources and obtain alternate sources of capital for such purposes. We presently do not have the capital available to satisfy all potential claims for rescission. The inability to obtain alternative sources of capital would have a material effect on our business, prospects, financial condition and our results of operations. We are ultimately dependent upon an increase in our revenues to provide sufficient capital to fund our current operations. Even if revenues increase, we anticipate the near-term need to raise additional capital. We cannot assure that we will be successful in raising additional working capital as may be necessary for our continued operations. Our future working capital requirements depend primarily on the rate at which we can decrease our use of cash to fund operations, which is in turn dependent on an increase in our revenues. Cash used for operations will be affected by numerous known and unknown risks and uncertainties including, but not limited to, our ability to successfully sell the DMSP, market our other existing products and services, the degree to which competitive products and services are introduced to the market, and our ability to control overhead expenses as we grow. We are constantly evaluating our cash needs and existing burn rate, in order to make appropriate adjustments in operating expenses. Based on our limited cash and other resources, we anticipate the near-term need to 8 raise additional working capital, which we cannot assure will be successfully raised. Depending on the terms and amount of any additional near-term capital, absent a material increase in our revenues during fiscal 2006, of which there is no assurance, it is likely we may need to raise additional debt or equity capital within the next 12 months to provide funding for ongoing future operations, or to refinance existing indebtedness. The amount of additional working capital we may need to raise will be dependent, in part, on our ongoing evaluation of cash needs and anticipated capital expenditures. If we raise additional capital through the issuance of debt, this will result in increased interest expense. If we raise additional funds through the issuance of equity or convertible debt securities, the percentage ownership of our company held by existing shareholders will be reduced and those shareholders may experience significant dilution. No assurances can be given that we will be successful in obtaining additional capital, or that such capital will be available on terms acceptable to us. If we are unable to raise additional working capital as needed, we may be required to curtail some of our operations. Our primary assets serve as collateral under outstanding convertible notes. If we were to default on these agreements, the holders could foreclose on our assets. In December 2004, we sold $4.35 million principal amount of 8% senior secured convertible notes and in February and April 2005 we issued an additional $2.175 million principal amount 8% senior secured convertible notes upon the exercise of the additional investment rights. Following the conversion to common shares by several note holders of principal amount 8% senior secured convertible notes totaling $2,875,000, the current principal balance of the 8% senior secured convertible notes is $3,650,000. The interest of 8% is payable in cash or in-kind at our option. Beginning in September 2007, any remaining 8% Convertible Debentures will be paid in nine equal quarterly installments. All or part of these installments may be paid in ONSM common shares subject to a formula based on trading volume and share price and provided that the volume weighted average share price during the quarter prior to payment exceeds $1.18 per share. The notes are collateralized by a blanket security interest in our assets and a pledge of the stock of our subsidiaries. If we should default under the payment of interest when due, the funding of redemptions as required, or other provisions of the notes, the holders could seek to foreclose on our primary assets. If the holders were successful, we would be unable to conduct our business as it is presently conducted and our ability to generate revenues and fund our ongoing operations would be materially adversely affected. In addition to the above, certain recently purchased hardware and software with an original cost of approximately $800,000 has been pledged as collateral for short-term notes payable with a combined outstanding principal balance of $900,000. We are dependent on contracts, some of which are short term. If these contracts are terminated, our results of operations would be materially adversely affected. We are dependent upon contracts and distribution agreements with our strategic partners and clients, including Thomson Financial Group and its subsidiary CCBN, and America Online, Inc. Revenues from sales to Thomson Financial Group were approximately $1.4 million, or 17%, and approximately $1.8 million, or 24%, of total consolidated revenue for the years ended September 30, 2005 and 2004, respectively. These revenues represented approximately 38% and 50% of Webcasting Group revenues for the same periods. During the year ended September 30, 2005 we also provided digital asset management services to America Online, Inc. under a contract which can be terminated upon a 30-day notification. Revenues from sales to America Online, Inc. were approximately $1.2 million, or 15%, of our consolidated revenue for the year ended September 30, 2005 and represented approximately 26% of the Digital Asset Management Group's revenues for that period. Both of these contracts can be terminated upon a 30-day notification. Because of the significant nature of the revenues from 9 these contracts to our consolidated results of operations, the termination of either contract could have a material adverse effect on our financial condition and results of operations. We may be unable to successfully market or sell the Digital Media Services Platform ("DMSP"). Our December 2004 purchase of Acquired Onstream included approximately $2.7 million capitalized by Acquired Onstream prior to that date for licensed software and development work by SAIC, Virage and other third parties related to the partially completed Digital Media Services Platform ("DMSP"). Subsequent to the acquisition, we have spent approximately $800,000 to complete the platform in a commercially viable form, including computer equipment used in its development and initial operation. Although we believe there is a market for the DMSP and as of November 2005 have placed a limited version of it in service with some third-party customers, there have only been limited sales for the DMSP to date and we do not know when, if ever, that we will generate any significant revenues from this product. In addition there is no assurance that we will be able to sell the DMSP on a profitable basis. Our inability to successfully market and/or sell the DMSP could have a material adverse effect on our financial condition and results of operations. We expect to continue to experience volatility in our stock price, which has recently been below $1.00 per share. Historically, there has been volatility in the market price for our common stock. Our quarterly operating results, changes in general conditions in the economy, the financial markets or the marketing industry, or other developments affecting us or our competitors, could cause the market price of our common stock to fluctuate substantially. We expect to experience significant fluctuations in our future quarterly operating results due to a variety of factors. Factors that may adversely affect our quarterly operating results include: - the announcement or introduction of new services and products by us and our competitors; - our ability to upgrade and develop our systems in a timely and effective manner; - our ability to retain existing clients and attract new clients at a steady rate, and maintain client satisfaction; - the level of use of the Internet and online services and the rate of market acceptance of the Internet and other online services for transacting business; - technical difficulties, system downtime, or Internet brownouts; - the amount and timing of operating costs and capital expenditures relating to expansion of our business and operations; - government regulation; and - general economic conditions and economic conditions specific to the Internet. As a result of these factors, in one or more future quarters, our operating results may fall below the expectations of securities analysts and investors. In this event, the market price of our common stock would likely be materially adversely affected. In addition, the stock market in general and the market prices for Internet-related companies in particular, have experienced extreme volatility that often has been unrelated to the operating performance of 10 those companies. These broad market and industry fluctuations may adversely affect the price of our common stock, regardless of our operating performance. The price of our common stock closed below $1.00 per share for thirty-two of the trading days from November 9, 2005 through December 30, 2005, with the longest consecutive period being twenty-four days. Thirty consecutive trading days below $1.00 per share may result in a deficiency letter from NASDAQ, which then allows the Company 180 calendar days to regain compliance. Lack of compliance by the Company would result in the inability to list its common shares on NASDAQ, which would adversely affect the marketability and value of the shares. In addition to the above, the 8% Convertible Debentures and the Additional 8% Convertible Debentures provide cash penalties of 1% of the original purchase price per month, for each month that the common stock underlying those securities and the related warrants is not listed on the NASDAQ Small Cap Market. If the selling security holders all elect to sell their shares of our common stock at the same time, the market price of our shares may decrease. It is possible that the selling security holders will offer all of the shares for sale. Further, because it is possible that a significant number of shares could be sold at the same time hereunder, the sales, or the possibility thereof, may have a depressive effect on the market price of our common stock. The exercise of options and warrants, the conversion of shares of our Series A-10 Convertible Preferred Stock or the conversion of our 8% senior secured convertible notes will be dilutive to our existing common shareholders. As of September 30, 2005 there were outstanding options and warrants to purchase a total of 15,114,093 shares of our common stock, with an average exercise price of $1.94 per share and the majority exercisable between $1.00 and $1.65 per share. Of these outstanding options and warrants, there are warrants to purchase an aggregate of 1,087,500 shares, contingently issuable upon the exercise of $1.00 warrants issued in connection with the Additional 8% Convertible Debentures. In addition, as of September 30, 2005 there were 416,031 shares of our Series A-10 Convertible Preferred Stock outstanding, which is convertible into 4,160,310 shares of our common stock, as well as $3,820,000 principal amount 8% senior secured convertible notes which are convertible into 3,820,000 shares of our common stock. A substantial portion of our assets are comprised of goodwill and other intangible assets, which may be subject to future impairment and result in financial statement write-offs. Our prior acquisitions of several businesses have resulted in significant increases in goodwill and other intangible assets. Unamortized goodwill and other intangible assets, which includes acquired customer lists, were approximately $10.6 million at September 30, 2005, representing approximately 61% of our total assets and 348% of the book value of shareholder equity, after reduction for equity securities subject to potential rescission. If there is a material change in our business operations, the value of the intangible assets we have acquired could decrease significantly. On an ongoing basis, we will evaluate, partially based on discounted expected future cash flows, whether the carrying value of such intangible assets may no longer be recoverable, in which case an additional charge to earnings may be necessary. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition and results of operations. 11 We have issued debt and preferred shares containing significant discounts which will adversely, and possibly unpredictably, affect interest and dividend expense in future years. We are required to record the fair value of warrants issued in conjunction with the Financing Transactions, plus the potential value arising from a beneficial conversion feature included in the terms of the financing, as a discount to the stated financing amount. The unamortized portions of these discounts were approximately $2.1 million for the Series A-10 Convertible Preferred and approximately $2.6 million for the 8% senior secured convertible notes, which were reflected on our balance sheet at September 30, 2005. These non-cash amounts will be amortized to dividend and interest expense over the four year financing terms, although any unamortized portion will be immediately expensed at the time of a conversion or redemption occurring before the end of those terms. Accordingly, conversions of approximately $170,000 occurring after September 30, 2005 will result in the write-off to expense of approximately $136,000 unamortized debt discount during the three months ending December 31, 2005. We may be exposed to potential risks relating to our internal controls over financial reporting and our ability to have those controls attested to by our independent auditors. As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the Securities and Exchange Commission adopted rules requiring public companies to include a report of management on the company's internal controls over financial reporting in their annual reports, including Form 10-KSB. In addition, the independent registered public accounting firm auditing a company's financial statements must also attest to and report on management's assessment of the effectiveness of the company's internal controls over financial reporting as well as the operating effectiveness of the company's internal controls. We were not subject to these requirements for the fiscal year ended September 30, 2005 and do not expect to be subject to them for the fiscal year ended September 30, 2006. We are evaluating our internal control systems in order to allow our management to report on, and our independent registered public accounting firm to attest to, our internal controls, as a required part of our Annual Report on Form 10-KSB beginning with our report for the fiscal year ended September 30, 2007. While we expect to eventually expend significant resources in developing the necessary documentation and testing procedures required by Section 404 of the Sarbanes-Oxley Act of 2002, there is a risk that we will not comply with all of the requirements imposed thereby. At present, there is no precedent available with which to measure compliance adequacy. Accordingly, there can be no positive assurance that we will receive a positive attestation from our independent auditors. In the event we identify significant deficiencies or material weaknesses in our internal controls that we cannot remediate in a timely manner or we are unable to receive a positive attestation from our independent auditors with respect to our internal controls, investors and others may lose confidence in the reliability of our financial statements and our ability to obtain equity or debt financing could suffer. In addition to the above, in the event that our independent registered public accounting firm is unable to rely on our internal controls in connection with their audit of our financial statements, and in the further event that they are unable to devise alternative procedures in order to satisfy themselves as to the material accuracy of our financial statements and related disclosures, it is possible that we would receive a qualified or adverse audit opinion on those financial statements. In that event, the quotation of our common stock on the Nasdaq SmallCap Market could be adversely affected. In addition, investors and others may lose confidence in the reliability of our financial statements and our ability to obtain equity or debt financing could suffer. 12 Provisions of our articles of incorporation and bylaws may delay or prevent a take-over which may not be in the best interests of our shareholders. Provisions of our articles of incorporation and bylaws may be deemed to have anti-takeover effects, which include when and by whom special meetings of our shareholders may be called, and may delay, defer or prevent a takeover attempt. In addition, certain provisions of the Florida Business Corporation Act also may be deemed to have certain anti-takeover effects which include that control of shares acquired in excess of certain specified thresholds will not possess any voting rights unless these voting rights are approved by a majority of a corporation's disinterested shareholders. In addition, our articles of incorporation authorize the issuance of up to 5,000,000 shares of preferred stock with such rights and preferences as may be determined from time to time by our board of directors, of which 416,031 shares of our Series A-10 Convertible Preferred Stock were issued and outstanding at September 30, 2005. Our board of directors may, without shareholder approval, issue preferred stock with dividends, liquidation, conversion, voting or other rights that could adversely affect the voting power or other rights of the holders of our common stock. ITEM 2. DESCRIPTION OF PROPERTY We lease a 25,000 square foot facility at 1291 SW 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 ends in September 2007 and provides for a five-year renewal option. The monthly base rental is approximately $17,000 (including our share of property taxes and common area expenses) with annual three percent (3%) increases. We also maintain business offices located at 440 Ninth Avenue, New York City, New York. This office, including available common areas, is approximately 2,000 square feet and serves as a sales office and as a backup to Florida for webcasting operations. We lease this space from an unaffiliated third party under a lease expiring on December 31, 2006 for a monthly rental of $6,000. In May 2004, we entered into a five-year operating lease for office space at 200 Vallejo Street in San Francisco. This is an approximately 8,500 square foot facility that operates as administrative headquarters for Digital Asset Management Group, including EDNet, and houses the centralized network hub for electronically bridging affiliate studios. In addition, the facility operates as a backup to Florida for webcasting operations. The lease provides for one five-year renewal option at 95% of fair market value. The monthly base rental is approximately $15,000 with annual increases up to five percent (5%). ITEM 3. LEGAL PROCEEDINGS On May 18, 2005 the Company agreed to sell its travel video library, as well as all rights associated with that library, including the customer contracts and the related websites, for $455,000. The Company received a $50,000 non-refundable deposit at the time of the initial agreement, with the remaining balance due upon closing, originally anticipated to be no later than September 2005. As part of the sale, the buyer also agreed to pay the Company $15,000 per month for a three-year period, in exchange for hosting and streaming services for the travel video library and similar content obtained elsewhere by the buyer. On September 23, 2005 the buyer filed a legal action against the Company in the District Court, 193rd Judicial District, Dallas County, Texas, alleging that the Company did not deliver the assets as agreed and seeking return of the $50,000 deposit plus reimbursement of unspecified due diligence expenses, attorney fees and interest. On December 4, 2005, the Company filed a response objecting to all claims by the buyer, which it believes are without merit. The 13 Company has not refunded the deposit, which is included in deferred revenue as of September 30, 2005. The Company does not believe that the ultimate resolution of this matter will have a material impact on its financial condition or results of operations. Pending closing of this transaction, the Company had the right to continue, and has continued, its travel production and distribution operations. The cost of the travel video library is fully depreciated as of September 30, 2005 and the associated travel production and distribution revenues were $208,177 and $251,232, respectively, for the years ended September 30, 2005 and 2004. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On September 13, 2005 we held our 2005 annual meeting of shareholders, at which all matters submitted to a vote of the company's shareholders as described in the proxy statement filed with the SEC on August 1, 2005 were approved. 7,412,332 shares were present, all by valid proxy and including 4,244,842 shares held in street names and thus only eligible to vote on certain of these matters. At the 2005 Annual Meeting, our shareholders took the following actions: Election of Directors - Our shareholders elected Randy S. Selman, Clifford Friedland, Alan M. Saperstein, Benjamin Swirsky, Robert J. Wussler, Charles C. Johnston and General Ronald W. Yates to serve as directors until the next annual meeting of shareholders or until their successors are elected and qualified. The number of votes cast for each of these individuals are set forth below: Shares For Shares Against Share Abstentions Randy S. Selman 7,362,500 19,670 30,162 Clifford Friedland 7,363,470 18,700 30,162 Alan M. Saperstein 7,337,475 44,695 30,162 Benjamin Swirsky 7,363,338 18,832 30,162 Robert J. Wussler 7,363,338 18,832 30,162 Charles C. Johnston 7,362,530 19,640 30,162 General Ronald W. Yates 7,363,272 18,898 30,162 Ratification of Accountants - Our shareholders ratified the appointment of Goldstein Lewin & Co., Certified Public Accountants, as our independent accountants. The vote totals were 7,401,238 shares for, 5,133 shares against and 5,961 share abstentions. Financing - Our shareholders approved the possible issuance of in excess of 19.99% of our presently issued and outstanding common stock upon the exercise of common stock purchase warrants. The vote totals were 2,963,179 shares for, 194,096 shares against and 10,215 share abstentions. Stock Options - Our shareholders approved an amendment to our 1996 Stock Option Plan increasing the number of shares available for issuance under the plan. The vote totals were 2,749,681 shares for, 402,460 shares against and 15,349 share abstentions. Our shareholders also approved a proposal for the acceleration of certain non-plan compensatory options previously granted to executives under the terms of their employment agreements. The vote totals were 2,669,161 shares for, 454,206 shares against and 44,123 share abstentions. 14 PART II ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Our common stock is quoted on the Nasdaq SmallCap Market. From July 1997 until January 5, 2005 our common stock traded under the symbol "VDAT." On January 5, 2005 following the change of our corporate name to Onstream Media Corporation our trading symbol was changed to "ONSM." The following table sets forth the high and low closing sale prices for our common stock as reported on the Nasdaq Stock Market and for the period from October 1, 2003 through December 31, 2005. These prices do not include retail mark-ups, markdowns or commissions, and may not necessarily represent actual transactions. High Low FISCAL YEAR 2004: First Quarter $3.05 $1.81 Second Quarter $2.63 $1.96 Third Quarter $2.80 $1.91 Fourth Quarter $2.19 $1.18 FISCAL YEAR 2005: First Quarter $1.79 $1.06 Second Quarter $2.33 $1.35 Third Quarter $1.70 $1.07 Fourth Quarter $1.16 $0.95 FISCAL YEAR 2006: First Quarter $1.17 $0.65 On January 11, 2006, the last reported sale price of the common stock on the Nasdaq SmallCap Market was $0.92 per share. As of January 11, 2006 there were approximately 553 shareholders of record of the common stock. Dividend Policy We have never declared or paid any cash dividends on our common stock. We currently expect to retain future earnings, if any, to finance the growth and development of our business. The approval of the holders of a majority of the outstanding principal face amount of the 8% Convertible Debentures and the Additional 8% Convertible Debentures is required prior to the payment of any dividend on our common stock. Dividends related to the Series A-10 Convertible Preferred are cumulative and must be fully paid by us prior to the payment of any dividend on our common stock. Recent Sales of Unregistered Securities During the three months ended September 30, 2005, we issued 92,715 shares of common stock for consulting, financial advisory and legal services. The services are being provided over periods ranging up to one year, and will result 15 in a professional fees expense of approximately $105,000 over the service period. During October 2005, we issued 45,000 ONSM common shares for professional services valued at approximately $45,000. None of these shares were issued to Company directors or officers. On November 30, 2005, we issued 44,444 shares of common stock, valued at approximately $36,000, as interest on $300,000 we borrowed on that date from Platinum Credit Group, LLC. We agreed to include these shares on the next S-3 or other registration statement filed. On January 9, 2006, we issued 305,878 shares of common stock, valued at approximately $226,350, for equipment purchases from BTI Computers, Inc. and we issued 20,000 shares of common stock for professional services valued at approximately $20,000. All of the above securities were issued in private transactions exempt from registration under the Securities Act of 1933 in reliance on an exemption provided by Section 4(2) of that act. The recipients were either accredited or otherwise sophisticated investors and the certificates evidencing the shares that were issued contained a legend restricting their transferability absent registration under the Securities Act of 1933 or the availability of an applicable exemption therefrom. The purchasers had access to business and financial information concerning our company. Each purchaser represented that he or she was acquiring the shares for investment purposes only, and not with a view towards distribution or resale except in compliance with applicable securities laws. Securities Authorized for Issuance Under Equity Compensation Plans The following table sets forth securities authorized for issuance under equity compensation plans, including our 1996 Stock Option Plan, individual compensation arrangements and any other compensation plans as of September 30, 2005.
Number of Weighted Number of securities to be average securities remaining issued upon exercise available for future exercise of price of issuance under equity of outstanding outstanding compensation plans options, warrants options, (excluding securities Plan category and rights warrants reflected in column (a)) and rights (a) (b) (c) 1996 Stock Option Plan (1) (3) 2,940,895 $1.89 3,532,346 Equity compensation plans approved by shareholders (2) 2,431,390 $2.09 none Equity compensation plans not approved by shareholders (3) 4,883 $13.27 none
16 (1) Our 1996 Stock Option Plan has previously been approved by our shareholders, and reflects the only such equity compensation plan for which we have sought shareholder approval. On April 11, 2002, an amendment to the Plan, ratified by the shareholders, reserved an aggregate of 733,334 plan options and added an equity compensation component. On December 15, 2004, a majority of our shareholders voted to increase the number of shares available for issuance under the plan to 3,500,000. On September 13, 2005, a majority of our shareholders voted to increase the number of shares available for issuance under the plan to 6,500,000. (2) On December 15, 2004, a majority of our shareholders voted to issue 1,631,390 Non Plan options to certain executives, directors and other management in connection with the Onstream Merger and 800,000 Non Plan options to certain executives in connection with their employment contracts. (3) On December 15, 2004 a majority of our shareholders voted to approve the cancellation of stock option grants to directors, executive officers, senior management and employees covering 292,992 shares (227,776 of which were issued under the 1996 Stock Option plan) with a weighted-average exercise price of $22.93, with such options to be re-issued six months and one day from the date of cancellation with an exercise price equal to the fair market value on the date of the reissue. This cancellation has not yet been implemented and 181,438 of the options (121,105 of which were issued under the 1996 Stock Option plan) had expired as of September 30, 2005. ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION The following discussion should be read together with the information contained in the Consolidated Financial Statements and related Notes included in the annual report. Overview We are an online service provider of live and on-demand media communication, including webcasting, webconferencing, digital asset management and web publishing services. Our objective is to provide these services via a fully robust, comprehensive digital media services platform (DMSP) that virtually any company, government agency or other enterprise having a need to manage rich media content will be able to utilize in an affordable and highly secure environment. We had 61 full time employees as of December 30, 2005. Our operations are organized in two main operating groups: o Digital Asset Management Group o Webcasting Group Our Digital Asset Management Group, which operates primarily from facilities in San Francisco, California, provides digital asset management services. Digital asset management is a set of coordinated technologies and processes that allow the quick and efficient storage, retrieval, and reuse of the digital files that are essential to all businesses. These digital files include photos, videos, audio files, engineering specs, architectural plans, web pages, and many other pieces of business collateral. In addition, the Digital Asset Management Group services include providing connectivity within the entertainment and advertising industries through its private network, which encompasses production and post-production companies, advertisers, producers, directors, and talent. 17 The Webcasting Group provides an array of corporate-oriented, web-based media services to the corporate market including live audio and video Webcasting and on-demand audio and video streaming for any business, government or educational entity. Our Webcasting Group also includes our travel production and distribution operations, which produces Internet-based multi-media streaming videos related to hotels, resorts, time-shares, golf facilities, and other travel destinations. For segment information related to the revenue and operating income of these groups, see Note 7 to the Consolidated Financial Statements. Revenue Recognition Revenues from recurring service are recognized when (i) persuasive evidence of an arrangement exists between us and the customer, (ii) the good or service has been provided to the customer, (iii) the price to the customer is fixed or determinable and (iv) collectibility of the sales prices is reasonably assured. Our Digital Asset Management Group recognizes revenues from the acquisition, editing, transcoding, indexing, storage and distribution of its customers' digital media. A customer's charges are generally based on the activity or volume of such media, expressed in megabytes or similar terms, and are recognized at the time the service is performed. Fees charged to customers for customized applications or set-up are recognized as revenue at the time the application or set-up is completed. Network usage and bridging revenue based on the timing of the customer's usage of those services. Revenue from the sale of equipment is recognized when the equipment is installed. Leases of equipment to customers are generally short-term and cancellable and therefore accounted for as operating leases and the rental revenue from leases is recognized ratably over the life of the lease. Our Webcasting group recognizes revenue from live and on-demand webcasting at the time an event is accessible for streaming over the Internet. Travel production revenue is recognized at the time of completion of the related video or website. Travel distribution revenue is recognized. when a user watches a video on the Internet, if charged on a per hit basis, or over the term of the contract, if charged as a fixed monthly fee. Results of Operations Our consolidated net loss for the year ended September 30, 2005 was approximately $9.6 million ($1.17 loss per share) as compared to a loss of approximately $4.0 million ($0.92 loss per share) for the prior year, an increase of approximately $5.6 million (143%). The additional net loss for the year ended September 30, 2005, as compared to the prior year, related primarily to increases in non-cash interest expense arising from (i) the Financing Transactions, including the write-off of unamortized discount arising from early debt repayments with those proceeds as well as subsequent conversions and (ii) a penalty related to unregistered shares from a previous financing, as well as increases in operating expenses, primarily compensation arising from the Onstream Merger and the Virage acquisition (Digital Asset Management) and expenses for marketing and financial consulting services, including amounts paid under severance agreements, paid for primarily with common shares and options. Although the net loss increased by approximately 143%, it only increased by approximately 27% on a per share basis, due to the approximately 3.9 million, or approximately 90%, increase in the weighted average number of common shares outstanding in the 2005 period as compared to the 2004 period. 18 The following table shows, for the periods presented, the percentage of revenue represented by items on our consolidated statements of operations. PERCENTAGE OF REVENUE Year Ended September 30, 2005 2004 ---------- ---------- Revenue: Digital asset management 24.1% 15.3% Network usage and services 25.1 28.2 Network equipment sales and rentals 5.6 8.7 Webcasting 42.6 44.5 Travel production and distribution 2.6 3.3 ---------- ---------- Total revenue 100.0% 100.0% ---------- ---------- Cost of revenue: Digital asset management 7.8 4.1 Network usage and services 14.6 14.4 Network equipment sales and rentals 2.4 5.2 Webcasting and related equipment 12.3 12.6 Travel production and distribution 0.9 0.4 ---------- ---------- Total costs of revenue 38.0% 36.7% ---------- ---------- Operating expenses: General administrative: Compensation 58.6 52.2 Professional fees 34.6 14.6 Other 19.4 19.8 Impairment loss on goodwill 4.0 6.2 Depreciation and amortization 14.1 18.1 ---------- ---------- Total operating expenses 130.7% 110.9% ---------- ---------- Loss from operations (68.7)% (47.6)% ---------- ---------- Other income (expense): Interest income 0.1 0.1 Interest expense (49.2) (7.9) Other income (expense), net (0.3) 3.0 ---------- ---------- Total other expense, net (49.4) (4.8) ---------- ---------- Net loss (118.1)% (52.4)% ========== ========== 19 The following table is presented to illustrate our discussion and analysis of our results of operations and financial condition. This table should be read in conjunction with the consolidated financial statements and the notes therein.
For the year ended September 30, Increase (Decrease) ---------------------------- ---------------------------- 2005 2004 Amount Percent ------------ ------------ ------------ ------------ Total revenue $ 8,156,394 $ 7,578,888 $ 577,506 7.6% Total costs of revenue 3,102,860 2,783,147 319,713 11.5% ------------ ------------ ------------ ------------ Gross margin 5,053,534 4,795,741 257,793 5.4% ------------ ------------ ------------ ------------ General and administrative expenses 9,178,309 6,559,025 2,619,284 39.9% Impairment loss on goodwill 330,000 470,000 (140,000) (29.8)% Depreciation and amortization 1,152,633 1,373,587 (220,954) (16.1)% ------------ ------------ ------------ ------------ Total operating expenses 10,660,942 8,402,612 2,258,330 26.9% ------------ ------------ ------------ ------------ Loss from operations (5,607,408) (3,606,871) 2,000,537 55.5% Other expense (4,030,480) (365,795) 3,664,685 1,001.8% ------------ ------------ ------------ ------------ Net loss $ (9,637,888) $ (3,972,666) $ 5,665,222 142.6% ============ ============ ============ ============
Revenues and Gross Margin Consolidated operating revenue increased approximately $578,000 (8%), as compared to the prior year, to approximately $8.2 million for the year ended September 30, 2005. This increase was primarily due to revenues of the Digital Asset Management Group. We recorded approximately $2.0 million of revenues from digital asset management services during the year ended September 30, 2005, as compared to approximately $1.2 million in the prior year. These operations commenced in February 2004 and therefore had no related revenues for a significant portion of the same period of the prior year. Revenue from network equipment sales and rentals, also part of the Digital Asset Management Group, decreased approximately $202,000 (31%), as compared to the prior year, to approximately $458,000. We have reduced our sales focus on this lower margin area and are currently evaluating our future involvement in this activity, as part of the reorganization of our sales function discussed below. Revenues from network usage and services, also part of the Digital Asset Management Group, decreased approximately $88,000 (4%), as compared to the prior year, to approximately $2,049,000, due to variations in customer usage. Although the decrease in the fourth quarter of fiscal 2005 over the corresponding period was more than the total decrease for the first three quarters, this was due to an unusually strong fourth quarter in fiscal 2004 and we expect future network usage and services revenues to continue to be approximately equal to the revenues in the corresponding period of the prior year, until such revenues begin to increase as a result of the marketing and sales of the DMSP to this customer base, although such increase cannot be assured. We expect the revenues of the Digital Asset Management Group to continue to exceed the corresponding prior year to date amounts in fiscal 2006, although such increase cannot be assured. This is because we expect to see increased sales in this group, including network usage and services revenues as discussed above, arising from the marketing of the DMSP and related products. We also anticipate increased digital asset management services revenues in fiscal 2006 arising from the signing of new customers for customized application and set-up 20 work, as well as ongoing processing, although such increase cannot be assured. Webcasting revenues increased approximately $97,000 (3%), as compared to the prior year, to approximately $3.5 million for the year ended September 30, 2005, primarily due to continuing growth in sales of higher priced video webcasts. Although the number of webcasts produced decreased to approximately 4,800 webcasts for the year ended September 30, 2005 compared to approximately 6,400 webcasts for the prior year, the average revenue per webcast event increased to approximately $701 for fiscal 2005 period compared to approximately $525 for the comparable 2004 period. We expect the revenues of the Webcasting Group to continue to exceed the corresponding prior year to date amounts in fiscal year 2006, although such increase cannot be assured. This is as a result of our focus on building sales in the higher per-event priced product segment that capitalizes on our proprietary feature set, including slides, chat, polling and streaming video solutions. In addition, we are continuously upgrading our webcasting software and hardware infrastructure, allowing us to introduce new features to the market on an ongoing basis. We are also currently developing the next generation of our Webcasting platform, which we expect to introduce by the end of fiscal year 2006. See Liquidity and Capital Resources below. Consolidated gross margin increased approximately $258,000 (5%), as compared to the prior year, to approximately $5.1 million for the year ended September 30, 2005. This increase was primarily due to the gross margin on the revenues from digital asset management services, which commenced in February 2004. Based on our expectations of increasing sales discussed above, we expect gross margin to also continue increasing, as compared to the corresponding prior year amounts, for fiscal year 2006, although such increase cannot be assured. We began a reorganization of our sales function in April 2005, which included changes in personnel and changes in compensation amounts and methods. Our CEO will directly supervise the sales function until the reorganization is satisfactorily completed, which we expect to result in better sales results from better targeting of receptive markets for our products and services and from the implementation and/or improved execution of the methods and techniques used by our sales force. Operating Expenses Consolidated operating expenses for the year ended September 30, 2005 increased approximately $2.3 million (27%), as compared to the prior year, to approximately $10.7 million primarily from increased compensation and professional fees expense, offset by reduced expenses for depreciation and impairment loss on goodwill. Compensation expense for the year ended September 30, 2005 increased approximately $826,000 (21%), as compared to the prior year, resulting from an increase in headcount necessary to service increased business primarily as a result of the Onstream Merger and the Virage acquisition (Digital Asset Management), as well as to build our sales and management infrastructure for planned future growth, although we cannot assure that such growth will occur. At September 30, 2005 we had 61 full time employees as compared to 58 full time employees at September 30, 2004. Although the total net headcount did not change significantly from the beginning to the end of fiscal 2005, the addition of five executives during that period accounted for an increase in compensation expense of approximately $500,000. Another approximately $100,000 was related to wages and severance paid to our prior CFO while we were also paying our new CFO. We expect that during fiscal 2006 that this expense will continue to exceed the corresponding prior year period as a result of the growth in our webcasting and digital asset management operations. Professional fees increased approximately $1.7 million (155%), as compared 21 to the prior year, primarily due to expenses for marketing and financial consulting services, including amounts paid under certain executive severance agreements, primarily paid for by the issuance of our common stock and options to buy our common stock. This non-cash portion increased by approximately $1.2 million to approximately $1.8 million the year ended September 30, 2005, from approximately $646,000 in the comparable period of the previous year. In addition, accounting and legal costs increased by $191,000, to approximately $392,000 for the year ended September 30, 2005, from approximately $201,000 in the comparable period of the previous year, primarily related to costs associated with several SEC filings, including a proxy statement and a registration statement as well as increased audit and quarterly review costs. We have entered into several consulting contracts that have resulted or will result in the issuance of common shares and options to purchase common shares, in addition to cash payments. Including contracts entered into after September 30, 2005, these contracts will result in future professional fee expenses of approximately $1.6 million recognized during fiscal year 2006. Based on this, as well as expected increased expenditures associated with Sarbanes-Oxley compliance and marketing programs, we expect continued increases in professional fee expenses for fiscal year 2006 as compared to the corresponding prior year amounts. The impairment loss on goodwill was $330,000 for the year ended September 30, 2005, as compared to a $470,000 loss for the prior year. The expense in both years was necessary to adjust the carrying value of the intangible assets arising from the 2001 acquisition of EDNet to fair value, based on our evaluation of projected cash flows from the EDNet operations as well as market values of independent comparable companies. We were assisted by an independent third party appraiser in calculating this adjustment, based on SFAS 142. As a result of the decline in EDNet's sales for fiscal 2005 as compared to fiscal 2004, the valuation assigned to EDNet's goodwill declined from the adjusted fiscal 2004 value and a second write-down was considered necessary in fiscal 2005. We also evaluated the September 30, 2005 carrying value of the intangible assets arising from the 2002 acquisition of MOD and determined that no adjustment was necessary. A similar evaluation as of September 30, 2004 resulted in no adjustment to that amount. Depreciation and amortization decreased approximately $221,000 (16%) for the year ended September 30, 2005, as compared to the prior year, due to assets in service becoming fully depreciated. We will experience a significant increase in depreciation expense in fiscal 2006 as a result of the DMSP being placed in service. Other Expense Other expense increased to approximately $4.0 million for the year ended September 30, 2005, as compared to approximately $366,000 for the comparable period of the previous year, an increase of approximately $3.7 million (1002%). This increase is primarily due to an increase in interest expense of approximately $3.4 million. The approximately $3.4 million increase in interest expense for the year ended September 30, 2005, as compared to the prior year, is primarily due to approximately $2.1 million representing discount amortization and interest expense on the 8% Convertible Debentures and the Additional 8% Convertible Debentures, including the effect of conversions; approximately $944,000 for a non-cash penalty (payable in common shares) we incurred as a result of a delay in registering shares issued in a previous financing and approximately $494,000 from the write-off of unamortized discount due to early debt repayments. As a result of the sale of 8% Convertible Debentures in December 2004 and the sale of the Additional 8% Convertible Debentures in February and April 2005, and after giving effect to conversions through June 30, 2005, we have recorded unamortized debt discounts of approximately $2.6 million on our September 30, 2005 balance sheet. In the event of redemption or conversion of the remaining outstanding balance of these debts before the end of their four-year term, we would write off the unamortized portion of the related debt discount to interest 22 expense at that time. Accordingly, conversions of approximately $170,000 occurring after September 30, 2005 will result in the write-off to expense of approximately $136,000 unamortized debt discount during the three months ending December 31, 2005. As of result of registering the shares from a previous financing on June 29, 2005, we will not incur additional penalty interest expense after that date. As a result of the Onstream Merger, we no longer recognize a portion of the results of Acquired Onstream on an equity basis. However, as a result of the Onstream Merger, we are incurring increased operating expenses of approximately $200,000 per quarter, primarily contracted salaries and related employee expenses, which began in the three months ended March 31, 2005. Liquidity and Capital Resources The independent auditor's report on our current financial statements states that we have suffered significant recurring losses from operations since inception that raise substantial doubt about our ability to continue as a going concern. At September 30, 2005 we had a working capital deficit of approximately $2.8 million, which reflects the Financing Transactions and the Onstream Merger. This working capital deficit balance includes $605,000 of prepaid expenses, primarily consulting fees paid with equity and which will be expensed in future periods over the remaining lives of the applicable consulting agreements. This working capital deficit balance also includes $151,000 of accounts payable for equipment purchases that was settled with the issuance of our common stock in January 2006 and a liability of approximately $2.3 million related to detachable warrants and embedded conversion features that we do not currently anticipate paying and may never be paid, although there is no assurance of this. On December 23, 2004, we received gross financing proceeds of $6.5 million from the sale of Series A-10 and 8% Convertible Debentures, out of which we paid approximately $700,000 in related fees and expenses. In addition, all promissory notes and convertible preferred shares outstanding as of September 30, 2004 (and as of the date of the new financing) were satisfied by cash payments of approximately $2.9 million, plus issuance of 239,650 shares of Series A-10 and warrants to purchase 500,000 of our common shares for $1.50 per share. Also, we paid approximately $1.3 million to satisfy certain obligations of Acquired Onstream, which included the balance due on their note to Virage guaranteed by us. After these payments, approximately $1.5 million of cash remained, which was used to satisfy existing deferred accounts payable of approximately $600,000 and to fund certain capital expenditures and operating losses. In February and April 2005, additional investment rights were exercised, resulting in the issuance of Additional 8% Convertible Debentures, which included common stock purchase warrants, for gross proceeds of $2,175,000. In connection with the exercise of these additional investment rights, our ability to borrow additional funds senior or equal in priority to the 8% Convertible Debentures was limited to $1.5 million incurred solely for the purchase of equipment or software used in our business and collateralized only by that equipment or software. The funds from the exercise of these rights were used to fund certain capital expenditures and operating losses. During August and September 2005 we borrowed $600,000 collateralized by previously purchased hardware and software. During October and November 2005, we borrowed an additional $450,000 collateralized by previously purchased hardware and software. We have an unfulfilled commitment from one of these lenders for additional financing of $300,000 collateralized by previously purchased hardware and software. Out of this total financing of $1,350,000, $750,000 is payable over five years and may be repaid at our option in the form of Series A-10 Preferred Stock, with the consent of required security holders. Of the remaining $600,000 financing, repayment of $300,000 is due by March 1, 2006 and $300,000 by August 19, 2006. There is no assurance that we will have the funds available to make these payments as scheduled. The holders of the 8% Convertible Debentures, the Additional 8% Convertible Debentures and the Series A-10 Preferred Stock may be entitled to certain rescission rights. The resale registration statement of shares of common stock underlying these securities and the related warrants was originally filed by the Company on February 23, 2005. Pursuant to the Securities Act of 1933 and the related rules and regulations, as interpreted by the Securities and Exchange 23 Commission, as a result of a portion of the additional investment rights granted with the 8% Convertible Debentures, which were the basis of the sale of the Additional 8% Convertible Debentures, being unexercised at the time the resale registration statement was originally filed, the private offerings have not been completed and accordingly, the public and private offerings would be integrated and result in a violation of Section 5 of the Securities Act. Accordingly, the investors who purchased the private placement securities may have a number of remedies available to them, including the potential right to rescind the purchase of those securities plus, potentially, any amount representing damage to such investors. The Company is unable to predict if the investors would attempt to exercise such potential rescission rights. Each investor's decision would be based upon, among other things, a decline in the price of the Company's common stock and other factors. These potential rescission rights would require the Company to refund at least the gross proceeds of these private offerings to the investors. In order to satisfy such potential obligations, the Company would be required to utilize our available capital resources and obtain alternate sources of capital for such purposes. The Company presently does not have the capital available to satisfy all potential claims for rescission. The inability to obtain alternative sources of capital would have a material effect on the Company's financial condition and results of operations. For purposes of accounting for this contingency in accordance with Statement of Financial Accounting Standards 5, "Accounting for Contingencies", the Company's management has evaluated the above factors and has determined that the ultimate liability to the company from the potential assertion by investors of rescission rights is not probable, although it is possible. This conclusion is based on management's determination that the factors and/or conditions that would encourage an attempt to assert such rights are significantly outweighed by the factors and/or conditions that would discourage an attempt to assert such rights. As of September 30, 2005, and prior to giving effect to the accounting for this potential rescission, our balance sheet reflected a liability, net of discount, of approximately $1.2 million associated with the 8% Convertible Debentures and the Additional 8% Convertible Debentures. The remainder of the proceeds arising from these securities, including the portion of the additional investment rights exercised through that date, and the Series A-10 Preferred Stock, including dividends and interest paid in kind, was approximately $10.4 million and was classified as part of stockholders' equity at that date. In order to recognize this potential rescission on our balance sheet as of September 30, 2005, the approximately $10.4 million was reclassified under the caption "Equity Securities Subject to Potential Rescission", which is located directly above the stockholders' equity section, but not included in it. As of December 31, 2005, fifteen individual investors had converted 8% Convertible Debentures of $2,875,000 and 61,969 shares of Series A-10 Preferred Stock to ONSM common shares. This represents approximately $3,565,000 of the amounts included in "equity securities subject to potential rescission" as of September 30, 2005. An additional approximately $1,375,000 of the September 30, 2005 balance of "equity securities subject to potential rescission" represents the securities owned but not converted by these fifteen individual investors. The Company has not yet determined the effect of these conversions on the potential rescission rights. As of September 30, 2004, we owned preferred shares of Curaspan, Inc. with an original cost of approximately $108,000, which was fully reserved since 2002 as a result of Curaspan's continuing operating losses and negative financial condition. However, on August 5, 2005 we sold those preferred shares to Curaspan for $50,000 cash and a $150,000 note from Curaspan, payable over 2 years at 6% interest. The note is collateralized by Curaspan's assets, subordinate to a lending bank's interest in certain of those assets. In addition, the preferred shares are being held in escrow and will be returned to us in the event of Curaspan's uncured default under the note. All scheduled payments have been made through January 4, 2006. 24 We have incurred losses since our inception and our operations have been financed primarily through the issuance of equity and debt. Our accumulated deficit was approximately $70.4 million at September 30, 2005. Our future working capital requirements depend primarily on the rate at which we can decrease our use of cash to fund operations, which is in turn dependent on an increase in our revenues. Cash used for operations will be affected by numerous known and unknown risks and uncertainties including, but not limited to, our ability to successfully market and sell the DMSP, market our other existing products and services, the degree to which competitive products and services are introduced to the market, and our ability to control overhead expenses as we grow. As a result of the Onstream Merger, we have increased our operating expenses by approximately $200,000 per quarter, starting in the quarter ended March 31, 2005, which are primarily attributable to contracted salaries and related employee expenses. In addition, as part of expanded marketing and financial management programs, neither of which is guaranteed to be successful, we have entered into several consulting contracts that will result in the issuance of common shares and options to purchase common shares, in addition to cash payments. Including contracts entered into after September 30, 2005, these contracts will result in future cash payments of approximately $249,000 over the next twelve months, not including amounts payable with common shares and options. We also expect increases in our operating expenses during the next year arising from a Sarbanes-Oxley 404 compliance program, although we cannot guarantee that this program will be successful and we may be able to defer these expenses based on the status of regulatory changes in this area. We also anticipate additional operating expenses in the coming year related to the continuation of our marketing program expansion that began in the year ended September 30, 2005, although we cannot guarantee that this expansion will be implemented or that our marketing efforts will be successful. We have spent $2.2 million for capital expenditures during the year ended September 30, 2005, including approximately $400,000 for capital expenditures incurred by Acquired Onstream but paid for by us after the Onstream Merger. Projected capital expenditures for the next twelve months total $900,000, which includes the further development of the recently completed DMSP as well as completion of the upgrade to the webcasting software and hardware infrastructure, now in process. We have recently hired several professionals that were previously employed with SAIC, including a new Chief Technology Officer, and accordingly expect an increasing percentage of our future development costs to be capitalized employee salaries and benefits, which are included in the anticipated capital expenditure amounts noted above. Other than working capital which may become available to us through the fulfillment of the outstanding equipment financing commitment or through the payments on the Curaspan note, as discussed above, and/or the exercise of outstanding options and warrants, we do not presently have any additional sources of working capital other than cash on hand and cash, if any, generated from operations. There are no assurances whatsoever that the outstanding equipment financing commitment will be fulfilled, that we will collect any further payments due from Curaspan under the note, that any options or warrants will be exercised, or that we will increase our revenues to a level sufficient to provide positive cash flow. Although our revenues for fiscal 2005 exceeded revenues for the previous fiscal year, we cannot assure that our revenues will continue to increase, nor can we assure that they will not decrease. We recently completed the DMSP and placed it in initial service with third-party customers in November 2005, but we cannot assure what the sales activity will be. As long as our cash flow from operations remains insufficient to completely fund operations, we will continue depleting our cash and other financial resources. As a result of the uncertainty as to our available working capital over the upcoming months, including the effect if any of the potential rescission rights discussed above, 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 25 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. Cash used in operating activities was approximately $1.9 million for the year ended September 30, 2005, as compared to approximately $1.1 million for the same period last year. The $1.9 million reflects our net loss of approximately $9.6 million, reduced by approximately $7.3 million of non-cash expenses included in that loss and approximately $459,000 arising from a net decrease in non-cash working capital items during the period. The primary non-cash expenses included in our loss for the year ended September 30, 2005 were approximately $2.6 million of amortization of discount on debentures and notes payable, including amounts arising from early debt repayment, approximately $1.8 million of amortization of deferred professional fee expenses, including severance, paid for by issuing stock and options, approximately $1.2 million of depreciation and amortization, approximately $944,000 for a non-cash financing penalty paid in common shares, approximately $453,000 for interest expense paid in common and preferred shares, $330,000 for impairment loss on goodwill and approximately $100,000 representing our loss on an equity basis from Acquired Onstream. 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. Net cash used in investing activities was approximately $3.8 million for the year ended September 30, 2005 as compared to approximately $1.4 million for the same period last year. The $3.8 million includes approximately $1.5 million for advances to Acquired Onstream, primarily payments (i) to Virage for principal and interest due on a promissory note of Acquired Onstream and guaranteed by the Company and (ii) to certain selling management of Acquired Onstream for accrued salaries and related employer taxes, as well as cash payments associated with the Onstream Merger of approximately $664,000, including subsequent payment of accounts payable assumed at the time of the Onstream Merger. In addition, we spent approximately $1.7 million to acquire property and equipment, including amounts paid toward the ultimate completion of the DMSP and equipment used to support those operations. Cash flows provided by financing activities was approximately $5.7 million for the year ended September 30, 2005 as compared to approximately $2.4 million for the same period last year. This $5.7 million primarily reflects the proceeds from the Financing Transactions of approximately $8.1 million (net of fees and other direct costs), offset by approximately $3.2 million for the repayment, primarily from those proceeds, of all other outstanding debt and preferred shares. This amount also includes approximately $750,000 of proceeds from other financings and $200,000 released from restricted cash, which was used to repay debt. 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 26 those that are both most important to the management's most subjective judgments. The Company's most critical accounting policies and estimates are described as follows. Our prior acquisitions of several businesses, including the Onstream Merger, have resulted in significant increases in goodwill and other intangible assets. Unamortized goodwill and other intangible assets, which includes acquired customer lists, were approximately $10.6 million at September 30, 2005, representing approximately 61% of our total assets and 348% of the book value of shareholder equity (after reduction for equity securities subject to potential rescission). In addition, property and equipment as of September 30, 2005 includes approximately $3.5 million related to the DMSP. In accordance with GAAP, the Company periodically tests these assets for potential impairment. As part of our testing, we rely on both historical operating performance as well as anticipated future operating performance of the entities that have generated these intangibles. Factors that could indicate potential impairment include a significant change in projected operating results and cash flow, a new technology developed and other external market factors that may affect our customer base. We will continue to monitor our intangible assets and our overall business environment. If there is a material change in our business operations, the value of our intangible assets, including the DMSP, could decrease significantly. In the event that it is determined that we will be unable to successfully market or sell the DMSP, an impairment charge to our statement of operations could result. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition and results of operations. We have estimated the fair value of warrants issued in conjunction with the Financing Transactions, plus the potential value arising from a beneficial conversion feature included in the terms of those financings, and recorded this estimate, along with the direct costs associated with that financing, as a discount to the face amount of the financing. The unamortized portion of this discount as of September 30, 2005 is approximately $2.1 million for the Series A-10 and approximately $2.6 million for the 8% Convertible Debentures and the Additional 8% Convertible Debentures. These non-cash amounts will be amortized as dividends and as interest expense over the balance of the four-year financing terms, although any unamortized portion will be immediately expensed at the time of a conversion or redemption occurring before the end of those terms. Accordingly, conversions of approximately $170,000 occurring after September 30, 2005 will result in the write-off to expense of approximately $136,000 unamortized debt discount during the three months ending December 31, 2005. ITEM 7. FINANCIAL STATEMENTS Our financial statements are contained in pages F-1 through F-42, which appear at the end of this annual report. 27 ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 8A. CONTROLS AND PROCEDURES As required by Rule 13a-15 under the Securities Exchange Act of 1934, as of the end of the period covered by the annual report, being September 30, 2005, we have carried out an evaluation of the effectiveness of the design and operation of our company's disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our company's management, including our company's President along with our company's Chief Financial Officer. Based upon that evaluation, our company's President along with our company's Chief Financial Officer concluded that our company's disclosure controls and procedures are effective. Based upon that evaluation, no change in our company's internal controls over financial reporting has occurred during the quarter then ended, which has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Disclosure controls and procedures and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time period specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934 is accumulated and communicated to management including our President and Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure. ITEM 8B. OTHER INFORMATION None. 28 PART III ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT Executive Officers and Directors Our executive officers and directors, and their ages are as follows: Name Age Position ---- --- -------- Randy S. Selman 49 Chairman of the Board, President and Chief Executive Officer Clifford Friedland 54 Vice Chairman of the Board, Senior Vice President Business Development Alan M. Saperstein 46 Director, Chief Operating Officer and Treasurer David Glassman 54 Senior Vice President and Chief Marketing Officer Robert E. Tomlinson 48 Senior Vice President and Chief Financial Officer Benjamin Swirsky (1)(2)(3)(4) 64 Director Robert J. Wussler (1)(2)(3)(4) 69 Director Charles C. Johnston (1)(3) 70 Director General Ronald W. Yates(1)(2)(3)(4) 67 Director (1) Member of the Compensation Committee. (2) Member of the Audit Committee. (3) Member of the Governance and Nominating Committee. (4) Member of the Finance Committee. Randy S. Selman. Since our inception in May 1993, Mr. Selman has served as our Chief Executive Officer, President, and a director and from September 1996 through June 1999 and from August 1 through December 15, 2004, as our Chief Financial Officer. From March 1985 through May 1993, Mr. Selman was Chairman of the Board, President and Chief Executive Officer of SK Technologies Corporation (Nasdaq:SKTC), a publicly-traded software development company. SKTC develops and markets software for point-of-sale with complete back office functions such as inventory, sales analysis and communications. Mr. Selman founded SKTC in 1985 and was involved in their initial public offering in 1989. Mr. Selman's responsibilities included management of SKTC, public and investor relations, finance, high level sales and general overall administration. Alan M. Saperstein. Mr. Saperstein has served as our Executive Vice President, Treasurer and a director since our inception in May 1993, and has been our Chief Operating Officer since December 2004. Mr. Saperstein also serves as an alternate member of the Compensation Committee of the board of directors. From March 1989 until May 1993, Mr. Saperstein was a free-lance producer of video film projects. Mr. Saperstein has provided consulting services for corporations that have set up their own sales and training video departments. From 1983 through 1989, Mr. Saperstein was the Executive Director/Entertainment Division of NFL Films where he was responsible for supervision of all projects, budgets, screenings and staffing. Clifford Friedland. Mr. Friedland was appointed as a member of our board of directors in December 2004. From June 2001 until the closing of the Onstream Merger in December 2004 he had served as Chairman, CEO and co-founder of privately held Onstream Media Corporation. Mr. Friedland was Vice President of Business Development and co-founder of TelePlace, Inc., a developer and owner of 29 internet data centers and central offices from December 1999 to May 2001. Mr. Friedland was co-founder, Chairman and co-CEO of Long Distance International, Inc., one of the first competitive European telephone operators from May 1993 to December 1999. Mr. Friedland was President of Clifford Friedland Inc., a technology consulting firm, from January 1991 to April 1993. Mr. Friedland was a Director and co-founder of Action Pay-Per-View, a pay per view cable channel from January 1988 to December 1990. Mr. Friedland was President and co-founder of Long Distance America, one of the first competitive long distance operators after the breakup of AT&T from June 1984 to December 1987. Mr. Friedland was Vice President and co-founder of United States Satellite Systems, Inc., an FCC licensed builder and operator of geosynchronous communications satellites from April 1981 until December 1983. Mr. Friedland was Director and co-founder of United Satellite Communications, Inc., the world's first direct-to-home satellite network from April 1981 until May 1984. Mr. Friedland received a B.B.A. cum laude, from City University of New York. David Glassman. Mr. Glassman has served as our Chief Marketing Officer since December 2004. As described below, at such time as an additional independent director is added to our board, Mr. Glassman will join our board of directors. He served as Vice Chairman, President and co-founder of Acquired Onstream from June 2001 until joining our company. Mr. Glassman was Vice President of Marketing and co-founder of TelePlace, Inc., a developer and owner of internet data centers and central offices from December 1999 to May 2001. Mr. Glassman was co-founder, Vice chairman and Co-CEO of Long Distance International, Inc., one of the first competitive European telephone operators from May 1993 to December 1999. Mr. Glassman was an independent technology consultant from January 1988 to April 1993. Clients included Action Pay Per View. Mr. Glassman was President and co-founder of Long Distance America, one of the first competitive long distance operators after the breakup of AT&T from January 1984 to December 1987. Mr. Glassman was a communications consultant from January 1981 to January 1984 providing services to United States Satellite Systems Inc. and United Satellite Communications Inc. Mr. Glassman was co-founder and director of All American Hero, Inc., from January 1981 until December 1986. Mr. Glassman received a B.S. in Business Management from Florida International University. Robert E. Tomlinson. On December 15, 2004 Mr. Tomlinson was appointed our Chief Financial Officer. Mr. Tomlinson joined us as Vice President-Finance in September 2004. Mr. Tomlinson started his financial and accounting career in 1977 with the international accounting firm of Price Waterhouse. In 1982 he left that firm to join Embraer, an international aircraft manufacturing and support firm, at their U.S. subsidiary in Fort Lauderdale, Florida, where he managed all financial functions and eventually was named Senior Vice President-Finance and a member of the U.S. firm's Board of Directors. Mr. Tomlinson left Embraer in 1994 and joined staffing and human resource firm OutSource International, serving as its Chief Financial Officer and helping to take the company public in 1997. Mr. Tomlinson's areas of responsibility at OutSource International included corporate accounting, treasury and risk management. From when he left OutSource International in February 2000 until 2002 he worked as an independent certified public accountant, focusing on accounting and tax services to corporations. From 2002 until joining us, Mr. Tomlinson served as CFO for Total Travel and Tickets, a Fort Lauderdale based ticket broker. Mr. Tomlinson has held an active Certified Public Accountant license since 1978. Benjamin Swirsky. Mr. Swirsky has been a member of our board of directors since July 1997 and serves on our Audit (as Chairman), Compensation, Governance and Nominating and Finance Committees. Mr. Swirsky is the owner of Beswir Properties Inc., an investment capital company. From June 1993 until January 1998, Mr. Swirsky was President and Chief Executive Officer of Slater Steel, Inc., a publicly-traded company listed on the (Toronto Stock Exchange ("TSE"): SSI) with investments in the steel, steel service, forging, pole-line hardware and trucking industries. Mr. Swirsky was Chairman of P.C.Docs International, Inc., a Canadian publicly-traded company (Nasdaq: DOCSF, TSE: DXX) from 1997-1999. Mr. Swirsky is also a member of the board of directors of Four Seasons Hotel Inc. (NYSE:FS), which owns a chain of first class hotels located 30 throughout the world, and serves on the Audit, Compensation and Governance committees of its Board. Mr. Swirsky also sits on the board of directors of a number of other companies, including (i) CamVec Corp., a Canadian publicly-traded company (CAT.CV), (ii) Commercial Alcohols, Inc., in which he is also a principal shareholder, (iii) Amica Mature Lifestyles, Inc., a Toronto Stock Exchange company, and (iv) Alliance Financial, Inc., a Canadian publicly-traded company where he serves as Chairman. Robert J. Wussler. Mr. Wussler has been a member of our board of directors since July 1999 and serves on our Audit, Compensation, Governance and Nominating and Finance Committees. Mr. Wussler is currently the President of Ted Turner Pictures LLC and is Chairman of the Board of Directors of Team Sports Entertainment, Inc., a publicly-traded company (OTC Bulletin Board:TSPT) that is in the closed-wheel auto racing business. Prior to that, he served as Chairman, Chief Executive Officer and President of U.S. Digital Communications, Inc., a global satellite communications firm. From June 1995 to May 1998, Mr. Wussler was President and Chief Executive Officer of Affiliate Enterprises, Inc., a company formed by ABC Television affiliates to pursue new business opportunities. From 1989 to 1992, he was President and Chief Executive Officer of COMSAT Video Enterprises. From 1980 to 1990, he was Senior Vice President and Chief Operating Officer of Turner Broadcasting System. Mr. Wussler spent 21 years at CBS in various capacities, starting in the mailroom, and served as President of CBS Television and Sports from 1975 to 1978. Charles C. Johnston. Mr. Johnston has been a member of our board of directors since April 2003 and serves on our Compensation, Governance and Nominating and Finance 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. General Ronald W. Yates (Ret.). General Yates, who was appointed as a member of our board of directors in December 2004, was commander, Air Force Materiel Command, Wright-Patterson Air Force Base, Ohio. The Air Force Materiel Command researches, develops, tests, acquires and provides logistics support necessary to keep Air Force units and weapons systems in a state of readiness, and to sustain their operations in peace and war. The command manages these systems from inception on the drawing board through their retirement from the inventory. The Air Force Material Command has 18 specialized centers and 116,000 military and civilian employees around the world. The general entered the Air Force in 1960 upon graduation from the U.S. Air Force Academy. He has served as a test pilot, program manager for a variety of weapons systems, commander of a test wing and as commander of Air Force Systems Command. There is no family relationship between any of the executive officers and directors. Each director is elected at our annual meeting of shareholders and holds office until the next annual meeting of shareholders, or until his successor is elected and qualified. At present, our bylaws provide for not less than two directors. The bylaws permit the board of directors to fill any vacancy and such director may serve until the next annual meeting of shareholders or until his successor is elected and qualified. The board of directors elects officers annually and their terms of office are at the discretion of the Board. Our officers devote full time to our business. Expansion of our board of directors Rule 4350(c) of the Nasdaq Marketplace Rules to which we are subject requires that a majority of the members of our board of directors are independent as defined in Rule 4200 of the Nasdaq Marketplace Rules. Under the terms of the purchase and sale agreement for our Series A-10 Convertible 31 Preferred Stock the purchasers have the right to designate one individual to join our board of directors. As of the date hereof, no individual has been designated. At such time as such individual is designated and elected to our board, and providing that the individual is an independent director, as defined in Rule 4200 of the Nasdaq Marketplace Rules, Mr. David Glassman will also join our board of directors. Directors' Compensation Directors who are not our employees received $3,750 per quarter as compensation for serving on the board of directors, as well as reimbursement of reasonable out-of-pocket expenses incurred in connection with their attendance at board of directors' meetings. As of January 7, 2006, we had accrued but not yet paid board fees for past services of approximately $30,000. 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, 2005 members of our board of directors held outstanding options to purchase an aggregate of 3,542,482 shares of our common stock at prices ranging from $1.12 to $22.50 per share. On December 15, 2004 a majority of our shareholders voted to approve the cancellation (subject to the option holder's approval) of these stock option grants, with such options to be re-issued six months and one day from the date of cancellation with an exercise price equal to the fair market value on the date of the reissue. On December 15, 2004 a majority of our shareholders voted additional compensation to our directors for the closing of the Onstream Merger. Accordingly, each of the directors listed below have received immediately exercisable five-year options to purchase shares of our common stock with an exercise price of $1.57 per share (fair market value on the date of issuance) in the amounts set forth below. These options were issued outside of our 1996 Stock Option Plan: Name No. of Shares (1) ---- ----------------- Randy S. Selman (1) 450,000 Alan M. Saperstein (1) 450,000 Benjamin Swirsky 100,000 Robert J. Wussler 100,000 Charles C. Johnston 100,000 ----------------- 1,200,000 ================= (1) Excludes non-Plan options to purchase 400,000 shares of our common stock with an exercise price of $2.50 per share (above fair market value on the date of issuance) that were issued as additional compensation under the new employment agreements each of Messrs. Selman and Saperstein executed following the closing of the Onstream Merger. In December 2004, we issued immediately exercisable four-year Plan options to purchase 50,000 shares of our common stock with an exercise price of $1.57 per share (fair market value on the date of issuance) granted to General Ronald W. Yates upon his initial appointment to our board of directors. 32 In July 2005 we issued immediately exercisable five-year Plan options to purchase 1,300,000 shares of our common stock with an exercise price of $1.12 per share (fair market value on the date of issuance), allocated as follows: Name No. of Shares ---- ------------- Randy S. Selman 450,000 Alan M. Saperstein 450,000 Benjamin Swirsky 100,000 Robert J. Wussler 100,000 Charles C. Johnston 100,000 Ronald W. Yates 100,000 ------------- 1,300,000 ============= Audit Committee The Audit Committee of the Board of Directors is responsible for the engagement of our independent public accountants, approves services rendered by our accountants, reviews the activities and recommendations of our internal audit department, and reviews and evaluates our accounting systems, financial controls and financial personnel. The Board has previously adopted a charter for the Audit Committee. Pursuant to the requirements of the Securities and Exchange Commission which requires that we provide our shareholders with a copy of the Audit Charter at least once every three years, we have included a copy of the Audit Charter as Appendix C to our proxy statement filed with the SEC on November 14, 2004. The Audit Committee is presently composed of Messrs. Swirsky, Wussler and General Yates. Mr. Swirsky is Chairman of the Audit Committee. Each member of the Audit Committee is independent, as independence for audit committee members is defined in the listing standards of The Nasdaq Stock Market, Inc., and each of Messrs. Swirsky and Wussler is an "audit committee financial expert" within the meaning of the applicable regulations of the Securities and Exchange Commission promulgated pursuant to the Sarbanes-Oxley Act of 2002. Compensation Committee The Compensation Committee establishes and administers our executive compensation practices and policies, reviews the individual elements of total compensation for elected officers and recommends salary adjustments to the board of directors. In addition, the Compensation Committee administers our 1996 Stock Option Plan and determines the number of performance shares and other equity incentives awarded to elected officers and the terms and conditions of which they are granted, amends compensation plans within the scope of the Compensation Committee's authority and recommends plans and plan amendments to the board, sets company policy for employee benefit programs and plans and oversees administration of employee retirement plans and various other benefit plans as we may establish from time to time. The Compensation Committee consists of Messrs. Swirsky, Wussler, Johnston and Yates. 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, 33 *customer financing activities, business and related customer finance business and funding plans, *overall company risk management program and major insurance programs, and *investment policies, administration and performance of the trust investments of our employee benefit plans. Messrs. Swirsky, Wussler, and Yates are the members of the Finance Committee. Governance and Nominating Committee The Governance and Nominating Committee reviews and makes recommendations to the board of directors with respect to: *the responsibilities and functions of the board and board committees and with respect to board compensation, *the composition and governance of the board, including recommending candidates to fill vacancies on, or to be elected or re-elected to, the board, *candidates for election as Chief Executive Officer and other corporate officers, and *monitoring the performance of the Chief Executive Officer and our plans for senior management succession. The consideration of any candidate to become a member of our board of directors will be based on the board's assessment of the individual's background, skills and abilities, and if such characteristics qualify the individual to fulfill the needs of the board at that time. The board does not assign any particular weight or priority to any particular factor it may consider. Candidates for director may be identified by management, other directors or advisors to our company. The board of directors may employ an executive search firm to assist it in future searches for board candidates. Messrs. Swirsky, Wussler, Johnston and Yates are the members of the Governance and Nominating Committee. Code of Ethics Effective December 18, 2003, our board of directors adopted a Code of Business Conduct and Ethics that applies to, among other persons, our President (being our principal executive officer) and our Chief Financial Officer (being our principal financial and accounting officer), as well as persons performing similar functions. As adopted, our Code of Business Conduct and Ethics sets forth written standards that are designed to deter wrongdoing and to promote: * honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships; * full, fair, accurate, timely, and understandable disclosure in reports and documents that we file with, or submit to, the Securities and Exchange Commission and in other public communications made by us; * compliance with applicable governmental laws, rules and regulations; * the prompt internal reporting of violations of the Code of Business Conduct and Ethics to an appropriate person or persons identified in the Code of Business Conduct and Ethics; and * accountability for adherence to the Code of Business Conduct and Ethics. 34 Our Code of Business Conduct and Ethics requires, among other things, that all of our company's personnel shall be accorded full access to our President and Chief Financial Officer with respect to any matter that may arise relating to the Code of Business Conduct and Ethics. Further, all of our company's personnel are to be accorded full access to our company's board of directors if any such matter involves an alleged breach of the Code of Business Conduct and Ethics by our President or Chief Financial Officer. In addition, our Code of Business Conduct and Ethics emphasizes that all employees, and particularly managers and/or supervisors, have a responsibility for maintaining financial integrity within our company, consistent with generally accepted accounting principles, and federal, provincial and state securities laws. Any employee who becomes aware of any incidents involving financial or accounting manipulation or other irregularities, whether by witnessing the incident or being told of it, must report it to his or her immediate supervisor or to our company's President or Chief Financial Officer. If the incident involves an alleged breach of the Code of Business Conduct and Ethics by the President or Chief Financial Officer, the incident must be reported to any member of our board of directors. Any failure to report such inappropriate or irregular conduct of others is to be treated as a severe disciplinary matter. It is against our company policy to retaliate against any individual who reports in good faith the violation or potential violation of our company's Code of Business Conduct and Ethics by another. Our Code of Business Conduct and Ethics is filed herewith with the Securities and Exchange Commission as Exhibit 14.1 to this annual report. We will provide a copy of the Code of Business Conduct and Ethics to any person without charge, upon request. Requests can be sent to: Onstream Media Corporation, 1291 SW 29 Avenue, Pompano Beach, Florida 33069. Compliance With Section 16(a) of the Exchange Act Based solely upon a review of Forms 3 and 4 and amendments thereto furnished to us under Rule 16a-3(d) of the Securities Exchange Act of 1934, as amended, during the fiscal year ended September 30, 2005 and Forms 5 and amendments thereto furnished to us with respect to the fiscal year ended September 30, 2005, 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, 2005, other than indicated below: On April 22, 2005 and April 25, 2005, David Glassman, our Senior VP-Marketing, filed Forms 3 and 3/A, respectively, related to his initial holdings in Onstream Media Corporation as a result of the Onstream Merger. In accordance with Section 16 of the Securities Exchange Act of 1934, this filing due date was within 10 days of the applicable event, or January 2, 2005. Clifford Friedland, our Senior VP- Business Development and one of our directors, has not filed a Form 3 on a timely basis, related to his initial holdings in Onstream Media Corporation as a result of the Onstream Merger. Mr. Friedland has represented to us that he will file this form as soon as practicable. Robert Tomlinson, our CFO, filed a Form 4 on April 22, 2005, related to 150,000 stock options granted him on December 15, 2004. In accordance with Section 16 of the Securities Exchange Act of 1934, this filing due date was within 10 days of the applicable event, or December 25, 2004. Mr. Tomlinson has not filed a Form 4 on a timely basis related to the accelerated vesting of those options, which occurred on July 6, 2005, nor the granting of 100,000 additional options to him, which also occurred on July 6, 2005. Mr. Tomlinson has represented to us that he will file these forms as soon as practicable. 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 850,000 options granted each of them on December 23, 2004, nor the accelerated vesting of 400,000 of those options for each of them, which occurred on September 13, 2004, nor the granting of 450,000 additional options to each of them, which occurred on July 6, 2005. Mr. Selman and Mr. Saperstein have represented to us that they will file these forms as soon as practicable. Charles Johnston, Benjamin Swirsky, and Robert Wussler, each being one of our directors, have not filed a Form 3 or Form 4 on a timely basis related to100,000 options granted to each of them on December 23, 2004 nor the granting of 100,000 additional options to each of them, which occurred on July 6, 2005. Mr. Johnston, Mr. Swirsky, and Mr. Wussler have represented to us that they will file these forms as soon as practicable. General Ronald W. Yates, one of our directors, has not filed a Form 3 or Form 4 on a timely basis related to 50,000 options granted to him on December 23, 2004 nor the granting of 100,000 additional options to him, which occurred on July 6, 2005. General Yates has represented to us that he will file these forms as soon as practicable. Eric Jacobs, our Corporate Secretary, filed a Form 4 and a Form 5 on January 11, 2006, for share purchases of 1,444, 1,649 and 1,966 shares on June 30, 2005, September 30, 2005 and December 31, 2005, respectively. This was not a timely filing. 35 ITEM 10. EXECUTIVE COMPENSATION The following table sets forth certain information relating to the compensation of (i) our Chief Executive Officer; and (ii) each of our executive officers who earned more than $100,000 salary and bonus (excluding severance) during the most recent fiscal year (collectively, the "Named Executive Officers"):
Annual Compensation Long-Term Compensation ----------------------------------- ---------------------------------------------- Awards Payouts -------------------------- ----------------- Securities All Restricted Underlying LTIP other Name, Principal Fiscal Other Annual Stock Options/SARs Payouts comp Position Year Salary Bonus Comp Awards (#) ($) ($) - ------------------ ------ -------- ----- ------------ ---------- ------------- -------- ------ Randy S. Selman - 2005 $175,536 -0- $ 47,441(1) -0- 1,300,000 -0- -0- President, Chief 2004 $166,350 -0- $ 34,945(2) -0- -0- -0- -0- Executive Officer 2003 $140,000 -0- $ 15,631(3) -0- -0- -0- -0- and Director Alan Saperstein - 2005 $165,000 -0- $ 53,048(4) -0- 1,300,000 -0- -0- Chief Operating 2004 $165,050 -0- $ 40,942(5) -0- -0- -0- -0- Officer, Treasurer 2003 $140,000 -0- $ 21,462(6) -0- -0- -0- -0- and Director Cliff Friedland - 2005 $124,003 -0- $ 44,108(7) -0- -0- -0- -0- Senior VP Busi- 2004 -0- -0- -0- -0- -0- -0- -0- ness Development 2003 -0- -0- -0- -0- -0- -0- -0- and Director David Glassman - 2005 $124,003 -0- $ 35,881(8) -0- -0- -0- -0- Senior VP 2004 -0- -0- -0- -0- -0- -0- -0- Marketing 2003 -0- -0- -0- -0- -0- -0- -0- Robert Tomlinson- 2005 $150,000 -0- $ 43,234(9) -0- 250,000 -0- -0- Chief Financial 2004 $ 7,981 -0- $ 375(10) -0- -0- -0- -0- Officer 2003 -0- -0- -0- -0- -0- -0- -0- George Stemper - 2005 $154,003(11) -0- $ 190,062(12) -0- 35,000 -0- -0- VP - Govt Markets 2004 $134,653 -0- $ 37,567(13) -0- -0- -0- -0- and former Chief 2003 $140,000 -0- $ 18,462(14) -0- -0- -0- -0- Operating Officer
36 (1) Includes $12,441 for medical and other insurance; $12,000 automobile allowance; $5,000 dues allowance and $18,000 deferred compensation. (2) Includes $9,295 for medical insurance; $12,000 automobile allowance and $13,650 deferred compensation. (3) Includes $5,126 for medical insurance and $12,000 automobile allowance. (4) Includes $18,048 for medical and other insurance; $12,000 automobile allowance; $5,000 dues allowance and $18,000 deferred compensation. (5) Includes $13,942 for medical insurance; $12,000 automobile allowance and $15,000 deferred compensation. (6) Includes $9,462 for medical insurance and $12,000 automobile allowance. (7) Includes $13,841 for medical and other insurance; $9,129 automobile allowance; $5,000 dues allowance and $16,139 deferred compensation and 401(k) match. Table excludes amounts paid to Mr. Friedland during fiscal 2005 related to compensation accrued prior to the Onstream Merger. (8) Includes $5,613 for medical and other insurance; $9,129 automobile allowance; $5,000 dues allowance and $16,139 deferred compensation and 401(k) match. Table excludes amounts paid to Mr. Glassman during fiscal 2005 related to compensation accrued prior to the Onstream Merger. (9) Includes $17,734 for medical and other insurance; $9,000 automobile allowance and $16,500 deferred compensation and 401(k) match. (10) Includes $375 automobile allowance. (11) Includes $78,500 representing the fair value assigned to 50,000 common shares issued under a professional services agreement. (12) Includes $17,510 for medical and other insurance; $4,625 automobile allowance and $10,928 deferred compensation and 401(k) match. Also includes $157,000 representing the fair value assigned to 100,000 common shares issued in connection with the Onstream Merger under a severance agreement. (13) Includes $13,942 for medical insurance; $8,625 automobile allowance and $15,000 deferred compensation. (14) Includes $9,462 for medical insurance and $9,000 automobile allowance. Employment Agreements Effective December 27, 2004 we entered into four-year employment agreements with Messrs. Randy Selman (President and CEO) and Alan Saperstein (COO and Treasurer). The contracts provide a base salary of $178,000, with 10% annual increases, for Mr. Selman and a base salary of $165,000, with 10% annual increases, for Mr. Saperstein. As additional compensation, each of Messrs. Selman and Saperstein are entitled to receive a bonus for each fiscal year during the term of the executive's employment by us in an amount equal to 1% of our earnings before income tax, depreciation and amortization (EBITDA) in excess of the EBITDA for the previous fiscal year. The base year for the bonus was fiscal 2003. The bonus is payable within 30 days of the determination of the amount of the bonus; provided that at the executive's sole discretion he may elect to take his bonus in cash or in shares of our restricted common stock. The shares of our common stock issued as a bonus will be valued at 75% of the average closing price of our common stock for the five trading days immediately prior to the determination of the bonus. No such bonus had been earned or accrued as of September 30, 2005. In addition, each executive receives an auto allowance of $1,000 per month, a "deferred compensation" payment of $1,500 per month and an annual $5,000 allowance for the reimbursement of dues. Upon a subsequent change of control or termination without cause, we would be obligated to pay Messrs. Selman and Saperstein their base salaries for a three year period, which can be dispersed in a lump sum or over the standard term, at the option of the executive, plus full benefits for a period of two years from the date of termination. In addition, if the five day average closing price of the common 37 stock is greater than or equal to $2.50 per share on the date of termination, all options previously granted will be cancelled, with all underlying shares (vested or unvested) issued to the executive, and we will pay all taxes for the executive. If the five-day average closing price of the common stock is less than $2.50 per share on the date of termination, the options will remain exercisable under the original term. Effective December 27, 2004 we also entered into four-year employment agreements with Messrs. Clifford Friedland (Senior Vice President Business Development) and David Glassman (Senior Vice President Marketing). The agreements provide a base salary of $163,000, with 10% annual increases. As additional compensation, each of Messrs. Friedland and Glassman are entitled to receive a bonus for each fiscal year during the term of the executive's employment by us in an amount equal to 1% of our earnings before income tax, depreciation and amortization (EBITDA) in excess of the EBITDA for the previous fiscal year. The base year for the bonus was fiscal 2003. The bonus is payable within 30 days of the determination of the amount of the bonus; provided that at the executive's sole discretion he may elect to take his bonus in cash or in shares of our restricted common stock. The shares of our common stock issued as a bonus will be valued at 75% of the average closing price of our common stock for the five trading days immediately prior to the determination of the bonus. No such bonus had been earned or accrued as of September 30, 2005. In addition, each executive receives an auto allowance of $1,000 per month, a "deferred compensation" payment of $1,500 per month and an annual $5,000 allowance for the reimbursement of dues. Upon a change of control or termination without cause, we would be obligated to pay Messrs. Glassman and Friedland their base salaries for a three year period, which can be dispersed in a lump sum or over the standard term, at the option of the executive, plus full benefits for a period of two years from the date of termination. Effective March 8, 2005 we entered into an Executive Employment Agreement with Robert E. Tomlinson (Chief Financial Officer). The term of the agreement is for three years, with automatic successive one-year renewals unless both parties agree to modify the terms of the agreement or one or both parties exercise their respective rights of termination under the agreement. Mr. Tomlinson is paid a base salary of $150,000 per year, with annual incremental increases of 10% per year beginning on December 27, 2005. In addition, he receives an auto allowance of $750 per month and a "deferred compensation" payment of $1,500 per month. He is entitled to a performance bonus equal to 1% of our earnings before income tax, depreciation and amortization (EBITDA) in excess of the EBITDA for the previous fiscal year. At his sole discretion this bonus, if earned, is payable in cash or shares of Onstream Media's common stock which would be valued at 75% of average closing price for the five prior trading days immediately prior to the determination of such bonus; his ability to receive shares of common stock, however, is subject to shareholder approval. No such bonus had been earned or accrued as of September 30, 2005. In the event of a change of control of the company as described in the agreement all unvested options will immediately vest. In the event Mr. Tomlinson is terminated for cause or he voluntary resigns, all unvested options will automatically terminate. Mr. Tomlinson is entitled to (i) participate in any profit-sharing or retirement plan and in other employee benefits applicable to our employees and executives, (ii) an automobile allowance, business reimbursement expense and fringe benefits commensurate with the duties and responsibilities of Mr. Tomlinson, and (iii) benefits in the event of disability. The agreement contains certain non-disclosure and non-competition provisions and we have agreed to indemnify Mr. Tomlinson in certain circumstances. Under the terms of the agreement, we may terminate the employment of Mr. Tomlinson upon his death or disability or with or without cause. If the agreement is terminated by us without cause or upon a change of control as described in the agreement, the company would be obligated give Mr. Tomlinson three months prior notice and upon termination pay him six months of total 38 compensation, including benefits, under the agreement. If Mr. Tomlinson should voluntarily terminate the agreement following two months written notice of his intent to do so, upon the termination we are obligated to pay him one month's total compensation, including benefits. To the extent that Mr. Tomlinson is terminated for cause, no severance benefits are due him. If the agreement is terminated as a result of Mr. Tomlinson's death, his estate will receive six months base salary and he will be entitled to a portion of any bonus he would have earned at the time of his death, and if the agreement is terminated as a result of his disability, as defined in the agreement, he is entitled to compensation in accordance with our disability compensation for senior executives to include compensation for at least 180 days. Severance Benefits In connection with the Onstream Merger, we issued 100,000 shares of our common stock to Mr. George Stemper, our former COO, who assisted us in the transition after the Onstream Merger. In addition to these shares, under the terms of his severance agreement, we continued to compensate Mr. Stemper at a reduced salary of approximately $76,000 per annum plus all benefits until August 31, 2005. At the time of Mr. Stemper's termination, we also entered into a professional services agreement with him and issued him 50,000 shares of our common stock as an advance against sales commissions to be earned in accordance with the terms of that agreement. Effective September 1, 2005, we re-hired Mr. Stemper as Vice President - Government Markets and as part of that arrangement agreed that the 50,000 shares had been fully earned by Mr. Stemper. In addition, options previously granted to Mr. Stemper, representing the right to purchase 13,334 shares of our common stock are fully vested and will remain exercisable throughout the term as prescribed by the individual grant. These options will be subject to the cancellation and re-grant as described in 1996 Stock Option Plan information below. 39 Stock Option Information The following table sets forth certain information with respect to stock options granted in fiscal 2005 to the Named Executive Officers. Option Grants in Year Ended September 30, 2005 (Individual grants)
% of Total No. of Options Securities Granted to Underlying Employees in Name Options Granted Fiscal Year Exercise Price Expiration Date - ------------------------------------ --------------- ------------ -------------- --------------- Randy S. Selman - President, Chief 450,000 10.3% $ 1.57 12/23/2009 Executive Officer and Director 400,000 9.1% $ 2.50 9/30/2009 450,000 10.3% $ 1.12 7/6/2010 Alan Saperstein - Chief Operating 450,000 10.3% $ 1.57 12/23/2009 Officer, Treasurer and Director 400,000 9.1% $ 2.50 9/30/2009 450,000 10.3% $ 1.12 7/6/2010 Cliff Friedland - Senior VP Business (1) -- -- -- Development and Director David Glassman - Senior VP (1) -- -- -- Marketing Robert Tomlinson- Chief Financial 150,000 3.4% $ 1.21 7/6/2009 Officer 100,000 2.3% $ 1.12 7/6/2010 George Stemper - VP - Govt Markets 35,000(2) 0.8% $ 1.12 7/6/2010 and former Chief Operating Officer
(1) Table excludes options issued in exchange for options issued by Acquired Onstream. (2) Options vest over one year in quarterly installments starting December 1, 2005. 40 The following table sets forth certain information regarding stock options held as of September 30, 2005 by the Named Executive Officers. Aggregate Option Exercises in Year Ended September 30, 2005 and Year-End Option Values
NO. OF SECURITIES UNDERLYING UNEXERCISED VALUE OF UNEXERCISED SHARES OPTIONS AT IN-THE-MONEY OPTIONS AT ACQUIRED SEPTEMBER 30, 2005 SEPTEMBER 30, 2005(1) ON VALUE ---------------------------- --------------------------- NAME EXERCISE REALIZED EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE - -------------------- -------- -------- ----------- ------------- ----------- ------------- Randy S. Selman, President, Chief Executive Officer and Director -- $ -- 1,330,000(2) -- $ -- $ -- Alan Saperstein, Chief Operating Officer, Treasurer and Director -- $ -- 1,330,000(2) -- $ -- $ -- Cliff Friedland, Senior VP Business Development and Director -- $ -- 89,527(3) -- $ -- $ -- David Glassman, Senior VP Marketing -- $ -- 89,527(3) -- $ -- $ -- Robert Tomlinson, Chief Financial Officer -- $ -- 250,000(4) -- $ -- $ -- George Stemper, former Chief Operating Officer -- $ -- -- 35,000(5) $ -- $ --
(1) The dollar value of the unexercised in-the-money options is calculated based upon the difference between the option exercise price and $1.12 per share, being the last sale price of our common stock on September 30, 2005 as reported by the Nasdaq SmallCap Market. (2) Of such exercisable options at September 30, 2005, 30,000 options were exercisable at $22.50 per share, 450,000 were exercisable at $1.57 per share, 400,000 were exercisable at $2.50 per share and 450,000 were exercisable at $1.12 per share. The 30,000 options are subject to cancellation and repricing as described below. 41 (3) Of such exercisable options at September 30, 2005, 667 options were exercisable at $4.50 per share and 88,860 were exercisable at $3.376 per share. (4) Of such exercisable options at September 30, 2005, 150,000 options were exercisable at $1.21 per share and 100,000 were exercisable at $1.12 per share. (5) These options vest over one year in quarterly installments starting December 1, 2005. 1996 Stock Option Plan On February 9, 1997, the board of directors and a majority of our shareholders adopted our 1996 Stock Option Plan (the "Plan"). Pursuant to an amendment to the Plan ratified by shareholders on September 13, 2005, we have reserved an aggregate of 4,500,000 shares of common stock for issuance pursuant to options granted under the Plan ("Plan Options") and 2,000,000 shares for restricted stock grants ("Stock Grants") made under the Plan. At December 31, 2005, we have options to purchase 2,935,226 shares of our common stock outstanding under the Plan. Such options were issued to our directors, employees and consultants at exercise prices ranging from $1.12 to $22.50 per share. On December 15, 2004 a majority of our shareholders voted to approve the cancellation (subject to the option holder's approval) of stock option grants to directors, executive officers, senior management and employees covering 292,992 shares (227,776 of which were issued under the 1996 Stock Option plan) with a weighted-average exercise price of $22.93, with such options to be re-issued six months and one day from the date of cancellation with an exercise price equal to the fair market value on the date of the reissue. This cancellation has not yet been implemented and 121,774 of the Plan options subject to this cancellation and re-issue had expired as of December 31, 2005. The stated purpose of the Plan is to increase our employees', advisors', consultants' and non-employee directors' proprietary interest in the company, and to align more closely their interests with the interests of our shareholders, as well as to enable us to attract and retain the services of experienced and highly qualified employees and non-employee directors. The Plan is administered by the Compensation Committee of our board of directors ("the Committee"). The Committee determines, from time to time, those of our officers, directors, employees and consultants to whom Stock Grants and Plan Options will be granted, the terms and provisions of the respective Grants and Plan Options, the dates such Plan Options will become exercisable, the number of shares subject to each Plan Option, the purchase price of such shares and the form of payment of such purchase price. Stock Grants may be issued by the Committee at up to a 10% discount to market at the time of grant. At no time may the Committee issue Stock Grants to exceed, in the aggregate, 2,000,000 shares. All other questions relating to the administration of the Plan, and the interpretation of the provisions thereof are to be resolved at the sole discretion of the board of directors or the Committee. Plan Options granted under the Plan may either be options qualifying as incentive stock options ("Incentive Options") under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code"), or options that do not so qualify ("Non-Qualified Options"). In addition, the Plan also allows for the inclusion of a reload option provision ("Reload Option"), which permits an eligible person to pay the exercise price of the Plan Option with shares of common stock owned by the eligible person and to receive a new Plan Option to purchase shares of common stock equal in number to the tendered shares. Any Incentive Option granted under the Plan must provide for an exercise price of not less than 100% 42 of the fair market value of the underlying shares on the date of such grant, but the exercise price of any Incentive Option granted to an eligible employee owning more than 10% of our common stock must be at least 110% of such fair market value as determined on the date of the grant. The term of each Plan Option and the manner in which it may be exercised is determined by the board of directors or the Committee, provided that no Plan Option may be exercisable more than 10 years after the date of its grant and, in the case of an Incentive Option granted to an eligible employee owning more than 10% of our common stock, no more than five years after the date of the grant. In any case, the exercise price of any stock option granted under the Plan will not be less than 85% of the fair market value of the common stock on the date of grant. The exercise price of Non-Qualified Options is determined by the Committee. The per share purchase price of shares subject to Plan Options granted under the Plan may be adjusted in the event of certain changes in our capitalization, but any such adjustment shall not change the total purchase price payable upon the exercise in full of Plan Options granted under the Plan. Officers, directors and key employees of and consultants to us and our subsidiaries will be eligible to receive Non-Qualified Options under the Plan. Only our officers, directors and employees who are employed by us or by any of our subsidiaries thereof are eligible to receive Incentive Options. All Plan Options are nonassignable and nontransferable, except by will or by the laws of descent and distribution and, during the lifetime of the optionee, may be exercised only by such optionee. If an optionee's employment is terminated for any reason, other than his death or disability or termination for cause, or if an optionee is not our employee but is a member of our board of directors and his service as a Director is terminated for any reason, other than death or disability, the Plan Option granted may be exercised on the earlier of the expiration date or 90 days following the date of termination. If the optionee dies during the term of his employment, the Plan Option granted to him shall lapse to the extent unexercised on the earlier of the expiration date of the Plan Option or the date one year following the date of the optionee's death. If the optionee is permanently and totally disabled within the meaning of Section 22(c)(3) of the Code, the Plan Option granted to him lapses to the extent unexercised on the earlier of the expiration date of the option or one year following the date of such disability. The Board of Directors may amend, suspend or terminate the Plan at any time, except that no amendment shall be made which (i) increases the total number of shares subject to the Plan or changes the minimum purchase price therefore (except in either case in the event of adjustments due to changes in our capitalization) without the consent of our shareholders, (ii) affects outstanding Plan Options or any exercise right thereunder, (iii) extends the term of any Plan Option beyond ten years, or (iv) extends the termination date of the Plan. Unless the Plan has been earlier suspended or terminated by the Board of Directors, the Plan shall terminate 10 years from the date of the Plan's adoption. Any such termination of the Plan shall not affect the validity of any Plan Options previously granted thereunder. The potential benefit to be received from a Plan Option is dependent on increases in the market price of the common stock. The ultimate dollar value of the Plan Options that have been or may be granted under the Plan is therefore not ascertainable. On January 11, 2006, the closing price of our common stock as reported on the Nasdaq SmallCap Market was $0.92. 43 ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table contains information regarding beneficial ownership of our common stock as of January 9, 2006 held by: * persons who own beneficially more than 5% of our outstanding common stock, * our directors, * named executive officers, and * all of our directors and officers as a group. Unless otherwise indicated, the address of each of the listed beneficial owners identified is c/o Onstream Media Corporation, 1291 Southwest 29 Avenue, Pompano Beach, Florida 33069. Unless otherwise noted, we believe that all persons named in the table have sole voting and investment power with respect to all shares of our common stock beneficially owned by them. A person is deemed to be the beneficial owner of securities that can be acquired by such a person within 60 days from January 9, 2006 upon exercise of options, warrants or convertible securities. Each beneficial owner's percentage of ownership is determined by assuming that options, warrants and convertible securities that are held by such a person (but not those held by any other person) and are exercisable within 60 days from the date hereof have been exercised. All information is based upon a record list of stockholders as of January 9, 2006. At that date, approximately 57% of the Company's outstanding shares were held by CEDE & Co., which is accounted for as a single shareholder of record for multiple beneficial owners, but is not listed in the beneficial ownership table. CEDE & Co. is a nominee of the Depository Trust Company (DTC), with respect to securities deposited by participants with DTC, e.g., mutual funds, brokerage firms, banks, and other financial organizations.
Shares of Common Stock Beneficially Owned ----------------------------------------- Name and Address of Beneficial Owner Number Percentage - ------------------------------------ --------------- --------------- Randy S. Selman (1) 1,339,853 9.4% Alan M. Saperstein (2) 1,341,820 9.4% Benjamin Swirsky (3) 200,751 1.5% Robert Wussler (4) 222,093 1.7% Charles C. Johnston (5) 371,714 2.8% Cliff Friedland (6) 832,276 6.4% David Glassman (7) 832,109 6.4% Ronald W. Yates (8) 164,810 1.3% Robert E. Tomlinson (9) 250,000 1.9% All directors and officers as a group (nine persons) (10) 5,555,426 33.1% Alpha Capital AG (11) 1,179,954 8.4% CCJ Trust (12) 731,276 5.4% DKR Soundshore Oasis Holding Fund, Ltd. (13) 1,426,135 9.99% Fennmore Holdings, LLC (14) 1,424,334 9.99% Fred DeLuca (15) 3,219,036 20.2% Neil Berman (16) 1,052,356 7.6% Omicron Master Trust (17) 992,718 7.2%
(1) Includes 9,853 shares of our common stock presently outstanding, options to acquire 30,000 shares of our common stock at an exercise price of $22.50 per share, options to acquire 450,000 shares of our common stock at an exercise price of $1.57 per share, options to acquire 450,000 shares of our common stock at an exercise price of $1.12 per share, and options to acquire 400,000 shares of our common stock at an exercise price of $2.50 per share. 44 (2) Includes 11,820 shares of our common stock presently outstanding, options to acquire 30,000 shares of our common stock at an exercise price of $22.50 per share, options to acquire 450,000 shares of our common stock with at an exercise price of $1.57 per share, options to acquire 450,000 shares of our common stock at an exercise price of $1.12 per share and options to acquire 400,000 shares of our common stock at an exercise price of $2.50 per share. (3) Includes 751 shares of our common stock presently outstanding, options to acquire 100,000 shares of our common stock at an exercise price of $1.57 per share and options to acquire 100,000 shares of our common stock at an exercise price of $1.12 per share. (4) Includes 616 shares of our common stock presently outstanding, options to acquire 6,667 shares of our common stock at an exercise price of $7.50 per share, options to acquire 100,000 shares of our common stock at an exercise price of $1.57 per share, options to acquire 100,000 shares of our common stock at an exercise price of $1.12 per share and warrants to purchase 14,810 shares of our common stock at an exercise price of $3.376 per share. (5) Includes 171,714 shares of our common stock held by J&C Resources, LLC, options to acquire 100,000 shares of our common stock at an exercise price of $1.57 per share and options to acquire 100,000 shares of our common stock at an exercise price of $1.12 per share. Mr. Johnston is the control person of J&C Resources, LLC. Mr. Johnston's holdings exclude our securities owned by CCJ Trust as described in footnote 12 below. CCJ Trust is a trust for Mr. Johnston's adult children and he disclaims any beneficial ownership interest in CCJ Trust. (6) Includes 447,216 shares of our common stock presently outstanding, 148,100 shares of our common stock held by Titan Trust, 148,100 shares of our common stock held by Dorado Trust and options to acquire 88,860 shares of our common stock at an exercise price of $3.376 per share. Mr. Friedland is the control person and beneficial owner of both Titan Trust and Dorado Trust. (7) Includes 447,049 shares of our common stock presently outstanding, 148,100 shares of our common stock held by JMI Trust, 148,100 shares of our common stock held by Europa Trust and options to acquire 88,860 shares of our common stock at an exercise price of $3.376 per share. Mr. Glassman is the control person and beneficial owner of both JMI Trust and Europa Trust. (8) Includes options to acquire 50,000 shares of our common stock at an exercise price of $1.57 per share, options to acquire 100,000 shares of our common stock at an exercise price of $1.12 per share and warrants to purchase 14,810 shares of our common stock at an exercise price of $3.376 per share. (9) Includes options to acquire 150,000 shares of our common stock at an exercise price of $1.21 per share and options to acquire 100,000 shares of our common stock at an exercise price of $1.12 per share. (10) See footnotes (1) through (9) above. (11) Includes 42,454 shares of our common stock presently outstanding, 250,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 387,500 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 125,000 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant) and 500,000 shares of our common stock issuable upon the conversion of $500,000 principal amount 8% senior secured convertible notes. Mr. Konrad 45 Ackerman is the control person of Alpha Capital AG. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. (12) Includes 164,416 shares of our common stock presently outstanding, 175,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.50 per share, and 391,860 shares of our common stock issuable upon the conversion of 39,186 shares of Series A-10 Convertible Preferred Stock. ATC Trustee LTD is the control person of CCJ Trust. Mr. Rolf Hedinger is the control person of ATC Trustee LTD. (13) Includes 46,135 shares of our common stock presently outstanding, 240,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 449,000 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 120,000 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant) and 700,000 shares of our common stock issuable upon the conversion of $700,000 principal amount 8% senior secured convertible notes, reduced by 9,000 shares due to conversion limitations discussed below. Mr. Seth Fischer is the control person of DKR Soundshore Oasis Holding Fund, Ltd. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. (14) Includes 64,834 shares of our common stock presently outstanding, 130,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $2.28 per share, 450,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 697,500 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 225,000 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant) and 350,000 shares of our common stock issuable upon the conversion of $350,000 principal amount 8% senior secured convertible notes reduced by 268,000 shares due to conversion limitations discussed below. Mr. Mark Nordlicht is the control person of Fennmore Holdings, LLC. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. Excludes any securities owned by Platinum Partners Value Arbitrage Fund, LP. (15) Includes 147,466 shares of our common stock presently outstanding, 200,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 240,000 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 100,000 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant), 500,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.50 per share, 2,571,570 shares of our common stock issuable upon the conversion of 257,157 shares of Series A-10 Convertible Preferred Stock, and 400,000 shares of our common stock issuable upon the conversion of $400,000 principal amount 8% senior secured convertible notes, reduced by 840,000 shares due to conversion limitations discussed below. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the 46 total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. (16) Includes 146,106 shares of our common stock presently outstanding, 6,250 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $2.65 per share, 150,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 250,000 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 75,000 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant), and 500,000 shares of our common stock issuable upon the conversion of $500,000 principal amount 8% senior secured convertible notes. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. (17) Includes 21,468 shares of our common stock presently outstanding, 175,000 shares of our common stock issuable upon the exercise of a common stock purchase warrant with an exercise price of $1.00 per share, 271,250 shares of our common stock issuable upon the exercise of common stock purchase warrants with an exercise price of $1.65 per share (including 87,500 shares underlying $1.65 Warrants contingently issuable upon the exercise of the aforementioned $1.00 warrant), and 525,000 shares of our common stock issuable upon the conversion of $525,000 principal amount 8% senior secured convertible notes. The number of shares of our common stock acquired by the holder upon conversion of the 8% senior secured convertible notes or the exercise of the warrants issued in connection with those notes is limited to the extent necessary to ensure that following the conversion and/or exercise the total number of shares of our common stock beneficially owned by the holder does not exceed 9.999% of our issued and outstanding common stock. Omicron Capital, L.P., a Delaware limited partnership ("Omicron Capital"), serves as investment manager to Omicron Master Trust, a trust formed under the laws of Bermuda ("Omicron"), Omicron Capital, Inc., a Delaware corporation ("OCI"), serves as general partner of Omicron Capital, and Winchester Global Trust Company Limited ("Winchester") serves as the trustee of Omicron. By reason of such relationships, Omicron Capital and OCI may be deemed to share dispositive power over the shares of our common stock owned by Omicron, and Winchester may be deemed to share voting and dispositive power over the shares of our common stock owned by Omicron. Omicron Capital, OCI and Winchester disclaim beneficial ownership of such shares of our common stock. Omicron Capital has delegated authority from the board of directors of Winchester regarding the portfolio management decisions with respect to the shares of common stock owned by Omicron and, as of April 21, 2003, Mr. Olivier H. Morali and Mr. Bruce T. Bernstein, officers of OCI, have delegated authority from the board of directors of OCI regarding the portfolio management decisions of Omicron Capital with respect to the shares of common stock owned by Omicron. By reason of such delegated authority, Messrs. Morali and Bernstein may be deemed to share dispositive power over the shares of our common stock owned by Omicron. Messrs. Morali and Bernstein disclaim beneficial ownership of such shares of our common stock and neither of such persons has any legal right to maintain such delegated authority. No other person has sole or shared voting or dispositive power with respect to the shares of our common stock being offered by Omicron, as those terms are used for purposes under Regulation 13D-G of the Securities Exchange Act of 1934, as amended. Omicron and Winchester are not "affiliates" of one another, as that term is used for purposes of the Securities Exchange Act of 1934, as amended, or of any other person named in this prospectus as a selling stockholder. No person or "group" (as that term is used in Section 13(d) of the Securities Exchange Act of 1934, as amended, or the SEC's Regulation 13D-G) controls Omicron and Winchester. 47 ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS On May 7, 2003 we entered into an agreement with Mr. Fred Deluca which restructured a previous loan, including a significant increase in the loaned amount outstanding. The new loan was evidenced by a three year promissory note in the principal amount of $3.0 million, interest payable only on a quarterly basis beginning in July 2003 at the rate of 5.25% per annum. The new loan was collateralized by a blanket security interest in our assets and a pledge of the stock of our subsidiaries. We issued Mr. Deluca 140,000 shares of our newly created Series A-8 Convertible Preferred Stock as consideration for entering into the above agreement. At the same time, he exchanged approximately 123,667 shares of our common stock already owned by him for an additional 92,750 shares of Class A-8. We granted Mr. Deluca demand and piggy-back registration rights covering the shares of common stock issuable upon the conversion of the Series A-8 Convertible Preferred Stock. In December 2004, we repaid $2.0 million of the May 2003 loan and the remaining $1.0 million was invested in 100,000 shares of Series A-10 Convertible Preferred Stock on the same terms as offered to new investors. Also, Mr. Deluca purchased $400,000 of 8% senior secured convertible notes on the same terms as the other investors. In addition, Mr. Deluca exchanged all 232,750 shares of Series A-8 for 139,650 shares of Series A-10, but did not receive accompanying warrants. Finally, Mr. DeLuca agreed to accept common shares, valued as of the date of issuance, for approximately $149,000 of unpaid interest on the three year promissory note. In February 2004, we received a $300,000 loan from J&C Resources, LLC. One of the members of our board of directors is the President, Chairman and CEO of J&C Resources, LLC. The term of the loan was one year, and all interest was prepaid through the issuance of 21,000 shares of common stock. In addition, we issued 9,000 shares of common stock as an origination fee and 10,000 shares of common stock for legal and other fees. The proceeds from this loan were used for working capital pending the closing of new financing in December 2004, at which time this loan was repaid. In December 2004, we paid $100,000 to each of Messrs. Clifford Friedland and David Glassman, as a partial payment of accrued and unpaid salaries due to them from Acquired Onstream. In February 2005 we paid an additional $50,000 to each of Messrs. Friedland and Glassman as a second partial payment of these accrued salaries. In January 2005, we entered into an addendum to an August 2002 consulting agreement with Mr. Neil Berman, a major shareholder, calling for the issuance of 5,000 restricted common shares per month for the year ended December 31, 2005. Under that agreement, 32,500 restricted common shares were issued for the year ended December 31, 2004. In August 2005, we received a $300,000 loan from Asset Factoring International, Inc., whose Investment Manager is a member of our board of directors. The term of the loan is one year, with a 2% loan origination fee and interest of 8% per annum. All interest and fees are due and payable in the event of early repayment. The terms of the loan, which is secured by $600,000 of recently purchased equipment and software, requires repayment within 5 days of us obtaining other financing, including but not limited to equipment financing. In August 2005, we entered into a consulting agreement with Allenstown Investments, Ltd., whose Investment Manager is a member of our board of directors. The agreement is for a term of one year and calls for the issuance of 30,000 restricted common shares. In October 2005, we entered into a five-year note with Mr. Neil Berman, a major shareholder in the aggregate principal amount of $750,000. The note, which is secured by $800,000 of hardware and software, bears interest at 10.85% per annum. At our option, and with the consent of required security holders, both interest and principal may be paid in the form of our Series A-10 Preferred Stock. In the event the loan is repaid in stock, the prepayment penalty will include all accrued interest. $450,000 of the total funding commitment had been advanced to us to date. 48 PART IV ITEM 13. EXHIBITS The following documents are filed as a part of this report or are incorporated by reference to previous filings, if so indicated: Number Description 2.1 Agreement and Plan of Merger dated as of October 22, 2003 by and between Visual Data Corporation, OSM, Inc., a subsidiary of Visual Data Corporation, and Onstream Media Corporation (11) 2.2 Amendment #1 to Agreement and Plan of Merger dated as of October 15, 2004 by and between Visual Data Corporation, OSM, Inc., a subsidiary of Visual Data Corporation, and Onstream Media Corporation (13) 2.3 Agreement and Plan of Merger dated June 4, 2001 among Entertainment Digital Network, Inc., Visual Data Corporation and Visual Data San Francisco, Inc. (6) 2.4 Agreement and Plan of Reorganization between Visual Data Corporation, Media on Demand, Inc. and Charles Saracino (7) 2.5 Voting Agreement (7) 3.1.1 Articles of Incorporation (1) 3.1.2 Articles of Amendment dated July 26, 1993 (1) 3.1.3 Articles of Amendment dated January 17, 1994 (1) 3.1.4 Articles of Amendment dated October 11, 1994 (1) 3.1.5 Articles of Amendment dated March 25, 1995 (1) 3.1.6 Articles of Amendment dated October 31, 1995 (1) 3.1.7 Articles of Amendment dated May 23, 1996 (1) 3.1.8 Articles of Amendment dated May 5, 1998 (5) 3.1.9 Articles of Amendment dated August 11, 1998 (2) 3.1.10 Articles of Amendment dated June 13, 2000 (4) 3.1.11 Articles of Amendment dated April 11, 2002 (8) 3.1.12 Articles of Amendment dated June 24, 2003, with regard to Series A-9 Convertible Preferred Stock(9) 3.1.13 Articles of Amendment dated June 20, 2003, with regard to reverse stock split (10) 3.1.14 Articles of Amendment dated December 23, 2004, with regard to the designations for Series A-10 Convertible Preferred Stock (17) 3.1.15 Articles of Amendment dated December 30, 2004, with regard to corporate name change (16) 3.1.16 Articles of Amendment dated February 7, 2005 with regard to the designations for Series A-10 Convertible Preferred Stock (18) 3.2 By-laws (1) 4.1 Specimen Common Stock Certificate (1) 4.2 Form of 8% Senior Secured Convertible Notes (17) 4.3 Form of $1.65 Warrant (17) 4.4 Form of $1.50 Warrant (17) 4.5 Form of $1.00 Warrant (23) 4.6 Form of $1.65 Warrant issuable upon exercise of $1.00 Warrant (23) 10.1 Form of Stock Option Plan and Amendment thereto (1)(3) 10.2 Employment Agreement dated December 27, 2004 between Onstream Media Corporation and Randy S. Selman (13) 10.3 Employment Agreement dated December 27, 2004 between Onstream Media Corporation and Alan Saperstein (13) 10.4 Employment Agreement dated December 27, 2004 between Onstream Media Corporation and Cliff Friedland (13) 49 10.5 Employment Agreement dated December 27, 2004 between Onstream Media Corporation and David Glassman (13) 10.6 Employment Agreement dated March 8, 2005 between Onstream Media Corporation and Robert Tomlinson (21) 10.7 Plan of Compensation Package dated April 22, 2005 between Onstream Media Corporation and Bradford Tyler (22) 10.8 Securities Purchase Agreement - A-9 Preferred (9) 10.9 Form of Securities Purchase Agreement for 8% Senior Secured Convertible Notes (17) 10.10 Form of Additional Investment Right (17) 10.11 Form of Pledge Agreement (17) 10.12 Form of Security Agreement (17) 10.13 Form of Letter Agreement with Additional Investment Right holders (19) 10.14 Deposit Control Agreement dated October 2004 (14) 14.1 Code of Business Conduct and Ethics (12) 14.2 Corporate Governance and Nominating Committee Principles (23) 14.3 Audit Committee Charter (15) 21.1 Subsidiaries of the registrant (13) 21.2 Financial statements of Acquired Onstream for the years ended December 31, 2003 and 2002 and for the three and six months ended June 30, 2004 and 2003 (20) 23.1 Consent of Independent Certified Public Accountants 31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer 31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer 32.1 Section 906 Certification of Chief Executive Officer 32.2 Section 906 Certification of Chief Financial Officer (1) Incorporated by reference to the exhibit of the same number filed with the registrant's registration statement on Form SB-2, registration number 333-18819, as amended and declared effective by the SEC on July 30, 1997. (2) Incorporated by reference to the registrant's current report on Form 8-K dated August 21, 1998. (3) Incorporated by reference to the registrant's Proxy Statement for the year ended September 30, 1998. (4) Incorporated by reference to the registrant's Quarterly Report on Form 10-QSB for the period ended June 30, 2000. (5) Incorporated by reference to the registrant's Annual Report on Form 10-KSB for the year ended September 30, 2000. (6) Incorporated by reference to the registrant's current report on Form 8-K filed on June 12, 2001. (7) Incorporated by reference to the registrant's current report on Form 8-K filed on February 5, 2002. (8) Incorporated by reference to exhibit 3.1 to the registrant's registration statement on Form S-3, file number 333-89042, declared effective on June 7, 2002. (9) Incorporated by reference to the registrant's current report on Form 8-K filed July 2, 2003. (10) Incorporated by reference to the registrant's Quarterly Report on Form 10-QSB for the period ended June 30, 2003. (11) Incorporated by reference to the registrant's current report on Form 8-K filed October 28, 2003. (12) Incorporated by reference to the registrant's Annual Report on Form 10-KSB for the year ended September 30, 2003. (13) Incorporated by reference to the registrant's Annual Report on Form 10-KSB for the year ended September 30, 2004. (14) Incorporated by reference to the registrant's current report on Form 8-K filed November 4, 2004. 50 (15) Incorporated by reference to the registrant's Proxy Statement for the 2004 Annual Shareholder's Meeting filed on November 14, 2004. (16) Incorporated by reference to the registrant's current report on Form 8-K filed on January 4, 2005. (17) Incorporated by reference to the registrant's current report on Form 8-K/A filed on January 4, 2005. (18) Incorporated by reference to the registrant's current report on Form 8-K filed February 11, 2005. (19) Incorporated by reference to the registrant's current report on Form 8-K filed February 17, 2005. (20) Incorporated by reference to the registrant's current report on Form 8-K/A filed March 8, 2005. (21) Incorporated by reference to the registrant's current report on Form 8-K filed March 11, 2005. (22) Incorporated by reference to the registrant's current report on Form 8-K filed July 11, 2005. (23) Incorporated by reference to the registrant's Proxy Statement for the 2005 Annual Shareholder's Meeting filed on August 1, 2005. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES. Audit Fees The aggregate audit fees billed to us by Goldstein Lewin & Co. for professional services rendered for the audit of our annual financial statements included in our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2005 and for the review of our quarterly financial statements included in our quarterly reports on Form 10-QSB for the quarters ended December 31, 2004, and March 31 and June 30, 2005 were $152,000. The aggregate audit fees billed to us by Goldstein Lewin & Co. for professional services rendered for the audit of our annual financial statements included in our Annual Report on Form 10-KSB for the fiscal year ended September 30, 2004 and for the review of our quarterly financial statements included in our quarterly reports on Form 10-QSB for the quarters ended December 31, 2003, and March 31 and June 30, 2004 were $119,985. 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 $87,922 and $45,230 for the fiscal years ended September 30, 2005 and 2004, respectively. Tax Fees The aggregate tax fees billed to us by Goldstein Lewin & Co. were $11,836 and $17,960 for the fiscal years ended September 30, 2005 and 2004, 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 51 to us by Goldstein Lewin & Co. for services rendered for the fiscal years ended September 30, 2005 or 2004. 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. 52 SIGNATURES In accordance with Section 13 or 15(d) of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. Onstream Media Corporation By: /s/ Randy S. Selman -------------------- Randy S. Selman, President, Chief Executive Officer By: /s/ Robert E. Tomlinson ------------------------ Robert E. Tomlinson, Chief Financial Officer In accordance with the Exchange Act, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Signature Title Date /s/ Randy S. Selman Director, President, January 12, 2006 - ------------------- Randy S. Selman Chief Executive Officer /s/ Robert E. Tomlinson Chief Financial Officer and - ----------------------- Robert E. Tomlinson Principal Accounting Officer January 12, 2006 /s/ Clifford Friedland Director and Senior VP January 12, 2006 - ---------------------- Clifford Friedland Business Development /s/ Alan Saperstein Director and Chief January 12, 2006 - ------------------- Alan Saperstein Operating Officer /s/ Benjamin Swirsky Director January 12, 2006 - -------------------- Benjamin Swirsky /s/ Robert J. Wussler Director January 12, 2006 - --------------------- Robert J. Wussler /s/ Charles C. Johnston Director January 12, 2006 - ----------------------- Charles C. Johnston /s/ Ronald W. Yates Director January 12, 2006 - ------------------- Gen. Ronald W. Yates 53 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders of Onstream Media Corporation: We have audited the accompanying consolidated balance sheets of Onstream Media Corporation (formerly Visual Data Corporation) and subsidiaries as of September 30, 2005 and 2004, 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, 2005 and 2004, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As more fully described in Note 1 to the financial statements, the Company has incurred significant recurring losses from operations since inception. This condition raises substantial doubt about its ability to continue as a going concern. The Company's continued existence is dependent upon its ability to raise additional capital and to successfully market and sell its services and or products. Management's plans regarding these matters are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty. GOLDSTEIN LEWIN & CO. /s/ GOLDSTEIN LEWIN & CO. Boca Raton, Florida January 12, 2006 F-1 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
September 30, 2005 2004 ----------- ----------- ASSETS CURRENT ASSETS: Cash and cash equivalents $ 4,137 $ 14,269 Restricted cash 8,485 207,876 Accounts receivable, net of allowance for doubtful accounts of $28,690 and $68,739, respectively 1,274,974 1,365,604 Prepaid expenses 604,928 456,521 Inventories 86,168 51,044 Other current assets 8,914 2,524 ----------- ----------- Total current assets 1,987,606 2,097,838 PROPERTY AND EQUIPMENT, net 4,809,877 745,056 INTANGIBLE ASSETS, net 917,761 1,645,496 GOODWILL, net 9,692,845 1,601,444 OTHER NON-CURRENT ASSETS 113,998 1,372,555 ----------- ----------- Total assets $17,522,087 $ 7,462,389 =========== ===========
(Continued) F-2 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued)
September 30, 2005 2004 ------------ ------------ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable and accrued liabilities $ 1,710,808 $ 1,562,166 Amounts due to shareholders and officers 224,419 -- Deferred revenue 170,971 77,711 Notes payable - current portion 330,598 365,500 Detachable Warrants and Embedded Conversion Feature associated with 8% Convertible Debentures - current portion 2,314,521 -- ------------ ------------ Total current liabilities 4,751,317 2,005,377 8% Convertible Debentures, net of discount 1,243,322 -- Notes payable, net of discount and current portion 399,600 2,660,225 Detachable Warrants and Embedded Conversion Feature associated with 8% Convertible Debentures, net of current portion 702,647 -- ------------ ------------ Total liabilities 7,096,886 4,665,602 ------------ ------------ COMMITMENTS AND CONTINGENCIES EQUITY SECURITIES SUBJECT TO POTENTIAL RESCISSION: Series A-10 Convertible Preferred stock, including potentially redeemable common stock issued upon conversion 4,779,998 -- Detachable warrants associated with 8% Convertible Debentures; beneficial conversion rights included in 8% Convertible Debentures; and potentially redeemable common stock issued upon conversion and/or in lieu of interest on 8% Convertible Debentures 2,595,596 -- ------------ ------------ Total equity securities subject to potential rescission 7,375,594 -- ------------ ------------ STOCKHOLDERS' EQUITY: Series A-8 Convertible Preferred stock, par value $.0001 per share, auth- orized 300,000 shares, 0 and 232,750 issued and outstanding, respectively -- 23 Series A-10 Convertible Preferred stock, par value $.0001 per share, auth- orized 700,000 shares, 416,031 and 0 issued and outstanding, respectively 41 -- Series A-11 Convertible Preferred stock, par value $.0001 per share, auth- orized 25,000 shares, 0 and 25,000 issued and outstanding, respectively -- 3 Common stock, par value $.0001 per share; authorized 75,000,000 shares, 12,191,001 and 4,666,324 issued and outstanding, respectively 1,219 467 Unamortized discount (2,067,461) -- Additional paid-in capital 75,556,043 62,473,209 Accumulated deficit (70,440,235) (59,676,915) ------------ ------------ Total stockholders' equity 3,049,607 2,796,787 ------------ ------------ Total liabilities and stockholders' equity $ 17,522,087 $ 7,462,389 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. F-3 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended, ---------------------------- September 30, 2005 2004 ------------ ------------ REVENUE: Digital asset management $ 1,969,697 $ 1,155,655 Network usage and services 2,049,337 2,137,719 Network equipment sales and rentals 458,369 660,468 Webcasting 3,470,814 3,373,814 Travel production and distribution 208,177 251,232 ------------ ------------ Total revenue 8,156,394 7,578,888 ------------ ------------ COSTS OF REVENUE: Digital asset management 633,801 310,472 Network usage and services 1,192,456 1,092,206 Network equipment sales and rentals 201,435 398,188 Webcasting 1,003,962 953,914 Travel production and distribution 71,206 28,367 ------------ ------------ Total costs of revenue 3,102,860 2,783,147 ------------ ------------ GROSS MARGIN 5,053,534 4,795,741 ------------ ------------ OPERATING EXPENSES: General and administrative: Compensation 4,778,694 3,952,447 Professional fees 2,824,400 1,107,084 Other 1,575,215 1,499,494 Impairment loss on goodwill 330,000 470,000 Depreciation and amortization 1,152,633 1,373,587 ------------ ------------ Total operating expenses 10,660,942 8,402,612 ------------ ------------ Loss from operations (5,607,408) (3,606,871) ------------ ------------ OTHER (EXPENSE) INCOME: Interest income 11,355 6,344 Interest expense (4,015,504) (595,248) Other (expense) income, net (26,331) 223,109 ------------ ------------ Total other (expense) income, net (4,030,480) (365,795) ------------ ------------ Net loss $ (9,637,888) $ (3,972,666) ============ ============ Loss per share - basic and diluted: Net loss per share $ (1.17) $ (0.92) ============ ============ Weighted average shares of common stock outstanding - basic and diluted 8,261,642 4,337,370 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 2004 AND 2005
Preferred Stock ------------------------------------------------ --------------------------- Series Series Series Common Stock A8/A9 A10 A11 ------------ --------------------------- ------------ ------ ------------ Shares Shares Shares Amount Shares Amount ------------ -- ------------ ------------ ------------ ------------ Balance, September 30, 2003 277,750 -- -- $ 28 3,246,443 $ 325 Proceeds from sale of stock, net -- -- 25,000 3 497,495 49 Issuance of shares, warrants and options for services and incentives -- -- -- -- 195,000 20 Conversion of Series A-8 and A-9 preferred shares to common shares (45,000) -- -- (5) 176,192 18 Issuance of shares and warrants for loan payments and interest -- -- -- -- 434,694 44 Issuance of shares for -- -- -- -- 64,000 6 satisfaction of obligations Dividends paid -- -- -- -- 52,500 5 Net loss -- -- -- -- -- -- ------------ -- ------------ ------------ ------------ ------------ Balance, September 30, 2004 232,750 -- 25,000 $ 26 4,666,324 $ 467 ------------ -- ------------ ------------ ------------ ------------
Additional Paid-in Capital --------------------- Accumulated Gross Discount Deficit Total ------------ --- ------------ ------------ Balance, September 30, 2003 $ 58,829,927 $-- $(55,576,128) $ 3,254,152 Proceeds from sale of stock, net 1,362,582 -- -- 1,362,634 Issuance of shares, warrants and options for services and incentives 957,582 -- -- 957,602 Conversion of Series A-8 and A-9 preferred shares to common shares (13) -- -- -- Issuance of shares and warrants for loan payments and interest 1,054,977 -- -- 1,055,021 Issuance of shares for 154,234 -- -- 154,240 satisfaction of obligations Dividends paid 113,920 -- (128,121) (14,196) Net loss -- -- (3,972,666) (3,972,666) ------------ --- ------------ ------------ Balance, September 30, 2004 $ 62,473,209 $-- $(59,676,915) $ 2,796,787 ------------ --- ------------ ------------
(Continued) F-5 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY YEARS ENDED SEPTEMBER 30, 2004 AND 2005 (Continued)
Preferred Stock ------------------------------------------------------------ Series Series Series Common Stock A8/A9 A10 A11 ------------ --------------------------- Shares Shares Shares Amount Shares Amount ------------ ------------ ------------ ------------ ------------ ------------ Balance, September 30, 2004 232,750 -- 25,000 $ 26 4,666,324 $ 467 Issuance of shares, warrants and options for Acquired Onstream purchase -- -- -- -- 2,207,966 221 Issuance of Series A-10 preferred shares, net -- 315,000 -- 32 -- -- Conversion of Series A-8 shares into Series A-10 preferred shares (232,750) 139,650 -- (9) -- -- Conversion of 8% Convertible Debentures to common shares -- -- -- -- 2,725,659 273 Conversion of Series A-10 preferred shares to common shares -- (61,969) -- (6) 619,690 62 Issuance of shares, warrants and options for services and incentives -- -- -- -- 712,626 71 Redemption of Series A-11 shares -- -- (25,000) (3) -- -- Warrants issued with 8% Convertible Debentures -- -- -- -- -- -- Common shares issued for severance and professional services -- -- -- -- 300,000 30 Common shares issued for financing penalty -- -- -- -- 606,000 61 Common shares issued for interest on 8% Convertible Debentures and Notes Payable -- -- -- -- 352,736 34 Series A-10 preferred shares issued for interest -- 8,562 -- -- -- -- Dividends accrued on Series A-10 preferred -- 14,788 -- 1 -- -- Equity securities subject to potential rescission -- -- -- -- -- -- Net loss -- -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ ------------ Balance, September 30, 2005 -- 416,031 -- $ 41 12,191,001 $ 1,219 ------------ ------------ ------------ ------------ ------------ ------------
Additional Paid-in Capital ---------------------------- Accumulated Gross Discount Deficit Total ------------ ------------ ------------ ------------ Balance, September 30, 2004 $ 62,473,209 $ -- $(59,676,915) $ 2,796,787 Issuance of shares, warrants and options for Acquired Onstream purchase 7,311,672 -- -- 7,311,893 Issuance of Series A-10 preferred shares, net 5,905,919 (2,928,041) -- 2,977,910 Conversion of Series A-8 shares into Series A-10 preferred shares 9 -- -- -- Conversion of 8% Convertible Debentures to common shares 2,725,386 -- -- 2,725,659 Conversion of Series A-10 preferred shares to common shares (56) 356,550 (356,550) -- Issuance of shares, warrants and options for services and incentives 1,678,794 -- -- 1,678,865 Redemption of Series A-11 shares (499,997) -- -- (500,000) Warrants issued with 8% Convertible Debentures 4,246,483 -- -- 4,246,483 Common shares issued for severance and professional services 470,970 -- -- 471,000 Common shares issued for financing penalty 943,779 -- -- 943,840 Common shares issued for interest on 8% Convertible Debentures and Notes Payable 459,140 -- -- 459,174 Series A-10 preferred shares issued for interest 85,620 -- -- 85,620 Dividends accrued on Series A-10 preferred 147,877 504,030 (768,882) (116,974) Equity securities subject to potential rescission (10,392,762) -- -- (10,392,762) Net loss -- -- (9,637,888) (9,637,888) ------------ ------------ ------------ ------------ Balance, September 30, 2005 $ 75,556,043 $ (2,067,461) $(70,440,235) $ 3,049,607 ------------ ------------ ------------ ------------
The accompanying notes are an integral part of these consolidated financial statements. F-6 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended -------------------------- September 30, 2005 2004 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net loss $(9,637,888) $(3,972,666) Adjustments to reconcile net loss to net cash (used in) operating activities: Depreciation and amortization 1,152,633 1,373,587 Amortization of discount on notes payable 494,150 337,624 Amortization of discount on convertible debentures 2,065,592 89,635 Interest penalty payable in common shares 943,840 -- Interest expense paid in common shares 367,838 119,874 Interest expense paid in A-10 preferred shares 85,620 -- Amortization of deferred services and incentives, including 1,768,598 645,649 shares issued for severance and services Impairment loss on goodwill 330,000 470,000 Loss on equity basis investment in Acquired Onstream 100,025 276,240 Decrease in allowance for doubtful accounts 694 35,999 Gain from settlements of obligations (44,079) (458,286) Loss on disposition/retirement of fixed assets 28,252 30,139 Changes in assets and liabilities, net of effects from the Onstream Merger: Decrease (Increase) in accounts receivable 89,936 (585,033) Decrease (Increase) in prepaid expenses 108,524 (101,498) Decrease (Increase) in other current assets (1,270) (868) (Increase) Decrease in inventories (35,125) 118,438 Increase in accounts payable and accrued liabilities 253,709 488,575 Increase in deferred revenue 43,260 34,796 ----------- ----------- Net cash (used in) operating activities (1,885,691) (1,097,795) ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Advances to Acquired Onstream (1,457,811) (512,512) Costs of Onstream Merger (153,317) -- Payment of accounts payable and accrued liabilities assumed at time of Onstream Merger (510,373) -- Acquisition of property and equipment (1,732,815) (190,424) Sale of assets 50,000 -- Purchase of Virage software and assets -- (648,250) ----------- ----------- Net cash (used in) investing activities (3,804,316) (1,351,186) ----------- -----------
(Continued) F-7 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
Years Ended ---------------------------- September 30, 2005 2004 ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from sale of 8% Convertible Debentures, net of expenses $ 4,013,713 $ -- Proceeds from sale of Additional 8% Convertible Debentures, 2,115,500 -- net of expenses Proceeds from Series A-10 convertible preferred, net of expenses 1,977,910 -- Proceeds from restricted cash 200,000 794,432 Proceeds from loans and notes payable 750,000 400,000 Proceeds from convertible debenture -- 150,000 Proceeds from issuance of common stock, net -- 862,635 Proceeds from subscription receivable for preferred stock -- 300,000 Dividends (116,974) (14,196) Repayment of loans, notes and leases payable (2,760,274) (3,475) (Payment of) proceeds from Series A-11 convertible preferred (500,000) 500,000 Payment of convertible debentures -- (608,520) ------------ ------------ Net cash provided by financing activities 5,679,875 2,380,876 ------------ ------------ NET (DECREASE) IN CASH AND CASH EQUIVALENTS (10,132) (68,105) CASH AND CASH EQUIVALENTS, beginning of period 14,269 82,374 ------------ ------------ CASH AND CASH EQUIVALENTS, end of period 4,137 14,269 ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Cash payments for interest $ 55,606 $ 40,303 ============ ============ SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Issuance of shares, options and warrants in conjunction with the Onstream Merger $ 7,311,893 $ -- Issuance of warrants with 8% Convertible Debentures $ 695,525 $ -- Issuance of warrants with Additional 8% Convertible Debentures $ 1,230,732 $ -- Issuance of warrants with Series A-10 convertible preferred $ 922,756 $ -- Conversion of note payable to Series A-10 convertible preferred $ 1,000,000 $ -- Conversion of Series A-8 convertible preferred to Series A-10 convertible preferred $ 1,396,500 $ -- Conversion of Series A-10 convertible preferred to common shares $ 619,690 $ -- Conversion of 8% Convertible Debentures to common shares $ 2,705,000 $ -- Conversion of convertible debentures to common shares $ -- $ 150,000 Conversion of preferred stock to common stock $ -- $ 450,000 Equity securities becoming subject to potential rescission including portion classified as liability $ 10,392,762 $ -- Issuance of common shares for repayment of debt $ -- $ 750,000 Issuance of shares, warrants and options for deferred services and incentives $ 1,678,865 $ 957,602 Issuance of shares for payment of accounts payable $ -- $ 72,300 Advances to Acquired Onstream by issuing common stock $ -- $ 81,940 Issuance of common shares for severance, services and financial penalties $ 1,414,840 $ -- Issuance of common shares for interest $ 459,174 $122, 015 Issuance of A-10 preferred shares for interest and dividends $ 233,498 $ -- Sale of Curaspan investment for promissory note (fully reserved) $ 150,000 Issuance of common shares for dividends $ -- $ 113,925 Settlement of accounts and notes payable $ -- $ 456,286
The accompanying notes are an integral part of these consolidated financial statements. F-8 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES Nature of Business Onstream Media Corporation (formerly Visual Data Corporation) (the "Company" or "Onstream" or "ONSM"), organized in 1993, is an online service provider of live and on-demand rich media communications, including digital asset management services and webcasting. Digital asset management services are provided primarily to entertainment, advertising and financial industry customers. Webcasting services are provided primarily to corporate, education, government and travel industry customers. See Note 2 regarding the Company's December 23, 2004 acquisition of Acquired Onstream. As a result of that acquisition, the Company changed its name to Onstream Media Corporation in January 2005 and has reorganized the previous three operating groups into two groups - Digital Asset Management and Webcasting. The Digital Asset Management group includes the previous Networking Solutions Group, as well as the operations resulting from software licenses and other assets acquired from Virage, Inc. and Acquired Onstream. The new Webcasting Group includes the previous Webcasting and Travel groups. Our Digital Asset Management Group, which operates from facilities in San Francisco, California, provides digital asset management services. Digital asset management is a set of coordinated technologies and processes that allow the quick and efficient storage, retrieval, and reuse of the digital files that are essential to all businesses. These digital files include photos, videos, audio files, engineering specs, architectural plans, web pages, and many other pieces of business collateral. Digital asset management provides the business rules and processes needed to acquire, store, index, secure, search, export and transform these assets and their descriptive information. In addition, through our subsidiary doing business under the name EDNet, the Digital Asset Management Group provides connectivity within the entertainment and advertising industries through its managed network, which encompasses production and post-production companies, advertisers, producers, directors, and talent. The global network, with approximately 500 active clients in cities throughout the United States, Canada, Mexico, Europe, and the Pacific Rim, enables high-speed exchange of high quality audio, compressed video and multimedia data communications, utilizing long distance carriers, regional phone companies, satellite operators, and major internet service providers. EDNet also provides systems integration and engineering services, application-specific technical advice, audio equipment, proprietary and off-the-shelf codecs, teleconferencing equipment, and other innovative products to facilitate the Company's broadcast and production applications. EDNet generates revenues from the sale, rental and installation of equipment, network usage, distribution fees and other related fees. The Webcasting Group provides an array of web-based media services to the corporate market including live audio and video webcasting, packaged corporate announcements, and rich media information storage and distribution for any business entity. The Webcasting Group also produces Internet-based multi-media streaming videos related to hotels, resorts, time-shares, golf facilities, and other travel destinations. The Company warehouses this travel content on its own on-line travel portal - www.travelago.com ("Travelago"). See Note 3 regarding the disputed sale of these travel related assets and operations. The Webcasting Group generates revenues through production and distribution fees. F-9 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Liquidity and Going Concern The consolidated financial statements have been presented on the basis that the Company is a going concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred losses since its inception, and has an accumulated deficit of approximately $70.4 million as of September 30, 2005. The Company's operations have been financed primarily through the issuance of equity and debt. For the year ended September 30, 2005, ONSM had a net loss of approximately $9.6 million and cash used in operations of approximately $1.9 million. The Company had a working capital deficit of $2,763,711 at September 30, 2005. The Company is constantly evaluating its cash needs and existing burn rate, in order to make appropriate adjustments to operating expenses. Depending on its actual future cash needs, the Company may need to raise additional debt or equity capital to provide funding for ongoing future operations, or to refinance existing indebtedness. No assurances can be given that the Company will be successful in obtaining additional capital, or that such capital will be available on terms acceptable to the Company. The Company's continued existence is dependent upon its ability to raise capital and to market and sell its services successfully. The financial statements do not include any adjustments to reflect future effects on the recoverability and classification of assets or amounts and classification of liabilities that may result if the Company is unsuccessful. The holders of the 8% Convertible Debentures, the Additional 8% Convertible Debentures and the Series A-10 Preferred Stock may be entitled to certain rescission rights - see Note 5. Basis of Consolidation The accompanying consolidated financial statements include the accounts of Onstream Media Corporation and its subsidiaries - Entertainment Digital Network, Inc., Media On Demand, Inc., HotelView Corporation and OSM Acquisition, Inc.. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company uses the equity method of accounting for investments where its ownership is between 20% and 50%. Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Estimates are used when accounting for allowances for doubtful accounts, revenue reserves, inventory reserves, depreciation and amortization, taxes, contingencies and impairment allowances. Such estimates are reviewed on an on-going basis and actual results could materially differ from those estimates. F-10 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Cash and cash equivalents Cash and cash equivalents consists of all highly liquid investments with original maturities of three months or less. Restricted cash Restricted cash consisted of amounts provided by a major investor in conjunction with a loan. The restricted cash is to be utilized by the Company at the lender's discretion. See Note 5. Fair Value of Financial Instruments The carrying amounts of cash and cash equivalents, restricted cash, accounts receivable, accounts payable, accrued expenses and notes payable approximate fair value due to the short maturity of the instruments. Bad Debt Reserves The Company evaluates the collectibility of its accounts receivable based on a combination of factors. In cases where the Company is aware of circumstances that may impair a specific customer's ability to meet its financial obligations to the Company, the Company records a specific allowance against amounts due to us, and thereby reduce the net recognized receivable to the amount the Company reasonably believes will be collected. For all other customers, the Company recognizes allowances for doubtful accounts based on the length of time the receivables are past due, the current business environment and historical experience. At September 30, 2005 and 2004, bad debt reserves were approximately $29,000 and $69,000, respectively. Concentration of Credit Risk The Company at times has cash in banks in excess of FDIC insurance limits and places its temporary cash investments with high credit quality financial institutions. The Company performs ongoing credit evaluations of its customers' financial condition and does not require collateral from them. Reserves for credit losses are maintained at levels considered adequate by management. See Note 7 regarding revenues from significant customers. Inventories Inventories are stated at the lower of cost (first-in, first-out method) or market by analyzing market conditions, current sales prices, inventory costs, and inventory balances. The Company evaluates inventory balances for excess quantities and obsolescence on a regular basis by analyzing backlog, estimated demand, inventory on hand, sales levels and other information. Based on that analysis, the Company management estimates the amount of provisions made for obsolete or slow moving inventory. Property and Equipment Property and equipment are recorded at cost, less accumulated depreciation. Property and equipment under capital leases are stated at the lower of the present value of the minimum lease payments at the beginning of the lease term or the fair value at the inception of the lease. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets. Amortization expense on assets acquired under capital leases is included in depreciation expense. The costs of leasehold improvements are amortized over the lesser of the lease term or the life of the improvement. F-11 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Software Included in property and equipment is computer software developed for internal use, including the Digital Media Services Platform ("DMSP") - see notes 2 and 3. Such amounts have been accounted for in accordance with Statement of Position 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" and Emerging Issues Task Force pronouncement ("EITF") 00-2 "Accounting for Web Site Development Costs". Such costs are amortized on a straight-line basis over three years, commencing when the related asset has been substantially placed in service. Goodwill and other intangible assets Statement of Financial Accounting Standards ("SFAS") 142, "Goodwill and Other Intangible Assets", adopted by the Company effective October 1, 2001, provides that goodwill is no longer amortized but is reviewed annually (or more frequently if impairment indicators arise) for impairment. Other intangible assets, such as customer lists, continue to be amortized to expense over their estimated useful lives, although they are still subject to review and adjustment for impairment. The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company assesses the recoverability of such assets by comparing the estimated undiscounted cash flows associated with the related asset or group of assets against their respective carrying amounts. The amount of an impairment, if any, is calculated based on the excess of the carrying amount over the fair value of those assets. See Note 2 - Goodwill and other Acquisition-Related Intangible Assets. Revenue Recognition Revenues from sales of goods and services are recognized when (i) persuasive evidence of an arrangement between the Company and the customer exists, (ii) the good or service has been provided to the customer, (iii) the price to the customer is fixed or determinable and (iv) collectibility of the sales prices is reasonably assured. The Digital Asset Management Group recognizes revenues from the acquisition, editing, transcoding, indexing, storage and distribution of its customers' digital media. The customer charges are generally based on the activity or volume of such media, expressed in megabytes or similar terms, and are recognized at the time the service is performed. Fees charged to customers for customized applications or set-up are recognized as revenue at the time the application or set-up is completed. The EDNet division of the Digital Asset Management Group generates revenues from customer usage of digital telephone connections controlled by the Company, bridging services and the sale of equipment. The Company purchases digital phone lines from telephone companies and sells access to the lines, as well as separate per-minute usage charges. Network usage and bridging revenue is recognized based on the timing of the customer's use of those services. F-12 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Revenue Recognition (Continued) The equipment EDNet sells is various audio codecs and video transport systems. The audio codecs and video transport systems enable customers to collaborate with other companies or with other locations. As such, revenue is recognized for the sale of equipment when the equipment is installed or upon signing of a contract after a free trial period. All sales are final and there are no refund rights or rights of return. The Company leases some equipment to customers under terms that are accounted for as operating leases. Rental revenue from leases is recognized ratably over the life of the lease and the related equipment is depreciated over its estimated useful life. All leases of the related equipment contain fixed terms. The Webcasting Group recognizes revenue from live and on-demand webcasts at the time an event is accessible for streaming over the Internet. Webcasting services are provided to customers using the Company's proprietary streaming media software, tools and processes. Customer billings are typically based on (i) the volume of data streamed at rates agreed upon in the customer contract or (ii) a set monthly fee. Since the primary deliverable for the webcasting group is a webcast, returns are inapplicable. If the Company has difficulty in producing the webcast, it may reduce the fee charged to the customer. Historically these reductions have been immaterial, and are recorded in the month the event occurs. Services for live webcast events are usually sold for a single price that includes on-demand webcasting services in which the Company hosts an archive of the webcast event for future access on an on-demand basis for periods ranging from one month to one year. However, on-demand webcasting services are sometimes sold separately without the live event component and the Company has referred to these separately billed transactions as verifiable and objective evidence of the amount of its revenues related to on-demand services. In addition, the Company has determined that the material portion of all views of archived webcasts take place within the first ten days after the live webcast. Based on its review of the above data, the Company has determined that the material portion of its revenues for on-demand webcasting services are recognized during the period in which those services are provided, which complies with the provisions of Staff Accounting Bulletin ("SAB") No. 101 and SAB 104, "Revenue Recognition", and EITF 00-21, "Accounting for Revenue Arrangements with Multiple Elements". Furthermore, the Company has determined that the maximum potentially deferrable revenue from on-demand webcasting services charged for but not provided as of September 30, 2005 and 2004 is immaterial in relation to the Company's recorded liabilities. The Webcasting Group recognizes a portion of their travel contract revenue at the time of completion of video production services with the remaining revenue recognized over the term of the contract. Per hit charges are recognized when users watch a video on the Internet. Fixed monthly fees are recognized on a monthly basis consistent with the terms of the contract. Commissions on bookings are recognized when the stays are completed. Deferred revenue represents amounts billed to customers for webcasting, EDNET or digital asset management services to be provided in future accounting periods. As projects or events are completed and/or the services provided, the revenue is recognized. Comprehensive Income or Loss The Company has no components of other comprehensive income or loss, and accordingly, net loss equals comprehensive loss for all periods presented. F-13 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Advertising and marketing Advertising and marketing costs, which are charged to operations as incurred, were approximately $204,000 and $13,000 for the years ended September 30, 2005 and 2004, respectively. Derivatives The Company accounts for non-hedging contracts that are indexed to, and potentially settled in, its own common stock in accordance with the provisions of EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock". These non-hedging contracts accounted for in accordance with EITF 00-19 include freestanding warrants to purchase the Company's common stock as well as embedded conversion features that have been bifurcated from the host financing contract in accordance with the requirements of SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". Under certain circumstances that could require the Company to settle these equity items in cash or stock, and without regard to probability, EITF 00-19 could require the classification of all or part of the item as a liability and the adjustment of that reclassified amount to fair value at each reporting date, with such adjustments reflected in the Company's statement of operations. Income Taxes As part of the process of preparing our consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves estimating current tax exposure together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included within the Company's consolidated balance sheet. The Company then assesses the likelihood that the deferred tax assets will be recovered from future taxable income and to the extent it believes that recovery is not likely, it establishes a valuation allowance. To the extent the Company establishes a valuation allowance or changes this allowance in a period, it includes an expense or a benefit within the tax provision in the Company's statement of operations. The Company has approximately $59.0 million in net operating loss carryforwards at of September 30, 2005, which expire in 2011 through 2025. The utilization of approximately $16.0 million of the net operating loss carryforward, acquired from the 2001 acquisition of EDNET and the 2002 acquisition of MOD and included in this total, against future taxable income may be limited as a result of ownership changes and other limitations. The Company also has an approximately $3.5 million capital loss carryforward which expires in 2008. F-14 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Income Taxes (continued) Significant judgment is required in determining the Company's provision for income taxes, its deferred tax assets and liabilities and any valuation allowance recorded against those deferred tax assets. The Company has a deferred tax asset of approximately $22.2 million primarily resulting from the net operating loss carryforwards. A full valuation allowance has been recorded related to the deferred tax asset due to the uncertainty of realizing the benefits of certain net operating loss carryforwards before they expire. The valuation allowance is based on the Company's historical taxable income and its estimates of future taxable income in each jurisdiction in which it operates and the period over which its deferred tax assets will be recoverable. Management will continue to assess the likelihood that the deferred tax asset will be realizable and the valuation allowance will be adjusted accordingly. Accordingly, no income tax benefit has been recorded in the accompanying consolidated statement of operations as a result of the net tax losses of approximately $1.8 million and $2.9 million for the years ended September 30, 2005 and 2004, respectively. The primary differences between the net loss for book and tax purposes are the following items expensed for book purposes but not deductible for tax purposes - amortization of customer lists, valuation allowance of goodwill, losses on an equity basis from Acquired Onstream, inventory and receivable reserves, and expenses for stock options issued in payment for consulting and other professional fees but not exercised by the recipients. In addition, the amount of depreciation expense allowed for tax purposes currently exceeds the depreciation expense on the Company's consolidated financial statements. There are no significant cumulative temporary differences as of September 30, 2005. Net Loss Per Share For the years ended September 30, 2005 and 2004, net loss per share is based on the weighted average number of shares of common stock outstanding, which includes the effect of 606,000 penalty shares that the Company was obligated to issue through June 29, 2005, and did issue on such date, under the terms of a convertible debenture agreement- see Note 6. Since the effect of common stock equivalents was anti-dilutive, all such equivalents were excluded from the calculation of net loss per share. The total outstanding options and warrants, which have been excluded from the calculation of net loss per share, were 15,114,093 and 1,134,274 at September 30, 2005 and 2004, respectively, which includes contingent warrants - see Notes 4 and 8. In addition, the potential dilutive effects of the following convertible securities outstanding at September 30, 2005 have been excluded from the calculation of net loss per share: (i) 416,031 shares of Series A-10 Convertible Preferred Stock ("Series A-10") which could potentially convert into 4,160,310 shares of our common stock and (ii) $3,820,000 of senior secured convertible notes ("8% Convertible Debentures") which could potentially convert into 3,820,000 shares of our common stock. F-15 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 Stock Compensation The Company has a stock based compensation plan for its employees (the "Plan"). The Company has elected to continue using Accounting Principles Board Opinion ("APB") 25, "Accounting for Stock Issued to Employees," in accounting for employee stock options. The following table summarizes the pro forma consolidated results of operations of the Company as though the fair value based accounting method in "Accounting for Stock-Based Compensation" ("SFAS 123") had been used in accounting for employee options issued within the Plan ("Plan Options") and outside the Plan ("Non-Plan Options"). For the years ended September 30, ---------------------------- 2005 2004 ------------ ------------ Net loss, as reported $ (9,637,888) $ (3,972,666) Total stock based compensation expense * (2,401,720) (532,610) ------------ ------------ Pro forma net loss $(12,039,608) $ (4,505,276) ============ ============ Net loss per share - basic and diluted: Net loss per share, as reported $ (1.17) $ (0.92) ------------ ------------ Net loss per share, pro forma $ (1.46) $ (1.04) ------------ ------------ * Total stock based compensation expense is determined by applying the fair value based method for all employee awards, net of tax. The fair value of each option granted is estimated on the date of grant using the Black-Scholes model with the following assumptions: expected volatility of 44% to 65%, risk-free interest rate of 6.25%, expected dividends of $0 and expected term is the full term of the related option, ranging from 4 to 5 years. In December 2004, the Company issued 1,350,000 Non-Plan Options to directors and management as additional compensation for the closing of the Onstream Merger, which it accounted for in accordance with APB 25. The compensation value of these options, approximately $1.0 million, is included in the above table for the year ended September 30, 2005, as it is considered to be an internal cost associated with a business combination, which is expensed in accordance with SFAS 141, "Business Combinations". See Note 2. The Company has granted Non-Plan Options to consultants and other third parties. These options have been accounted for under SFAS 123, under which the fair value of the options at the time of their issuance is reflected in the Company's consolidated financial statements and expensed at the time the services contemplated by the options are provided to the Company. In December 2004, the FASB issued SFAS 123R, "Share-Based Payments", which requires all companies to measure compensation cost for all share-based payments, including employee stock options, at fair value. In April 2005, the Securities and Exchange Commission ("SEC") made certain changes to the effective dates of SFAS 123R. SFAS 123R, as amended by the SEC, is effective for public companies for the first interim or annual period of their fiscal year beginning after June 15, 2005, except small business issuers (as defined in SEC Regulation S-B), for which it is effective for the first fiscal year beginning after December 15, 2005. The Company is in the process of determining the impact of this statement on its consolidated financial statements, although our ability to quantify the future impact is limited due to the lack of our ability to predict future share-based payments and the potential variability of these payments between accounting periods. See Note 8 for additional information related to all stock option issuances. F-16 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Employee 401(k) plan The Company's 401(k) plan, the Onstream Media Corporation 401(k) Retirement Plan and Trust (the "Plan"), is available to all full-time employees and provides them with tax deferred salary reductions and alternative investment options (directly solely by the employees). Employees may contribute a portion of their salary, subject to certain limitations, including an annual maximum of $14,000 for employees under 50 years of age and $18,000 for employees over 50 years of age. The Company matches employees' contributions to the Plan, up to the first 8% of eligible compensation, at a 25% rate. The Company's matching contribution was approximately $38,000 and $25,000 for the years ended September 30, 2005 and 2004, respectively. The Company expensed approximately $28,000 and $8,000 in those fiscal years, respectively, with the remaining amounts of $10,000 and $17,000., respectively, satisfied by amounts previously funded by the Company but forfeited by terminated employees. The Company's contributions to the Plan vest over five years. Reclassifications Certain prior year amounts have been reclassified to conform to the current year presentation. F-17 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Effects of Recent Accounting Pronouncements In November 2004, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards ("SFAS") 151, "Inventory Costs", an amendment of ARB No. 43, Chapter 4. The amendments made by SFAS 151 clarify that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and require the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The guidance is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. Earlier application is permitted for inventory costs incurred during fiscal years beginning after November 23, 2004. . The Company has evaluated the impact of the adoption of SFAS 151, and does not believe the impact will be significant to the Company's overall results of operations or financial position. In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets, an amendment of APB 29, Accounting for Nonmonetary Transactions." The amendments made by SFAS 153 are based on the principle that exchanges of nonmonetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for nonmonetary exchanges of similar productive assets and replace it with a broader exception for exchanges of nonmonetary assets that do not have commercial substance. Previously, APB 29 required that the accounting for an exchange of a productive asset for a similar productive asset or an equivalent interest in the same or similar productive asset should be based on the recorded amount of the asset relinquished. APB 29 provided an exception to its basic measurement principle (fair value) for exchanges of similar productive assets. The FASB believes that exception required that some nonmonetary exchanges, although commercially substantive, be recorded on a carryover basis. By focusing the exception on exchanges that lack commercial substance, the FASB believes SFAS 153 produces financial reporting that more faithfully represents the economics of the transactions. SFAS 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchanges occurring in fiscal periods beginning after the date of issuance. The provisions of this statement shall be applied prospectively. The Company is in the process of determining the impact of this statement on its consolidated financial statements. In December 2004, the FASB issued SFAS 123R, "Share-Based Payments", which is discussed in this Note 1 above, under "Stock compensation". In March 2005, the FASB issued FASB Interpretation ("FIN") 47, "Accounting for Conditional Asset Retirement Obligations", which clarifies that the term "conditional asset retirement obligations" as used in SFAS 143, "Accounting for Asset Retirement Obligations", refers to a legal obligation to perform an asset retirement activity in which the timing and/or the method of settlement are conditional on a future event that may or may not be within the control of the entity. This uncertainty should be factored into measurement of the liability, based on guidance provided in FIN 47. FIN 47 is effective for fiscal years ending after December 15, 2005 and adoption by the Company is not expected to have a material impact to the Company's overall results of operations or financial position. F-18 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES (Continued) Effects of Recent Accounting Pronouncements (Continued) In June 2005, the FASB issued SFAS 154, "Accounting Changes and Error Corrections", which replaced APB Opinion 20, "Accounting Changes" and SFAS 3, "Reporting Accounting Changes in Interim Financial Statements". SFAS 154 changes the requirements for the accounting and reporting of a change in an accounting principle. APB 20 required that most voluntary changes in accounting principle be recognized by including the cumulative effect of the new principle in net income for the period of the change. SFAS 154 now requires retrospective application of changes in an accounting principle to prior period financial statements, unless it is impracticable to determine the necessary information. SFAS 154 is effective for fiscal years beginning after December 15, 2005 and adoption by the Company is not expected to have a material impact to the Company's overall results of operations or financial position. In June 2005, the Emerging Issues Task Force ("EITF") issued EITF 05-2, "The Meaning of Conventional Convertible Debt Instrument in Issue No. 00-19". EITF 05-2 retained the definition of a conventional convertible debt instrument as set forth in EITF 00-19, and which is used in determining certain exemptions to the accounting treatments prescribed under SFAS 133, "Accounting for Derivative Instruments and Hedging Activities". EITF 05-2 also clarified that certain contingencies related to the exercise of a conversion option would not be outside the definition of "conventional" and determined that convertible preferred stock with a mandatory redemption date would also qualify for similar exemptions if the economic characteristics of the preferred stock are more akin to debt than equity. EITF 05-2 is effective for new instruments entered into and instruments modified in periods beginning after June 29, 2005 We adopted the provisions of EITF 05-2 on July 1, 2005, which did not have a material effect on our financial statements. However, see Notes 4 and 5 related to classification of certain amounts related to detachable warrants and embedded conversion features as a liability as of September 30, 2005, which was based on our application of EITF 00-19 as well as other authoritative literature. In July 2005, the FASB issued FASB Staff Position ("FSP") 150-5, "Accounting Under SFAS 150 for Freestanding Warrants and Other Similar Instruments on Redeemable Shares". FSP 150-5 clarifies that warrants on shares that are redeemable or puttable immediately upon exercise and warrants on shares that are redeemable or puttable in the future qualify as liabilities under SFAS 150, regardless of the redemption feature or redemption price. The FSP is effective for the first reporting period beginning after June 30, 2005, with resulting changes to prior period statements reported as the cumulative effect of an accounting change in accordance with the transition provisions of SFAS 150. We adopted the provisions of FSP 150-5 on July 1, 2005, which did not have a material effect on our financial statements. However, see Note 4 related to classification of certain amounts related to detachable warrants and embedded conversion features as a liability as of September 30, 2005, which was based on our application of SFAS 150 as well as other authoritative literature. In July 2005, the FASB issued EITF 05-6, "Determining the Amortization period for Leasehold Improvements Purchased After Lease Inception or Acquired in a Business Combination", which addressed the amortization period for leasehold improvements made on operating leases acquired significantly after the beginning of the lease. The EITF is effective for leasehold improvements made in periods beginning after June 29, 2005. We adopted the provisions of EITF 05-6 on July 1, 2005, which did not have a material impact to the Company's overall results of operations or financial position. F-19 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS Information regarding the Company's intangible assets is as follows:
September 30, 2005 September 30, 2004 -------------------------------------------- -------------------------------------------- Gross Gross Carrying Accumulated Net Book Carrying Accumulated Net Book Amount Amortization Value Amount Amortization Value ------------ ------------ ------------ ------------ ------------ ------------ Goodwill-Acquired Onstream $ 8,421,401 $ -- $ 8,421,401 $ -- $ -- $ -- Goodwill - EDNet 1,271,444 -- 1,271,444 1,601,444 -- 1,601,444 Customer Lists - MOD 3,071,722 (2,303,791) 767,931 3,071,722 (1,689,447) 1,382,275 Customer Lists - Virage 332,000 (182,170) 149,830 332,000 (68,779) 263,221 ------------ ------------ ------------ ------------ ------------ ------------ $ 13,096,567 $ (2,485,961) $ 10,610,606 $ 5,005,166 $ (1,758,226) $ 3,246,940 ============ ============ ============ ============ ============ ============
On October 22, 2003 the Company executed an agreement and plan of merger agreement with privately held Acquired Onstream to acquire the remaining 74% of Acquired Onstream not already owned by the Company. On December 23, 2004, after approval by a majority of the Company's shareholders in a duly constituted meeting, Acquired Onstream was merged with and into OSM Acquisition Inc., a Delaware corporation and the Company's wholly owned subsidiary (the "Onstream Merger"). At that time, all outstanding shares of Acquired Onstream capital stock and options not already owned by the Company were converted into 2,207,966 shares of the ONSM restricted common stock and 463,554 options and warrants to purchase ONSM common stock at an exercise price of $3.376 per share. An investment banking firm issued a fairness opinion regarding this transaction to the Company's board of directors. Acquired Onstream was a development stage company founded in 2001 that began the development of a feature rich digital asset management service, offered on an application service provider ("ASP") basis, to allow corporations to better manage their digital rich media without the major capital expense for the hardware, software and additional staff necessary to build their own digital asset management solution. This new product (the "Onstream Media Platform") is being designed and managed by Science Applications International Corporation ("SAIC"), one of the country's foremost IT security firms, providing services to all branches of the federal government as well as leading corporations. The summarized balance sheet of Acquired Onstream as of the December 23, 2004 Onstream Merger is as follows, showing the fair values assigned by the Company to Acquired Onstream's assets and liabilities in accordance with SFAS 141 and recorded by the Company at that time. Cash and other current assets $ 36,059 Property and equipment 2,667,417 ------------ Total assets $ 2,703,476 ============ Accounts payable and accrued expenses $ 814,739 Notes payable and capitalized lease 335,179 ------------ Total liabilities 1,149,918 Shareholder's equity 1,553,558 ------------ Total liabilities and shareholder's equity $ 2,703,476 ============ F-20 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued) Property and equipment in the above table represents the partially completed Digital Media Services Platform ("DMSP"), primarily Acquired Onstream's payments to its vendors SAIC, Virage, North Plains and Nine Systems. This was the primary asset included in the purchase of Acquired Onstream, and was recorded at fair value as of the December 23, 2004 closing, in accordance with SFAS 141 - see Note 3. The fair value, determined by an independent third party appraiser, was primarily based on the discounted projected cash flows related to this asset for the next five years, as projected by the Company's and Acquired Onstream's management on a stand-alone basis without regard to the Onstream Merger. The discount rate utilized by the independent third party appraiser considered equity risk factors (including small stock risk and bridge/IPO stage risk) as well as risks associated with profitability and working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining. The $8,421,401 excess included in the $9,974,959 (see below) paid by the Company for 100% of Acquired Onstream over $1,553,558 (the fair values assigned to the tangible and intangible assets, net of liabilities at fair value) was recorded by the Company as goodwill, subject to regular future valuations and adjustments as required by SFAS 142. The Company's management performed internal valuations of this goodwill as of December 31, 2004 and as of September 30, 2005, determining that no impairment existed as of those dates. These internal valuations were performed on a basis consistent with the valuations of EDNET and MOD in conjunction with the September 30, 2005 and 2004 financial statements. The Company anticipates that its next evaluation of the Acquired Onstream goodwill and other intangible assets will be performed in connection with its December 31, 2005 financial statements and at least annually thereafter. In the event that it is determined that the Company will be unable to successfully complete, produce, market, or sell the DMSP, an impairment charge reflected in the Company's statement of operations could result at that time. Accounts payable of $435,000 was comprised of amounts due to SAIC, North Plains and other vendors, which have been paid by the Company as of April 1, 2005 and therefore the carrying values were determined to be a reasonable approximation of fair value. Accrued expenses included $362,000 of salary and expenses due to Company shareholders and officers, who were major shareholders in Acquired Onstream. This amount is after reduction for $200,000 paid by the Company at the time of the Onstream Merger and the repayment of these remaining amounts is subject to mutual agreement by the Company and the officers. Therefore, the carrying values were determined to be a reasonable approximation of fair value. $100,000 of the remaining amount was paid by the Company in February 2005. A note payable of $181,500 bearing interest was repaid by the Company in February 2005 and therefore the carrying value plus the interest included in accrued expenses is determined to be a reasonable approximation of fair value. The capitalized lease liability of $153,000 bears interest at rates approximating market - see notes 4 and 5. The $9,974,959 paid by the Company for 100% of Acquired Onstream, was comprised of the following: $6,623,898 - the value of 2,207,966 shares of ONSM restricted common stock, issued in exchange for all outstanding shares of Acquired Onstream capital stock and options not already owned by the Company as of December 23, 2004 and valued based on the Company's share value of $3.00 on October 22, 2003, the date the Company executed the merger agreement for the remaining 74% of Acquired Onstream not already owned by the Company, such valuation date established in accordance with the requirements of SFAS 141. F-21 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued) $688,000 - the value of 462,073 options and warrants to purchase ONSM common stock at an exercise price of $3.376 per share, valued based on Black-Sholes methodology. $402,563 - the carrying value of the Company's investment in Acquired Onstream prior to the Onstream Merger, comprised of prior investments of $950,000 in cash and stock, reduced by $547,437 representing the Company's share of Acquired Onstream operating losses, accounted for by the Company on the equity basis through December 23, 2004. In March 2003, the Company increased its initial $200,000 investment in Acquired Onstream by an additional $750,000 through the issuance of Series A-7 Convertible Preferred Stock. At that time, the Company appointed two of the four members of the Acquired Onstream board of directors and began to account for its investment in Acquired Onstream under the equity method. Included in other income and expense for the nine months ended June 30, 2005 and 2004 are losses of approximately $100,000 and $223,000, respectively, which represent approximately 28% of Acquired Onstream's net loss for those periods. The equity method of accounting was discontinued after the Onstream Merger. $2,098,832 - Cash and other advances made to or on behalf of Acquired Onstream prior to the Onstream Merger, including the Company's payment of $1,477,438 for principal and interest on Acquired Onstream's note payable to Virage, guaranteed by the Company. $161,666 - Direct costs of the Acquired Onstream purchase, including a fairness opinion from an investment banking firm. The Company also issued common stock options to directors and management as additional compensation for the Onstream Merger - see "stock compensation" in Note 1. The carrying value of the Company's investment in Acquired Onstream at September 30, 2004 was $502,589, included in the balance sheet caption other non-current assets. Also included in other non-current assets at that date was $642,671 advanced from the Company to or on behalf of Acquired Onstream. The following table sets forth the unaudited pro-forma consolidated results of operations for the years ended September 30, 2005 and 2004, giving effect to the Onstream Merger, as if the acquisition had occurred as of the beginning of the periods presented: For the years ended September 30, --------------------------- 2005 2004 (unaudited) Revenue $ 8,166,469 $ 7,584,118 ============ =========== Net loss $ (8,267,456) $(5,514,915) ============ =========== Net loss applicable to common stock $ (9,363,187) $(6,533,809) ============ =========== Net loss per common share $ (0.94) $ (0.81) ============ =========== Net loss applicable to common stock per common share $ (1.06) $ (0.96) ============ =========== F-22 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS (Continued) The above pro-forma numbers include the effects of the $6.5 million in debt and equity financing discussed in Notes 4 and 6, since that financing was a condition of the Onstream Merger. The effect of including the pro-forma adjustments for this financing decreases the pro-forma net loss presented above by approximately $1,629,000 for the year ended September 30, 2005 and increases the pro-forma net loss presented above by approximately $477,000 for the year ended September 30, 2004. The difference between the pro-forma net loss and the pro-forma net loss applicable to common stock as presented above is entirely related to the inclusion of the effects of the equity portion of this $6.5 million financing. EDNet, which is part of the Digital Asset Management Group, was purchased by the Company in June 2001. MOD, which is part of the Webcasting Group, was purchased by the Company in February 2002. In February 2004, the Company acquired certain assets and licensed certain software from Virage, Inc., which operations are part of the Digital Asset Management Group. The consideration was (i) $400,000 cash upon closing and (ii) a convertible secured note payable of $206,250, which was repaid on June 21, 2004. The Company determined that the purchase is not a "significant" transaction under Regulation S-B. SFAS 142, Goodwill and Other Intangible Assets, which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, requires that goodwill no longer be amortized, and instead, be tested for impairment on a periodic basis. The Company performed impairment tests on the two reporting units, the Webcasting Group and EDNet (the previous Networking Solutions Group). The Company, assisted by an independent third party appraiser, assessed the fair value of the net assets of each of those reporting units by considering the projected cash flows of those two groups and by analysis of comparable companies, including such factors as the relationship of the comparable companies' revenues to their respective market values. Based on these factors, the Company reduced the carrying value of EDNet's net assets by $330,000 and $470,000 for the years ended September 30, 2005 and 2004, respectively. The valuations of EDNet and the Webcasting Group incorporate management's estimates of sales growth, which sales estimates are dependent on the effect of the introduction of the DMSP, which is yet to be realized. The Company also concluded that there was no impairment of the Webcasting Group's net assets for the years ended September 30, 2005 and 2004. The Company is required to perform reviews for impairment in future periods, at least annually, that may result in future periodic write-downs. Tests for impairment between annual tests may be required if events occur or circumstances change that would more likely than not reduce the fair value of the net carrying amount. Amortization expense of the customer lists was approximately $728,000 and $683,000 for the years ended September 30, 2005 and 2004, respectively. Estimated amortization expense for future fiscal years is as follows: For the fiscal year ended September 30, 2006 $ 728,000 2007 190,000 ----------- $ 918,000 =========== As of September 30, 2004, the Company owned preferred shares representing a minority interest in Curaspan, Inc. having an original cost of approximately $108,000. This investment was fully reserved since 2002 as a result of Curaspan's continuing operating losses and negative financial condition. However, on August 5, 2005 the Company sold those preferred shares to Curaspan for $50,000 cash and a $150,000 note from Curaspan, payable in equal monthly installments over 2 years at 6% interest, commencing October 4, 2005. The note is collateralized by Curaspan's assets, subordinate to a lending bank's interest in certain of those assets. In addition, the preferred shares are being held in escrow and will be returned to the Company in the event of Curaspan's uncured default under the note. Due to Curaspan's continued operating losses and negative financial condition, proceeds from this sale will be recognized by the Company as other income on a cash basis as received. All scheduled payments have been made through January 4, 2006. F-23 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 3: PROPERTY AND EQUIPMENT Property and equipment, including equipment acquired under capital leases, consists of:
September 30, September 30, ------------ ------------ Useful Lives 2005 2004 (Years) ------------ ------------ --------------- Equipment and Software $ 7,178,929 $ 6,530,075 1-5 DMSP 3,503,879 -- 3 Travel video library 1,368,112 1,368,112 2 Furniture and fixtures 231,905 219,373 5-7 Capitalized internal use software 385,985 113,794 3 Leasehold improvements 234,988 243,833 5 ------------ ------------ 12,903,798 8,475,187 Less: Accumulated depreciation and amortization (8,093,921) (7,730,131) ------------ ------------ Net book value $ 4,809,877 $ 745,056 ============ ============
Depreciation and amortization of property and equipment included in the statements of operations amounted to approximately $413,000 and $675,000 for the years ended September 30, 2005 and 2004, respectively. The DMSP is comprised of four separate "products", only two of which were available on an individual basis at the time of the Onstream Merger. The four separate products are transcoding, storage, search and retrieval and distribution. Effective April 29, 2005, all four products were accessible on an integrated basis via an SAIC designed interface using North Plains technology and incorporating security features available through SAIC. The DMSP has not been depreciated as of September 30, 2005. A limited version of the DMSP, which included three of the four products, was first placed in service with third-party customers in November 2005. See Note 2 regarding the initial purchase of this asset from Acquired Onstream and Note 5 regarding the SAIC contract. On May 18, 2005 the Company agreed to sell its travel video library, as well as all rights associated with that library, including the customer contracts and the related websites, for $455,000. The Company received a $50,000 non-refundable deposit at the time of the initial agreement, with the remaining balance due upon closing, originally anticipated to be no later than September 2005. As part of the sale, the buyer also agreed to pay the Company $15,000 per month for a three-year period, in exchange for hosting and streaming services for the travel video library and similar content obtained elsewhere by the buyer. On September 23, 2005 the buyer filed a legal action against the Company alleging that the Company did not deliver the assets as agreed and seeking return of the $50,000 deposit plus reimbursement of unspecified due diligence expenses, attorney fees and interest. On December 4, 2005, the Company filed a response objecting to all claims by the buyer, which it believes are without merit. The Company has not refunded the deposit, which is included in deferred revenue as of September 30, 2005. The Company does not believe that the ultimate resolution of this matter will have a material impact on its financial condition or results of operations. Pending closing of this transaction, the Company had the right to continue, and has continued, its travel production and distribution operations. The cost of the travel video library is fully depreciated as of September 30, 2005 and the associated travel production and distribution revenues were $208,177 and $251,232, respectively, for the years ended September 30, 2005 and 2004. F-24 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 4: CONVERTIBLE DEBENTURES AND NOTES PAYABLE 8% Convertible Debentures On December 23, 2004, the Company sold senior secured convertible notes ("8% Convertible Debentures"), which have a $1.00 conversion rate per common share and include five-year warrants to purchase 1,522,500 common shares of ONSM for $1.65 per share, to several accredited investors for gross proceeds of $4.35 million. The 8% Convertible Debentures are collateralized by a blanket security interest in our assets and a pledge of the stock of our subsidiaries. The 8% Convertible Debentures included an Additional Investment Right ("AIR") of $2.175 million, of which $2.050 million was exercised in February 2005 and the remaining $125,000 was exercised in April 2005. The debentures issued under the AIR (the "Additional 8% Convertible Debentures") have substantially the same terms as the 8% Convertible Debentures, although additional warrants were granted to induce the early exercise. The Additional 8% Convertible Debentures included five-year warrants to purchase 761,250 common shares of ONSM for $1.65 per share and one-year warrants to purchase 2,175,000 common shares of ONSM for $1.00 per share. The one-year warrants were subject to the approval of a majority of the Company's shareholders, which was obtained at the September 13, 2005 shareholder meeting, and at which time the one-year term of those warrants began. In the event the one-year warrants are exercised, the Company will issue additional five year warrants, exercisable at $1.65 per share, to purchase 50% of the common shares of ONSM acquired upon the exercise of the one-year warrants. The 8% Convertible Debentures contain a provision requiring mandatory redemptions of up to $1.0 million by June 2006, with at least $500,000 of that occurring by December 2005. These redemption amounts are reduced by the amount of securities converted into common shares before those dates. As of September 30, 2005, $2,705,000 of 8% Convertible Debentures, plus accrued interest, had been converted into 2,725,659 common shares. Accordingly, the Company is classifying the entire outstanding balance of the 8% Convertible Debentures as a non-current liability as of September 30, 2005. As of September 30, 2005, $3,820,000 of the 8% Convertible Debentures (including the AIR) had not been converted. See Note 9 regarding conversions occurring after September 30, 2005. The Company included the common shares underlying the 8% Convertible Debentures (including the AIR shares) on a registration statement declared effective by the SEC on June 29, 2005. Beginning on the date of such registration, and provided that the average price during at least 20 days of the 30-day period prior to conversion exceeds $1.63 per share, all or part of the 8% Convertible Debentures will automatically convert to common shares, the dollar amount of the 8% Convertible Debentures being converted based on a formula incorporating the trading volume and share price of ONSM stock. Beginning in September 2007, any remaining 8% Convertible Debentures will be paid in nine equal quarterly installments. All or part of these installments may be paid in ONSM common shares subject to a formula based on trading volume and share price and provided that the volume weighted average share price during the quarter prior to payment exceeds $1.18 per share. However, the number of shares acquired by any holder upon conversion is limited so that following the conversion the total number of shares owned by the holder does not exceed 9.999% of the Company's issued and outstanding stock. The closing ONSM share price was $0.92 per share on January 11, 2006. The 8% Convertible Debentures and the Additional 8% Convertible Debentures provide cash penalties of 1% of the original purchase price for each month that (a) the Company's common shares are not listed on the Nasdaq Small Cap Market for a period of 3 trading days or (b) the common shares underlying those securities and the related warrants are not saleable subject to an S-3 or other registration statement then effective with the SEC. The latter penalty only applies for a five-year period beginning with the June 29, 2005 registration statement effective date and does not apply to shares saleable under the provisions of Rule 144(k). F-25 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 4: CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued) 8% Convertible Debentures (continued) The $1.65 warrants provide that in the event the shares are not subject to an effective registration statement at the time of exercise, the holder could elect a "cashless exercise" whereby the Company would issue shares based on the excess of the market price at the time of the exercise over the warrant exercise price. The holders of the 8% Convertible Debentures and the Additional 8% Convertible Debentures may be entitled to certain rescission rights - see Note 5. Based on the Company's application of EITF 00-19 and SFAS 133, it determined that the existence of the 1% per month penalties for lack of an effective registration and/or listing for the company's shares, as well as the "cashless exercise" option, all discussed above, required that a portion of the amount originally recorded as equity for the $1.00 warrants and the embedded conversion feature in the 8% Convertible Debenture and Additional 8% Convertible Debenture, as well as the entire value recorded in equity for the $1.65 warrants, be classified as a current and non-current liability. Although the Company does not believe that these actual assessment of these penalties is likely, EITF 00-19 requires that the accounting for them be done without regard to probability. These amounts, totaling $3,017,168, were also subject to the accounting for potential rescission, which is discussed in Note 5. EITF 00-19 requires that the amount recorded as a liability be adjusted to fair value at each reporting period. Since the Company determined that there was no material difference between the original amounts recorded for these items in aggregate and their fair value as of September 30, 2005 in aggregate, there was no effect on the statement of operations related to this matter for the year ended September 30, 2005. The placement agent fees and direct issue costs for the 8% Convertible Debentures financing were approximately $336,000 in cash plus five-year warrants to purchase 435,000 shares of ONSM common stock for $1.65 per share. The broker dealer fees and legal expenses for the Additional 8% Convertible Debentures were approximately $57,500 plus warrants to purchase 217,500 shares of ONSM common stock for $1.65 per share. The estimated fair value of all warrants given in connection with the 8% Convertible Debentures plus the value of the 8% Convertible Debentures' beneficial conversion feature is $2,131,025, which, in accordance with EITF 98-05 ("Accounting for Convertible Securities with Beneficial Conversion Features") and EITF 00-27 ("Application of Issue No. 98-5 to Certain Convertible Instruments"), was allocated to additional paid in capital and debt discount. The Company's management calculated the discount based primarily on its estimate of the fair value of the warrants as a percentage of the face value of the convertible securities. The estimate was based on the closing price of the stock at the date of the agreement and the relationship to the conversion price of the instrument and the exercise price of the warrants. The debt discount, which totals $2,467,269 after inclusion of other direct costs associated with the financing, is being amortized to interest expense over the four year term of the 8% Convertible Debentures. In addition, the unamortized portion of the discount related to converted securities is expensed as interest at the time of the conversion. The estimated fair value of the warrants (including warrants subject to shareholder approval and contingent warrants) given in connection with the Additional 8% Convertible Debentures plus the value of the Additional 8% Convertible Debentures' beneficial conversion feature, plus other direct costs associated with the financing, exceed the face value of the Additional 8% Convertible Debentures. In accordance with EITF 98-05 and EITF 00-27, which limits the recorded discount to the face value of the related debt, $2,175,000 was allocated to additional paid in capital and debt discount and is being amortized to interest expense over the four year term of the Additional 8% Convertible Debentures. In addition, the unamortized portion of the discount related to converted securities is expensed as interest at the time of the conversion. F-26 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 4: CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued) 8% Convertible Debentures (continued) The above transactions are summarized as follows through September 30, 2005: Initial gross proceeds $ 6,525,000 Less: conversions to common shares (2,705,000) Less: initial discount (4,642,269) Plus: amortization of discount 2,065,591 ------------- 8% Convertible Debentures, net of discount $ 1,243,322 ============ The interest on the Convertible Debentures of 8% per annum is payable quarterly in cash, or common shares (at 85% of the market price per share) at the Company's option. During the year ended September 30, 2005, the Company issued 267,248 common shares in lieu of the $310,427 interest accrued and due through that date. Notes Payable Notes payable consist of the following as of September 30:
2005 2004 ----------- ----------- Note payable to affiliate of a director of the Company, with original funding in August 2005 $ 300,000 $ -- Note payable to a major shareholder of the Company, with original funding in September 2005 300,000 -- Capitalized software lease 130,198 Note payable to major investor - The principal was paid with cash and stock in December 2004 and the interest was paid with stock in January 2005 -- 3,119,875 Note payable to affiliate of a director of the Company, with original funding in February 2004. Interest was paid in advance and the principal balance was paid in full in December 2004 -- 300,000 Note payable to an executive and former director of the Company, with original funding in September 2004. The principal balance and accrued interest was paid in full in December 2004 -- 100,000 ----------- ----------- Total notes payable 730,198 3,519,875 Less: discounts on notes payable ( --) (494,150) ----------- ----------- Notes payable, net of discount 730,198 3,025,725 Less: current portion (330,598) (365,500) ----------- ----------- Long term notes payable, net of discount $ 399,600 $ 2,660,225 =========== ===========
Interest expense to related parties was approximately $52,000 and $48,000 for the years ended September 30, 2005 and 2004, respectively. Related parties include Company directors and employees, and their affiliates, but exclude major shareholders. F-27 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 4: CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued) Notes Payable (continued) On August 19, 2005, the Company received a $300,000 loan from Asset Factoring International, Inc., whose Investment Manager is a member of our board of directors. The term of the loan is one year, with a 2% loan origination fee and interest of 8% per annum. All interest and fees are due and payable in the event of early repayment. The terms of the loan, which is collateralized by $600,000 (original purchase price) of recently purchased equipment and software, requires repayment within 5 days of the Company obtaining other financing, including but not limited to equipment financing. Accordingly, Asset Factoring has agreed to extend the repayment of this loan to at least February 1, 2006. On October 11, 2005, the Company entered into a five-year note with a major shareholder in the aggregate principal amount of $750,000. The note, which is collateralized by $800,000 (original purchase price) of recently purchased hardware and software, bears interest at 10.85% per annum. At the Company's option, and with the consent of required security holders, both interest and principal may be paid in the form of the Company's Series A-10 Preferred Stock. In the event the loan is repaid in stock, the prepayment penalty will include all accrued interest. $300,000 of the related funding had been advanced prior to the signing of the note and is reflected in notes payable as of September 30, 2005. $150,000 of the remaining funding was received in October 2005 and the $300,000 balance of the funding commitment has not yet been received. As part of the Onstream Merger, the Company assumed a capitalized lease for software, which has an outstanding principal balance of $130,198 as of September 30, 2005. The balance is payable in equal monthly payments of $3,366 through May 2009, which includes interest at approximately 7% per annum. See Note 5. All notes payable outstanding as of September 30, 2004 were satisfied on December 23, 2004 by cash payments totaling approximately $2.4 million and issuance of 100,000 shares of Series A-10 Convertible Preferred ("Series A-10"), which included five-year warrants to purchase 500,000 common shares of ONSM for $1.50 per share. In connection with the retirement of this indebtedness, the Company wrote off the related unamortized discount of approximately $494,000, which is included in interest expense for the year ended September 30, 2005. The details of the $2.4 million in repaid notes are as follows: As compensation to a lender for a May 2003 note restructuring, the Company issued the lender 140,000 shares of Series A-8 Convertible Preferred Stock ("Series A-8") with a stated value of $840,000, which was recorded as a discount to the $3.0 million note. Approximately $164,000 of transaction fees paid for the restructuring were expensed as incurred. In accordance with APB 21, the unamortized transaction costs from the original December 2001 obligation and the discount from the May 2003 restructuring were reflected in the balance sheet as a debt discount, which was being amortized over the term of the loan using the effective interest method. The unamortized portion of this discount, shown as a reduction of the face value of the note on the balance sheet, was approximately $460,000 at September 30, 2004. $2.0 million of this loan was repaid from the proceeds of new financing received by the Company in December 2004, with the remaining $1.0 million converted to 100,000 shares of Series A-10 and five-year warrants to purchase 500,000 common shares of ONSM for $1.50 per share. During January 2005, the Company issued 85,488 shares of common stock in repayment of approximately $149,000 of interest due on this note through the date of repayment. F-28 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 4: CONVERTIBLE DEBENTURES AND NOTES PAYABLE (Continued) Notes Payable (continued) On February 26, 2004, the Company received a $300,000 loan from J&C Resources, LLC, whose President, Chairman and CEO is a members of our board of directors. The term of the loan was one year, and all interest was prepaid through the issuance of 21,000 shares of common stock. In addition, the Company issued 9,000 shares of common stock as an origination fee and 10,000 shares of common stock for legal and other fees. The shares issued for interest, origination and other fees resulted in a charge of approximately $83,000, which was recorded as a discount and was being amortized over the term of the note. The unamortized portion of this discount, shown as a reduction of the face value of the note on the balance sheet, was approximately $34,000 at September 30, 2004. This loan was repaid from the proceeds of new financing received by the Company in December 2004. On September 30, 2004, the Company received a $100,000 short-term loan from an employee and former director of the Company. The principal balance and the combined interest and service fees ($3,000 first month, $200 per day thereafter), plus another $150,000 in aggregate lent on substantially the same terms by this lender and another party in October 2004, was repaid from the proceeds of new financing received by the Company in December 2004. F-29 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 5: COMMITMENTS AND CONTINGENCIES Rescission rights - The holders of the 8% Convertible Debentures, the Additional 8% Convertible Debentures and the Series A-10 Preferred Stock may be entitled to certain rescission rights. The resale registration statement of shares of common stock underlying these securities and the related warrants was originally filed by the Company on February 23, 2005. Pursuant to the Securities Act of 1933 and the related rules and regulations, as interpreted by the Securities and Exchange Commission, as a result of a portion of the additional investment rights granted with the 8% Convertible Debentures, which were the basis of the sale of the Additional 8% Convertible Debentures, being unexercised at the time the resale registration statement was originally filed, the private offerings have not been completed and accordingly, the public and private offerings would be integrated and result in a violation of Section 5 of the Securities Act. Accordingly, the investors who purchased the private placement securities may have a number of remedies available to them, including the potential right to rescind the purchase of those securities plus, potentially, any amount representing damage to such investors. The Company is unable to predict if the investors would attempt to exercise such potential rescission rights. Each investor's decision would be based upon, among other things, a decline in the price of the Company's common stock and other factors. These potential rescission rights would require the Company to refund at least the gross proceeds of these private offerings to the investors. In order to satisfy such potential obligations, the Company would be required to utilize our available capital resources and obtain alternate sources of capital for such purposes. The Company presently does not have the capital available to satisfy all potential claims for rescission. The inability to obtain alternative sources of capital would have a material effect on the Company's financial condition and results of operations. For purposes of accounting for this contingency in accordance with Statement of Financial Accounting Standards 5, "Accounting for Contingencies", the Company's management has evaluated the above factors and has determined that the ultimate liability to the company from the potential assertion by investors of rescission rights is not probable. This conclusion is based on management's determination that the factors and/or conditions that would encourage an attempt to assert such rights are significantly outweighed by the factors and/or conditions that would discourage an attempt to assert such rights. Since the Company has determined that a rescission is not probable, although it may be possible, no accrual is required under SFAS 5. In addition, the existing current/non-current classification of the liability now shown for the 8% Convertible Debentures was not adjusted, based on the same rationale that an effect on the Company's liability arising from this issue is not probable. As of September 30, 2005, the Company's balance sheet reflects a liability, net of discount, of $1,243,322 associated with the 8% Convertible Debentures. The total proceeds arising from the 8% Convertible Debentures, the Additional 8% Convertible Debentures and the Series A-10 Preferred Stock, including related dividends and interest paid in kind, were $11,636,084. The excess of these proceeds over the recorded liability was $10,392,762, of which a) $7,375,594 was reclassified from shareholders' equity, where it was originally recorded, to the balance sheet classification "equity securities subject to potential rescission" as of September 30, 2005, in accordance with Emerging Issues Task Force Topic D-98, "Classification and Measurement of Redeemable Securities" and b) $3,017,168 was reclassified to the liability "Detachable Warrants and Embedded Conversion Feature associated with 8% Convertible Debentures", in accordance with EITF 00-19 and other applicable accounting, as discussed in Note 4. As of November 30, 2005, fifteen individual investors had converted 8% Convertible Debentures of $2,875,000 and 61,969 shares of Series A-10 Preferred Stock to ONSM common shares. This represents approximately $3,565,000 of the amounts included in "equity securities subject to potential rescission" as of September 30, 2005. An additional amount of approximately $1,375,000 of the September 30, 2005 balance of "equity securities subject to potential rescission" represents the securities owned but not converted by these fifteen individual investors. The Company has not yet determined the effect of these conversions on the potential rescission rights. F-30 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 5: COMMITMENTS AND CONTINGENCIES (continued) Consulting agreements - The Company is obligated under agreements to issue approximately 471,000 common shares and options to purchase approximately 700,000 shares (with exercise prices from $1.00 to $2.50) for consulting services subsequent to September 30, 2005, which will be valued at fair value as of the date of issuance and expensed under SFAS 123. These contracts also call for future cash payments of approximately $249,000. SAIC agreement - As part of the December 2004 Onstream Merger (see Note 2), the Company became obligated under a Basic Ordering Agreement for Professional Solutions ("BOA") entered into by Acquired Onstream and SAIC in June 2003, pursuant to which SAIC would build an outsourced solution for customers that allows for management and use of digital rich media and offers flexible applications, including collaboration and re-purposing (the "DMSP"). SAIC agreed to design the DMSP, as hosted and managed by SAIC, to allow for the addition and customization of applications to fit the specific needs of customers. SAIC also agreed to provide certain hosting and back-office services directly to the Company, as Acquired Onstream's successor, and in support of the Company's customers. The original term of the BOA runs through December 31, 2006 and the Company, as Acquired Onstream's successor, may, at its option, extend the term for up to an additional 48 months by executing four, one year renewal options. Acquired Onstream agreed to minimum expenditures of $1.9 million in the aggregate through December 31, 2006, the initial term of the BOA, and $1 million for each of the four one-year renewal periods thereafter. SAIC agreed that its services under the BOA would be billed at a discount to its regular rates throughout the term of the BOA. The Company may terminate the BOA prior to the expiration of the term for convenience upon 30 days notice. SAIC may terminate the BOA if the Company, as Acquired Onstream's successor, does not satisfy the minimum expenditure thresholds or is otherwise in material breach of its obligations. Contemporaneously with the BOA, Acquired Onstream and SAIC entered into a Stock Issuance Agreement, pursuant to which Acquired Onstream, at its option, could pay up to 20% of $1,250,000 of invoices for services subsequent to the execution of the Stock Issuance Agreement, with its common stock. Such common stock would be valued at the lesser of $0.50 per share or fair market value as of the date of issuance. Prior to the Onstream Merger, Acquired Onstream had issued 158,910 shares of its common stock to SAIC under this arrangement, valued at approximately $59,000 and converted to 23,535 ONSM shares in December 2004. Acquired Onstream granted to SAIC certain piggyback registration rights in connection with any such shares of common stock issued to SAIC. Within 30 days after notice of a forward merger of Acquired Onstream with another entity, or the sale of all or substantially all of the assets of the Acquired Onstream to another entity, SAIC had the right to terminate the Stock Issuance Agreement. SAIC did not terminate the Agreement and the Company has continued to pay 20% of SAIC invoices with ONSM common stock - 87,715 ONSM shares valued at $130,153 were issued to SAIC subsequent to the Onstream Merger and through September 30, 2005, including $57,142 included in Acquired Onstream's accounts payable at the time of the Onstream Merger - see Note 2. SAIC has not objected to the use of a fair market value for ONSM shares consistent with the December 2004 conversion of its Acquired Onstream shares to ONSM shares, even though such valuation is higher than the $0.50 per share maximum established in the Stock Issuance Agreement. However, the Company has entered into negotiations with SAIC which may result in the future discontinuance of the stock payment option. As of September 30, 2005, SAIC had been paid approximately $1,736,000 in cash or common stock (which includes approximately $909,000 paid under a predecessor professional services agreement for design and technology demonstration of a media asset management system, not considered BOA expenditures) and was owed approximately $143,000, of which the Company paid $50,000 in cash subsequent to that date. F-31 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued) Employment Contracts and Severance On December 27, 2004, in connection with the Company's closing of Onstream Merger (see Note 2), the Company entered into four-year employment contracts with the Company's President, Executive Vice President, Chief Marketing Officer and Executive Vice President of Business Development. The contracts provide for base annual salaries of $163,000 ($178,000 for the President) increasing 10% per year. Each executive also receives a combined auto allowance, deferred compensation allocation and dues reimbursement allowance of $35,000 per year. In the event of a subsequent change of control or termination without cause, the Company is obligated to make payments of base salary for three years, which the executive may elect to take in a lump sum payment, plus benefits for two years. On March 8, 2005 the Company entered into a similar three-year employment agreement with its Chief Financial Officer, with a base salary of $150,000 and other compensation of $27,000 per year. In the event of a subsequent change of control or termination without cause, the company is obligated to make payments of base salary and benefits for nine months. Lease Commitments In September 2002, the Company completed the sale and lease back of its principal executive offices in Pompano Beach, Florida. In connection with the agreement the Company entered into a five-year operating lease ending in September 2007. The lease provides for one five-year renewal option. The monthly base rental is currently approximately $17,000 (including the Company's share of property taxes and common area expenses) with annual three percent (3%) increases. Approximately $80,000 is included in accounts payable at September 30, 2005 related to amounts due under this lease. In May 2004, the Company entered into a five-year operating lease for office space in San Francisco. The lease provides for one five-year renewal option at 95% of fair market value. The monthly base rental is approximately $15,000 with annual increases up to five percent (5%). In December 2005, the Company extended its annual operating lease for office space in New York City, through December 31, 2006. The monthly base rental is approximately $6,000. Future minimum lease payments required under the non-cancelable leases, plus the capital lease discussed in Note 4, are as follows:
Operating Capital All Year Ending September 30: Leases Lease Leases 2006 $ 446,448 $ 40,394 $ 486,842 2007 408,155 40,394 448,549 2008 196,517 40,394 236,911 2009 111,095 26,931 138,026 2010 -- -- -- ---------- ---------- ---------- Total minimum lease payments $1,162,215 148,113 $1,310,328 ========== ---------- Less: amount representing interest 17,916 ---------- Present value of net minimum lease payments 130,197 Less: current portion 30,597 ---------- Long-term portion $ 99,600 ==========
F-32 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued) Lease Commitments (continued) Total rental expense for all operating leases was approximately $452,000 and $483,000 for the years ended September 30, 2005 and 2004, respectively. Annual Long Distance Purchase Commitment EDNet entered into a two-year long distance telephone rate agreement with a national telecommunications company, which included a purchase commitment of approximately $384,000 (before taxes) per year. The Company is in compliance with this agreement, which expires in March 2006, and in December 2005 completed negotiations for a two-year renewal that included a purchase commitment of approximately $120,000 (before taxes) per year with approximately 40% lower rates. NOTE 6: CAPITAL STOCK Common Stock In October 2003, the Company raised approximately $864,000 in a private placement to a group of 17 accredited investors for 411,500 shares of its common stock, plus four-year warrants for an aggregate of 82,300 common shares at an exercise price of $3.00 per share. In connection with this private placement, the Company issued 53,495 shares of common stock, with a fair value of approximately $112,000, for commissions and finders fees, which were recorded as a reduction of additional paid-in capital. The Company granted the purchasers registration rights covering the shares, including the shares issuable upon exercise of the warrants. In February 2004, the Company issued 32,500 shares of common stock for an origination fee in connection with the issuance of Series A-11 Convertible Preferred Stock and 52,500 shares of common stock for prepaid dividends related to the same issuance. During the year ended September 30, 2004, the Company issued 195,000 shares of common stock for consulting and financial advisory services. The services were provided over periods ranging from 1 to 12 months, and resulted in a professional fees expense of approximately $434,000 over the service period. During the same period, the Company issued warrants and options to purchase 270,000 shares of common stock at prices from $2.25 to $2.50 per share, which will result in professional fees expense of approximately $523,000 over the service period from 12 to 24 months. See Note 8. During the year ended September 30, 2004, the Company issued 176,192 shares of common stock arising from the conversion of preferred shares - 33,334 common shares for 25,000 shares of Series A-8 Convertible Preferred Stock and 142,858 common shares for 20,000 shares of Series A-9 Convertible Preferred Stock. During the year ended September 30, 2004, the Company issued 434,694 shares of its common stock for loan payments and interest, primarily the following three transactions: In October 2003, under the terms of a redemption agreement for a portion of 6% convertible debentures originally sold on December 8, 2000, the debentures were satisfied by approximately $610,000 in cash and 300,000 shares of the Company's common stock, valued at $2.50 per share, or $750,000. This transaction resulted in a net gain of approximately $185,000, included in other income and expense for the year ended September 30, 2004. F-33 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 6: CAPITAL STOCK (Continued) Common Stock (Continued) In February 2004, the Company issued 40,000 shares of common stock for interest and expenses related to a loan from an affiliate of a Company director - see Note 4. In March 2004 the Company sold an aggregate of $150,000 principal amount of 14% convertible debentures to accredited investors. The term of the debentures were one year, and all interest and fees were prepaid through the issuance of 19,226 shares of common stock. In April 2004, the holders converted the debentures into 75,000 shares of common stock, using a fixed conversion price of $2.10 per share, which was below the stock price at the time of the original sale. Approximately $72,000 for the value of this beneficial conversion feature plus the common shares issued for interest and fees was charged to interest expense during the year ended September 30, 2004. During the year ended September 30, 2004, the Company issued 64,000 shares of common stock to settle approximately $154,000 of certain liabilities with various vendors, which was approximately equal to the value of the stock at the date of issuance. This included 34,000 shares of common stock provided to vendors of Acquired Onstream to settle approximately $82,000 of Acquired Onstream obligations, which was recorded by the Company as an increase in its receivable from Acquired Onstream. In December 2004, the Company issued 2,207,966 shares of its common stock in connection with the Onstream Merger - see Note 2. During the year ended September 30, 2005, the Company issued 2,725,659 ONSM common shares as a result of a eleven individual investors' conversions of $2,705,000 8% Convertible Debentures and Additional 8% Convertible Debentures, plus accrued interest through the respective conversion dates - see Notes 4 and 5. Also during the year ended September 30, 2005, the Company issued 619,690 ONSM common shares as a result of four individual investors' conversions of a total of 61,969 shares of Series A-10 preferred shares, which included accrued dividends through the respective conversion dates - see Note 5 and below. During the year ended September 30, 2005, the Company issued 712,626 shares of common stock for consulting, financial, advisory and other services, as follows: 497,135 shares valued at approximately $779,000 and recognized as professional fees expense over the various service periods of up to 24 months. 12,273 of these shares were issued to a company controlled by the Company's former CFO. None of the remaining shares were issued to Company directors or officers. See Note 5 regarding the Company's obligation to issue additional shares under such agreements. 10,000 shares issued to an employee as a bonus, with an immediately expensed value of approximately $12,100 and 26,759 shares of common stock to employees under the Plan valued at approximately $34,000. 87,715 shares issued to SAIC for services in connection with the DMSP, valued at $130,153 - see Note 5. 91,017 shares for legal services valued at approximately $134,000, including $14,400 included in Acquired Onstream's accounts payable at the time of the Onstream Merger - see Note 2. F-34 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 6: CAPITAL STOCK (Continued) Common Stock (Continued) During the year ended September 30, 2005, the Company issued options to purchase its common shares, in exchange for consulting and financial advisory services, such options valued at approximately $590,000. The Company recognized professional fee expenses arising from these and prior issuances of shares and options for consulting and financial advisory services, including amounts related to certain executive severance agreements discussed above, of approximately $1,769,000 and $646,000 for the years ended September 30, 2005 and 2004, respectively. As a result of previously granted or issued options, warrants or shares for consulting expenses, the Company has approximately $566,000 in deferred equity compensation expense at September 30, 2005, which will be amortized over the remaining periods of service for these issuances, which range from two to 21 months. The deferred equity compensation expense is included in the balance sheet captions prepaid expenses and other non-current assets. In January 2005, also in connection with the Onstream Merger and pursuant to Board and shareholder approval received in December 2004, the Company issued 150,000 shares of ONSM common stock to Envision Management Group, a consulting firm controlled by Ms. Gail Babitt, our former CFO, and the Company issued 100,000 shares of ONSM common stock to Mr. George Stemper, our former COO currently employed by the Company in another capacity. The Company recorded the issuance of these common shares at $392,500, based on the fair value of the 250,000 shares at the date of Board and shareholder authorization, which was included in professional fee expense during the year ended September 30, 2005. In January 2005, pursuant to Board approval received in December 2004, the Company issued Mr. Stemper 50,000 shares of ONSM common stock as an advance against sales commissions to be earned by him through August 31, 2005 in connection with a professional services agreement. The Company recorded the issuance of these common shares at $78,500, based on the fair value of the 50,000 shares at the date of Board authorization. Based on an August 1, 2005 employment agreement entered into between the Company and Mr. Stemper, these shares are considered fully earned by him as of August 31, 2005 and were expensed by the Company as of that date. On June 29, 2005, the Company issued 606,000 ONSM common shares, to satisfy in full a penalty of 2,000 common shares per day for every day starting August 31, 2004, that certain common shares issued in April 2004 (arising from March 2004 convertible debentures) were not registered. The Company recorded interest expense of $943,840 for the year ended September 30, 2005, related to its valuation of this stock issued in satisfaction of this penalty. The valuation was based on the closing share price for each day that the penalty was incurred through June 29, 2005, when a registration statement filed with the SEC and containing these shares was declared effective. During the year ended September 30, 2005, the Company issued 267,248 common shares in lieu of the $310,427 interest accrued and due through that date on the 8% Convertible Debentures and Additional 8% Convertible Debentures. During January 2005, the Company issued 85,488 shares of common stock in repayment of approximately $149,000 of interest due on a $3.0 million note through the date of repayment. See Note 4. F-35 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 6: CAPITAL STOCK (Continued) Preferred Stock As of September 30, 2005, the only preferred stock outstanding is Series A-10 Convertible Preferred Stock. Series A-8 Convertible Preferred Stock In May 2003, the Company issued 140,000 shares of Series A-8 Convertible Preferred Stock ("Series A-8") to a shareholder as compensation for restructuring an existing loan to the Company and loaning the Company additional funds - see Note 4. In addition, the shareholder converted his outstanding common stock in the Company into 92,750 shares of Series A-8. In December 2004, this shareholder converted all 232,750 shares of Series A-8 held by him into 139,650 shares of Series A-10 Preferred Stock. In May 2003, the Company also paid a finders fee of 25,000 shares of Series A-8 to a third party, which the holder converted to 33,334 shares of common stock during the year ended September 30, 2004. Series A-9 Convertible Preferred Stock In June 2003, the Company completed an agreement for a $750,000 private sale of Series A-9 Preferred Stock. In the first tranche the Company received $450,000 for the issuance of 30,000 shares of Series A-9 and four year warrants, exercisable at $4.50 per share, to purchase 10,000 shares of its common stock. In September 2003, the holders of the Series A-9 converted the 30,000 outstanding shares into 214,286 shares of common stock. At the same time, the investors executed the second tranche of the Series A-9, issuance of 20,000 shares of its Series A-9 Preferred Stock plus four year warrants, exercisable at $3.00 per share, to purchase 40,000 shares of common stock As of September 30, 2003, the Company had not received the $300,000 proceeds, which was therefore reflected in the September 30, 2003 balance sheet as a subscription receivable and satisfied during the first quarter of fiscal 2004. In March 2004, the holders of 20,000 shares of Series A-9 converted those shares to 142,858 shares of common stock, based on a $2.10 per common share conversion price and a stated value of $15.00 per Series A-9 share. During the year ended September 30, 2004 the Company declared and paid cash dividends of approximately $14,000 on the Series A-9. Series A-10 Convertible Preferred Stock On December 23, 2004, the Company sold 215,000 shares of Series A-10 Convertible Preferred Stock for $2.15 million ("Series A-10") to sixteen accredited investors, plus 100,000 shares of Series A-10 for $1.0 million of previously outstanding debt to a single accredited investor - see Note 4. The 315,000 shares of Series A-10 included five-year warrants to purchase 1,575,000 common shares of ONSM for $1.50 per share. Another 8,562 shares of Series A-10 were issued to the purchasers in January 2005 as compensation for their funds being held in escrow from June 2004 through December 2004, pending shareholder approval, in accordance with Nasdaq Marketplace Rule 4350(i), of the issuance in excess of 19.99% of the Company's common stock. In December 2004, a single shareholder converted all 232,750 shares of Series A-8 held by him into 139,650 shares of Series A-10. The Company's Board of Directors declared a dividend payable on May 15, 2005 to Series A-10 shareholders of record as of May 10, 2005 of 13,974 Series A-10 preferred shares, in lieu of a $139,738 cash payment. During the year ended September 30, 2005, the Company issued 619,690 ONSM common shares as a result of four investors converting a total of 61,989 shares of Series A-10 preferred shares, which included 814 Series A-10 shares issued for accrued dividends through the respective conversion dates. F-36 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 6: CAPITAL STOCK (Continued) Preferred Stock (Continued) The holders of the Series A-10 may be entitled to certain rescission rights - see Note 5. The Series A-10 has a coupon of 8% per annum, payable annually in cash (or semi-annually at the Company's option in cash or in additional shares of Series A-10), has a stated value of $10.00 per preferred share and has a conversion rate of $1.00 per common share. The Series A-10 is not redeemable by the Company and any shares of Series A-10 that are still outstanding as of December 2008 will automatically convert into common shares. Series A-10 is senior to all other preferred share classes that may be issued by the Company and the Company may not incur any additional indebtedness greater than $1.5 million without the consent of the holders of at least 50% of the outstanding Series A-10 shares. The Series A-10 holders have the right to designate one member of the Company's board of directors. In February 2005, the board of directors and the holders of a majority of the issued and outstanding shares of Series A-10 voted to approve an increase in the authorized number of Series A-10 from 500,000 shares to 700,000 shares to provide for the possible issuance of shares of Series A-10 as dividends on Series A-10 presently outstanding. The placement agent fees and direct issue costs for the Series A-10 financing were approximately $172,000 plus five-year warrants to purchase approximately 215,000 shares of ONSM common stock for $1.50 per share. The estimated fair value of all warrants given in connection with the Series A-10 plus the Series A-10's beneficial conversion feature, is $2,755,951, which, in accordance with EITF 98-05 and EITF 00-27, was allocated to additional paid in capital and discount. The Company's management calculated the discount primarily based on its estimate of the fair value of the warrants as a percentage of the face value of the convertible securities. The estimate was based on the closing price of the stock at the date of the agreement and the relationship to the conversion price of the instrument and the exercise price of the warrants. The discount, which totals $2,928,041 after inclusion of other direct costs associated with the financing, is being amortized as a dividend over the four-year term of the Series A-10. In addition, the unamortized portion of the discount related to converted securities is expensed as an additional dividend at the time of the conversion. Series A-11 Convertible Preferred Stock On February 10, 2004, the Company sold 25,000 shares of its Series A-11 non-voting redeemable Convertible Preferred Stock, plus three-year warrants to purchase 130,000 shares of its common stock, for $500,000. The three-year warrants are exercisable at $2.28 per share (based on 105% of the Company's common stock average closing bid price for the five trading days prior to February 10, 2004). The Company also issued 32,500 shares of restricted common stock to the purchaser as an origination fee and issued an additional 52,500 shares of restricted common stock in lieu of dividend payments over the initial 18-month term after closing. The Company determined that the estimated fair value of the warrants and the beneficial conversion feature, computed in accordance with EITF 98-05 and EITF 00-27, was immaterial. In December 2004, the Company redeemed all outstanding shares of Series A-11 for cash. F-37 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 7: SEGMENT INFORMATION The Company's operations are currently comprised of two operating groups, Digital Asset Management and Webcasting. These operating units are managed from the Company's Pompano Beach facility and the San Francisco facility directed by EDNet. See Note 1 for details about the Company's redefinition of its segments in fiscal 2005. All material balances related to Company sales, primary business activities, and location of property and equipment are within the United States. In March 2004, Thomson Financial Group completed the acquisition of CCBN. As a result, we have combined revenues from both of these companies for disclosure. For the years ended September 30, 2005 and 2004 the Company provided webcasting services to one significant customer, Thomson Financial Group, under a contract, which can be terminated upon a 30-day notification. Revenues from sales to Thomson Financial Group (including CCBN) were approximately $1,389,000, or approximately 17%, and approximately $1,808,000, or approximately 24%, of total consolidated revenue for the years ended September 30, 2005 and 2004, respectively. These revenues represented approximately 38% and 50% of Webcasting Group revenues for the same periods. For the year ended September 30, 2005 the Company provided digital asset management services to another significant customer, America Online, Inc., under a contract which can be terminated upon a 30-day notification. Revenues from sales to this customer were approximately $1,184,000, or approximately 15% of total consolidated revenue for the year ended September 30, 2005. These revenues represented approximately 26% of Digital Asset Management Group revenues for the same period. F-38 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 7: SEGMENT INFORMATION (Continued) Detailed below are the results of operations by segment for the years ended September 30, 2005 and 2004, and total assets by segment as of those dates. For the years ended September 30, -------------------------- 2005 2004 ----------- ----------- Revenue: Digital Asset Management Group $ 4,477,402 $ 3,953,842 Webcasting Group 3,678,992 3,625,046 ----------- ----------- Total consolidated revenue $ 8,156,394 $ 7,578,888 =========== =========== Segment operating income (loss): Digital Asset Management Group $ 763,540 $ 615,426 Webcasting Group 826,634 931,531 ----------- ----------- Total segment operating income 1,590,174 1,546,957 Depreciation and amortization (1,152,633) (1,373,587) Impairment loss on goodwill (330,000) (470,000) Corporate and unallocated shared expenses (5,714,949) (3,310,241) Other (expense) income, net (4,030,480) (365,795) ----------- ----------- Net loss $(9,637,888) $(3,972,666) =========== =========== September 30, ------------------------- 2005 2004 ----------- ----------- Total assets: Digital Asset Management Group $14,580,103 $ 3,373,128 Webcasting Group 1,925,137 1,996,286 Corporate and unallocated 1,016,847 2,092,975 ----------- ----------- Total $17,522,087 $ 7,462,389 =========== =========== Depreciation, amortization and impairment losses are not utilized by the Company's primary decision makers for making decisions with regard to resource allocation or performance evaluation. F-39 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 8: STOCK OPTIONS AND WARRANTS As of September 30, 2005, the Company had 15,114,093 issued and outstanding options and warrants, including 2,940,895 Plan Options; 2,436,273 Non-Plan Options to employees and directors; 1,199,906 Non-Plan Options to consultants; and 8,537,019 warrants issued in connection with various financings and other transactions, and including contingent warrants as discussed below. On February 9, 1997, the Board of Directors and a majority of the Company's shareholders adopted the 1996 Stock Option Plan (the "Plan"). On April 11, 2002, an amendment to the Plan, ratified by the shareholders, reserved an aggregate of 733,334 Plan Options and added an equity compensation component. On December 15, 2004, a majority of the Company's shareholders voted to increase the number of shares available for issuance under the plan to 3,500,000, including stock grants of up to 500,000 shares. On September 13, 2004, a majority of the Company's shareholders voted to increase the number of shares available for issuance under the plan to 6,500,000, including stock grants of up to 3,000,000 shares. In June 2003 the Company affected a one-for-fifteen reverse stock split. All references to shares, share prices, per share amounts and stock plans have been adjusted retroactively for the one-for-fifteen reverse stock split. As of September 30, 2005 the Company has granted options to management, employees and directors under the Plan. The term of these options are from three to eight years and the vesting periods are from immediate to four years. All options are granted at a price equal to or greater than the fair market value at the date of grant. On December 15, 2004 a majority of the Company's shareholders voted to approve the cancellation (subject to the option holder's approval) of Plan Options to directors, senior management and employees covering 227,776 shares (plus 65,216 Non-Plan Options) with a weighted-average exercise price of $21.93, with such options to be re-issued six months and one day from the date of cancellation with an exercise price equal to the fair market value on the date of the reissue. This cancellation has not yet been implemented and 121,774 of the Plan Options subject to this cancellation and re-issue had expired as of December 31, 2005. In July 2005 the Company's Board of Directors granted 2,634,224 five-year Plan options, exercisable at $1.12 per share, which was the fair market value on the date of grant. This included 1,500,000 fully vested options to Company directors and senior management, with the balance issued to other Company employees and vesting quarterly during the year ended September 30, 2006. At the same time, the Board accelerated the vesting of 150,000 four-year Plan options previously granted to a Company executive in December 2004 at an exercise price of $1.21 per share, which was the fair market value on the date of grant. The options, which were to vest in installments of 50,000 options per year, beginning December 15, 2005, were declared fully vested. At the same time, the Company issued 26,759 Plan fully paid stock grants to Company executives. F-40 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 8: STOCK OPTIONS AND WARRANTS (Continued) Detail of Plan Option activity for the years ended September 30, 2005 and 2004 is as follows:
September 30, 2004 September 30, 2005 ---------------------- --------------------- Weighted Weighted Average Average Number of Exercise Number of Exercise Shares Price Shares Price --------- --------- -------- --------- Balance, beginning of period 236,100 $ 21.93 464,942 $ 31.40 Granted during the period 2,984,224 1.14 -- Expired or forfeited during the period (279,429) 2.66 (228,842) 41.17 --------- ------- Balance, end of the period 2,940,895 1.89 236,100 21.93 --------- ------- Exercisable at end of the period 1,806,671 $ 2.37 213,436 $ 22.67 --------- -------
The Company's 1,700,000 outstanding Plan Options at September 30, 2005 not subject to the cancellation and re-grant discussed above have a remaining life of approximately 5 years and exercise prices ranging from $1.12 to $1.57 per share. The Company's 106,671 outstanding Plan Options subject to this cancellation and re-grant have a remaining life of less than 1 year and exercise prices ranging from $7.50 to $26.25 per share. As of September 30, 2005, the Company has 2,436,273 outstanding Non Plan options issued to employees and directors, of which 2,431,390 were issued during the year ended September 30, 2005. During that period, the Company issued immediately exercisable five-year options to certain executives, directors and other management for the purchase of 1,350,000 shares of our common stock at $1.57 per share (fair market value at date of issuance); five-year options to certain executives, fully-vested as of September 30, 2005, for the purchase of 800,000 shares of our common stock at $2.50 per share (greater than the $1.57 fair market value at date of issuance); and 281,390 options at an exercise price of $3.376 per share in conjunction with the Onstream Merger. As of September 30, 2005, the Company had 1,199,906 outstanding Non Plan options issued to consultants, of which 929,240 were issued during the year ended September 30, 2005, 870,000 with exercise prices ranging from $1.10 to $3.00 per share, and 59,240 issued at an exercise price of $3.376 per share in conjunction with the Onstream Merger. These options issued to consultants have exercise prices from $1.10 to $4.50 per share and expire at various dates from January 2006 to March 2010. 395,000 of the above options, including 125,000 options issued prior to the year ended September 30, 2005, were not vested as of that date. See Note 5. F-41 ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS SEPTEMBER 30, 2005 NOTE 8: STOCK OPTIONS AND WARRANTS (Continued) As of September 30, 2005, the Company had outstanding vested warrants to purchase an aggregate of 7,449,519 shares of common stock, inclusive of warrants issued in connection with various financings. The warrants contain exercise prices ranging from $1.00 to $45.00 expiring from August 2005 to April 2010. During the year ended September 30, 2005 the Company granted 7,022,693 of these warrants - 2,175,000 one-year warrants at an exercise price of $1.00 per share issued in connection with the Additional 8% Convertible Debentures; 2,936,250 five-year warrants at an exercise price of $1.65 per share in conjunction with the sale of 8% Convertible Debentures and Additional 8% Convertible Debentures; 1,790,000 five-year warrants at an exercise price of $1.50 per share in conjunction with the sale of Series A-11; and 121,443 warrants at an exercise price of $3.376 per share in conjunction with the Onstream Merger. In addition, 262,300 of these warrants were granted by the Company in connection with other financing activities in periods prior to the year ended September 30, 2005- 10,000 four-year warrants at an exercise price of $4.50 per share issued with the sale of Series A-9; 40,000 one-year warrants at an exercise price of $3.00 per share issued with the sale of Series A-9; 130,000 three-year warrants at an exercise price of $2.28 per share issued with the sale of Series A-11; and 82,300 four-year warrants at an exercise price of $3.00 per share issued with the sale of common stock. See Notes 4 and 6. These vested warrants do not include 1,087,500 warrants at an exercise price of $1.65 per share, which have been approved for issuance by a majority of the Company's shareholders, such issuance contingent on the exercise of $1.00 warrants issued in connection with the Additional 8% Convertible Debentures - see Note 5. NOTE 9: SUBSEQUENT EVENTS - FINANCING AND EQUITY TRANSACTIONS During October 2005, the Company issued 174,211 ONSM common shares as a result of two investors' conversion of $170,000 of 8% Convertible Debentures, plus accrued interest. During October 2005, the Company issued 45,000 ONSM common shares for professional services valued at approximately $45,000. The Company's Board of Directors declared a dividend payable on November 15, 2005 to Series A-10 shareholders of record as of November 10, 2005 of 16,641 Series A-10 preferred shares, in lieu of a $166,413 cash payment. On November 30, 2005, the Company borrowed $300,000 from Platinum Credit Group, LLC, secured by a secondary lien on up to $300,000 of the Company's tangible equipment and other assets. In addition, the Company dedicated certain receivables and financing proceeds to assure the repayment of the Note on or before its due date of March 1, 2006. Origination and finder's fees totaling $30,000 were paid in connection with this financing. Interest was paid in the form of 44,444 shares of ONSM common stock, which the Company agreed to include on the next S-3 or other registration statement filed. During December 2005, the Company issued 15,510 ONSM common shares as a result of three investors' conversion of 1,551 shares of Series A-10 Preferred. During January 2006, the Company issued 95,672 common shares in lieu of the $74,622 interest accrued and due through December 31, 2005 on the 8% Convertible Debentures and the Additional 8% Convertible Debentures. During January 2006, the Company issued 305,878 common shares as satisfaction for equipment purchases of $151,350 included in accounts payable at September 30, 2005, plus another $75,000 of equipment purchases to be received after that date. During January 2006, the Company also issued 20,000 common shares for professional services valued at approximately $20,000. F-42 EX-23.1 2 v033164_ex23-1.txt EXHIBIT 23.1 CONSENT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS As independent certified public accountants, we hereby consent to the incorporation by reference in the following registration statements of our report dated January 12, 2006 included in Onstream Media's Corporation's Form 10-KSB for the year ended September 30, 2005. * Registration statement on Form S-8, SEC file number 333-63822, as filed with the Securities and Exchange Commission on June 25, 2001, * Registration statement on Form S-3, SEC file number 333-63792, as declared effective by the Securities and Exchange Commission on July 2, 2001, * Registration statement on Form S-8, SEC file number 333-64588, as filed with the Securities and Exchange Commission on July 3, 2001, * Registration statement on Form S-3, SEC file number 333-71308, as declared effective by the Securities and Exchange Commission on November 14, 2001, * Registration statement on Form S-3, SEC file number 333-89042, as declared effective by the Securities and Exchange Commission on June 7, 2002, * Registration statement on Form S-3, SEC file number 333-18819, as declared effective by the Securities and Exchange Commission on July 30, 2002, * Registration statement on Form S-3, SEC file number 333-92064, as declared effective by the Securities and Exchange Commission on August 21, 2002, * Registration statement on Form S-3, SEC file number 333-104588, as declared effective by the Securities and Exchange Commission on May 2, 2003, * Registration statement on Form S-3, SEC file number 333-106516, as declared effective by the Securities and Exchange Commission on September 2, 2003, * Registration statement on Form S-3, SEC file number 333-110142, as declared effective by the Securities and Exchange Commission on November 12, 2003, and * Registration statement on Form S-3, SEC file number 333-124002, as declared effective by the Securities and Exchange Commission on June 29, 2005. /s/ GOLDSTEIN LEWIN & CO. GOLDSTEIN LEWIN & CO. Boca Raton, Florida, January 12, 2006 EX-31.1 3 v033164_ex31-1.txt Exhibit 31.1 RULE 13a-14(a)/15d-14(a) CERTIFICATION OF CHIEF EXECUTIVE OFFICER I, Randy S. Selman, certify that: 1. I have reviewed this annual report on Form 10-KSB of Onstream Media Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting. 5. The small business issuer's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal controls over financial reporting. January 12, 2006 By: /s/ Randy S. Selman -------------------- Randy S. Selman, President, CEO and Principal Executive Officer EX-31.2 4 v033164_ex31-2.txt Exhibit 31.2 RULE 13a-14(a)/15d-14(a) CERTIFICATION OF CHIEF FINANCIAL OFFICER I, Robert Tomlinson, certify that: 1. I have reviewed this annual report on Form 10-KSB of Onstream Media Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this report; 4. The small business issuer's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures as of the end of the period covered by this report based on such evaluation; and c. Disclosed in this report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter (the small business issuer's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting. 5. The small business issuer's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a. all significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial infomation; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal controls over financial reporting. January 12, 2006 By:/s/ Robert E. Tomlinson ------------------------ Robert E. Tomlinson, Chief Financial Officer EX-32.1 5 v033164_ex32-1.txt Exhibit 32.1 SECTION 906 CERTIFICATION OF CHIEF EXECUTIVE OFFICER Pursuant to Section 906 of the Sarbanes-Oxley Act 2002 (18 U.S.C. 350), the undersigned, Randy Selman, Chief Executive Officer of Onstream Media Corporation (the "Company") has executed this certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-KSB for the year ended September 30, 2005 (the "Report"). The undersigned certifies that: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. IN WITNESS WHEREOF, the undersigned has executed this certification as of the 12th day of January 2006. ONSTREAM MEDIA CORPORATION /s/ Randy S. Selman ------------------- Name: Randy Selman Title: Chief Executive Officer EX-32.2 6 v033164_ex32-2.txt Exhibit 32.2 SECTION 906 CERTIFICATION OF CHIEF FINANCIAL OFFICER Pursuant to Section 906 of the Sarbanes-Oxley Act 2002 (18 U.S.C. 1350), the undersigned, Robert E. Tomlinson, Chief Financial Officer of Onstream Media Corporation (the "Company") has executed this certification in connection with the filing with the Securities and Exchange Commission of the Company's Annual Report on Form 10-KSB for the year ended September 30, 2005 (the "Report"). The undersigned certifies that: (1) the Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the Report fairly presents, in all material respects, the financial condition and results of operation of the Company. IN WITNESS WHEREOF, the undersigned has executed this certification as of the 12th day of January 2006. ONSTREAM MEDIA CORPORATION /s/ Robert E. Tomlinson ------------------------ Name: Robert E. Tomlinson Title: Chief Financial Officer -----END PRIVACY-ENHANCED MESSAGE-----