10-Q 1 form10q.htm FORM 10-Q form10q.htm - Generated by SEC Publisher for SEC Filing

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

(x) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to _________

Commission file number 000-22849

Onstream Media Corporation

(Exact name of registrant as specified in its charter)

65-0420146

(IRS Employer Identification No.)

Florida

(State or other jurisdiction of incorporation or organization)

1291 SW 29 Avenue, Pompano Beach, Florida 33069

(Address of principal executive offices)

954-917-6655

(Registrant's telephone number)

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

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

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

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

Large accelerated filer ( ) Accelerated filer ( )

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

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. As of May 10, 2013 the registrant had issued and outstanding 16,100,744 shares of common stock.

PART I – FINANCIAL INFORMATION	PAGE
Item 1 - Financial Statements

Unaudited Consolidated Balance Sheet at March 31, 2013 and Consolidated Balance Sheet at September 30, 2012	4

Unaudited Consolidated Statements of Operations for the Six and Three Months Ended March 31, 2013 and 2012	5

Unaudited Consolidated Statement of Stockholders’ Equity for the Six Months Ended March 31, 2013	6

Unaudited Consolidated Statements of Cash Flows for the Six Months Ended March 31, 2013 and 2012	7 –8

Notes to Unaudited Consolidated Financial Statements	9 – 71

Item 2 - Management’s Discussion and Analysis of Financial Condition
and Results of Operations	72 – 98

Item 4 - Controls and Procedures	99

PART II – OTHER INFORMATION
Item 1 – Legal Proceedings	100

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds	100

Item 3 – Defaults upon Senior Securities	100

Item 4 – Removed and Reserved	100

Item 5 – Other Information	100

Item 6 - Exhibits	101

Signatures	101

CERTAIN CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING INFORMATION

Certain statements in this quarterly report on Form 10-Q contain or may contain forward-looking statements that are subject to known and unknown risks, uncertainties and other factors which may cause actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. These forward-looking statements were based on various factors and were derived utilizing numerous assumptions and other factors that could cause our actual results to differ materially from those in the forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, our ability to implement our strategic initiatives (including our ability to successfully complete, produce, market and/or sell the DMSP and/or MP365 and/or our ability to eliminate cash flow deficits by increasing our sales), economic, political and market conditions and fluctuations, government and industry regulation, interest rate risk, U.S. and global competition, and other factors affecting our operations and the fluctuation of our common stock price, and other factors discussed elsewhere in this report and in other documents filed by us with the Securities and Exchange Commission from time to time. Most of these factors are difficult to predict accurately and are generally beyond our control. You should consider the areas of risk described in connection with any forward-looking statements that may be made herein. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of March 31, 2013, unless otherwise stated. You should carefully review this Form 10-Q in its entirety, including but not limited to our financial statements and the notes thereto, as well as our most recently filed 10-K. Except for our ongoing obligations to disclose material information under the Federal securities laws, we undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events. Actual results could differ materially from the forward-looking statements. In light of these risks and uncertainties, there can be no assurance that the forward-looking information contained in this report will, in fact, occur. For any forward-looking statements contained in any document, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

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

PART I – FINANCIAL INFORMATION

Item 1 - Financial Statements

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	March 31, 2013		September 30, 2012
(unaudited) ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	314,705	$	359,795
Accounts receivable, net of allowance for doubtful accounts of $206,299 and $195,737, respectively		2,212,072		2,357,726
Prepaid expenses		297,214		293,294
Inventories and other current assets		143,714		146,159
Total current assets		2,967,705		3,156,974
PROPERTY AND EQUIPMENT, net		3,146,720		2,841,115
INTANGIBLE ASSETS, net		757,127		277,579
GOODWILL, net		10,558,604		10,146,948
OTHER NON-CURRENT ASSETS		136,215		146,215
Total assets	$	17,566,371	$	16,568,831

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	1,743,499	$	1,634,110
Accrued liabilities		1,465,724		1,398,668
Amounts due to directors and officers		281,606		669,697
Deferred revenue		71,024		138,856
Notes and leases payable – current portion, net of discount		2,349,839		1,650,985
Convertible debentures – current portion, net of discount		387,531		407,384
Total current liabilities		6,299,223		5,899,700
Accrued liabilities – non-current portion		293,622		-
Notes and leases payable, net of current portion and discount		782,438		189,857
Convertible debentures, net of current portion and discount		580,128		801,844
Detachable warrant, associated with sale of common/preferred shares		-		81,374
Total liabilities		7,955,411		6,972,775
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Series A-13 Convertible Preferred stock, par value $.0001 per share, authorized 170,000 shares, zero and 17,500 issued and outstanding, respectively		-		2
Series A-14 Convertible Preferred stock, par value $.0001 per share, authorized 420,000 shares, zero and 160,000 issued and outstanding, respectively		-		16
Common stock, par value $.0001 per share; authorized 75,000,000 shares, 16,100,744 and 12,902,217 issued and outstanding, respectively		1,609		1,289
Common stock committed for issue – 3,950,000 and zero shares, respectively		395		-
Additional paid-in capital		144,087,135		141,199,626
Accumulated deficit		(134,478,179)		(131,604,877)
Total stockholders’ equity		9,610,960		9,596,056
Total liabilities and stockholders’ equity	$	17,566,371	$	16,568,831

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	Six Months Ended March 31,				Three Months Ended March 31,
	2013		2012		2013		2012
REVENUE:
Audio and web conferencing	$	4,479,741	$	4,262,637	$	2,437,658	$	2,250,936
Webcasting		2,594,731		2,938,070		1,216,419		1,438,116
DMSP and hosting		476,538		921,554		234,554		448,597
Network usage		1,007,965		949,115		480,598		469,670
Other		116,064		99,078		26,093		49,018
Total revenue		8,675,039		9,170,454		4,395,322		4,656,337

COSTS OF REVENUE:
Audio and web conferencing		1,252,685		1,323,744		678,199		678,233
Webcasting		754,294		869,559		364,499		437,562
DMSP and hosting		68,886		461,734		36,307		221,940
Network usage		523,063		463,571		269,717		247,226
Other		36,787		34,735		17,734		21,294
Total costs of revenue		2,635,715		3,153,343		1,366,456		1,606,255

GROSS MARGIN		6,039,324		6,017,111		3,028,866		3,050,082

OPERATING EXPENSES:
General and administrative:
Compensation (excluding equity)		3,955,880		3,784,466		2,110,969		2,015,197
Compensation paid with common shares and other equity		1,417,570		321,803		1,279,311		95,196
Professional fees		794,099		1,146,523		388,086		540,288
Other		1,269,678		1,082,436		641,142		560,701
Depreciation and amortization		704,681		714,622		375,456		358,114
Total operating expenses		8,141,908		7,049,850		4,794,964		3,569,496

Loss from operations		(2,102,584)		(1,032,739)		(1,766,098)		(519,414)

OTHER EXPENSE, NET:
Interest expense		(635,599)		(385,197)		(329,573)		(202,349)
Debt extinguishment loss		(143,251)		-		(74,651)		-
Gain (loss) from adjustment of derivative liability to fair value		27,480		14,951		-		(8,100)
Other (expense) income, net		(30,635)		29,553		1,101		9,269
Total other expense, net		(782,005)		(340,693)		(403,123)		(201,180)

Net loss	$	(2,884,589)	$	(1,373,432)		(2,169,221)		(720,594)

Loss per share – basic and diluted:
Net loss per share	$	(0.19)	$	(0.12)	$	(0.12)	$	(0.06)
Weighted average shares of common stock outstanding – basic and diluted		15,319,555		11,924,999		17,410,860		11,998,381

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

SIX MONTHS ENDED MARCH 31, 2013

(unaudited)

	Series A- 13 Preferred Stock		Series A- 14 Preferred Stock		Common Stock Issued		Common Stock Committed for Issue		Additional Paid-In	Accumulated
	Shares	Par	Shares	Par	Shares	Par	Shares	Par	Capital	Deficit	Total

Balance, September 30, 2012	17,500	$ 2	160,000	$ 16	12,902,217	$ 1,289	-	$ -	$ 141,199,626	$ (131,604,877)	$ 9,596,056
Issuance of common shares and options for employee services	-	-	-	-	-	-	3,950,000	395	1,806,452	-	1,806,847
Issuance of common shares for consultant services	-	-	-	-	538,943	54	-	-	178,248	-	178,302
Issuance of common shares for interest and financing fees	-	-	-	-	1,470,000	147	-	-	592,553	-	592,700
Issuance of right to obtain common shares for financing fees	-	-	-	-	-	-	-	-	78,750	-	78,750
Reclassification from liability arising from modification of detachable warrant associated with sale of common shares and Series A-14 preferred	-	-	-	-	-	-	-	-	53,894	-	53,894
Conversion of debt to common shares	-	-	-	-	583,334	58	-	-	174,942	-	175,000
Conversion of Series A-13 to common shares	(17,500)	(2)	-	-	437,500	44	-	-	(42)	-	-
Conversion of Series A-14 to common shares	-	-	(160,000)	(16)	160,000	16	-	-	-	-	-
Dividends on Series A-13	-	-	-	-	8,750	1	-	-	2,712	11,287	14,000
Net loss	-	-	-	-	-	-	-	-	-	(2,884,589)	(2,884,589)

Balance, March 31, 2013	-	$ -	-	$ -	16,100,744	$ 1,609	3,950,000	$ 395	$ 144,087,135	$ (134,478,179)	$ 9,610,960

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Six Months Ended March 31,
	2013		2012

CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss	$	(2,884,589)	$	(1,373,432)
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		704,681		714,622
Professional fee expenses paid with equity, including amortization of deferred expenses for prior period issuances		139,537		418,918
Compensation expenses paid with common shares and other equity		1,417,570		321,803
Amortization of discount on convertible debentures		67,076		107,013
Amortization of discount on notes payable		111, 483		20,124
Debt extinguishment loss		143,251		-
Gain from adjustment of derivative liability to fair value		(27,480)		(14,951)
Bad debt expense and other		102,596		(13,400)
Net cash (used in) provided by operating activities, before changes in current assets and liabilities other than cash		(225,875)		180,697
Changes in current assets and liabilities other than cash:
Decrease (increase) in accounts receivable		124,752		(85,652)
(Increase) in prepaid expenses		(114,341)		(120,847)
Decrease (increase) in inventories and other current assets		2,445		(3,999)
(Decrease) increase in accounts payable, accrued liabilities and amounts due to directors and officers		280,024		440,969
(Decrease) in deferred revenue		(67,832)		(19,263)
Net cash (used in) provided by operating activities		(827)		391,905

CASH FLOWS FROM INVESTING ACTIVITIES:
Intella2 acquisition (see note 2)		(713,477)		-
Acquisition of property and equipment		(439,608)		(425,208)
Net cash (used in) investing activities		(1,153,085)		(425,208)

(Continued)

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(continued)

	Six Months Ended March 31,
	2013		2012
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from notes payable, net of expenses	$	2,221,382	$	785,333
Proceeds from convertible debentures, net of expenses		350,000		-
Proceeds from sale of common shares, net of expenses		-		140,000
Repayment of notes and leases payable		(1,086,846)		(623,613)
Repayment of convertible debentures		(375,714)		(223,321)
Net cash provided by financing activities		1,108,822		78,399

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(45,090)		45,096

CASH AND CASH EQUIVALENTS, beginning of period		359,795		290,865

CASH AND CASH EQUIVALENTS, end of period	$	314,705	$	335,961

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash payments for interest	$	457,040	$	275,501

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

Issuance of common shares for consultant services	$	178,302	$	116,830
Issuance of shares and options for employee services	$	1,806,847	$	220,975
Issuance of common shares for interest and financing fees	$	592,700	$	51,448
Issuance of right to obtain common shares for financing fees	$	78,750	$	-
Increase in value of common shares underlying Series A-13 preferred, arising from adjustment of conversion rate in connection with financing commitment letter	$	107,442	$	21,081
Declaration of dividends payable on Series A-13 preferred	$	3,500	$	14,000
Issuance of common shares for dividends payable on A-13 preferred shares	$	2,713	$	4,025
Elimination of obligation for previously accrued or declared dividends payable on A-13 preferred shares	$	14,787		9,975
Issuance of common shares upon conversion of debt	$	175,000	$	-
Issuance of common shares upon conversion of Series A-13 preferred	$	175,000	$	175,000
Issuance of common shares upon conversion of Series A-14 preferred	$	200,000	$	-
Reclassification from liability to additional paid-in capital arising from modification of detachable warrant associated with sale of common shares and Series A-14 preferred	$	53,894	$	-
Initial estimated present value of future obligations for cash payments in connection with the Intella2 acquisition (see note 2)	$	704,452	$	-
Satisfaction of short-term obligations with note payable issuances	$	518,231	$	-
Issuance of note for equipment purchase	$	43,953	$	-

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

Onstream Media Corporation (“we” or "Onstream" or "ONSM"), organized in 1993, is a leading online service provider of live and on-demand corporate audio and web communications, virtual event technology and social media marketing, provided primarily to corporate (including large as well as small to medium sized businesses), education and government customers.

The Digital Media Services Group consists primarily of our Webcasting division, our DMSP (“Digital Media Services Platform”) division and our MP365 (“MarketPlace365”) division. The DMSP division includes the related UGC (“User Generated Content”) and Smart Encoding divisions.

The Webcasting division, which operates primarily from Pompano Beach, Florida and has a sales and support facility in New York City, provides an array of corporate-oriented, web-based media services to the corporate market including live audio and video webcasting and on-demand audio and video streaming for any business, government or educational entity. The Webcasting division generates revenue primarily through production and distribution fees.

The DMSP division, which operates primarily from Colorado Springs, Colorado, provides an online, subscription based service that includes access to enabling technologies and features for our clients to acquire, store, index, secure, manage, distribute and transform these digital assets into saleable commodities. The DMSP division generates revenues primarily from monthly subscription fees, plus charges for hosting, storage and professional services. Our UGC division, which also operates as Auction Video (see note 2) and operates primarily from Colorado Springs, Colorado, provides a video ingestion and flash encoder that can be used by our clients on a stand-alone basis or in conjunction with the DMSP. The Smart Encoding division, which operates primarily from San Francisco, California, provides both automated and manual encoding and editorial services for processing digital media. This division also provides hosting, storage and streaming services for digital media, which are provided via the DMSP.

The MP365 division, which operates primarily from Pompano Beach, Florida with additional operations in San Francisco, California, enables publishers, associations, tradeshow promoters and entrepreneurs to self-deploy their own online virtual marketplaces using the MarketPlace365® platform. The MP365 division generates revenues primarily from monthly subscription fees, as well as booth fees, charged to MP365 promoters.

The Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division, our Onstream Conferencing Corporation (“OCC”) division and our EDNet division. Our Infinite division, which operates primarily from the New York City area, and our OCC division, which operates primarily from San Diego, California, generate revenues from usage charges and fees for other services provided in connection with “reservationless” and operator-assisted audio and web conferencing services – see note 2.

The EDNet division, which operates primarily from San Francisco, California, provides connectivity (in the form of high quality audio, compressed video and multimedia data communications) within the entertainment and advertising industries through its managed network, which encompasses production and post-production companies, advertisers, producers, directors, and talent. EDNet generates revenues primarily from network access and usage fees as well as sale, rental and installation of equipment.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Liquidity

Our consolidated financial statements have been presented on the basis that we are an ongoing concern, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. We have incurred losses since our inception, and have an accumulated deficit of approximately $134.5 million as of March 31, 2013. Our operations have been financed primarily through the issuance of equity and debt, including convertible debt and debt combined with the issuance of equity.

Effective October 22, 2012, we moved the listing of our common stock from The NASDAQ Capital Market ("NASDAQ") to OTC Markets' OTCQB marketplace ("OTCQB"), maintaining our ticker symbol "ONSM". On October 21, 2011, we received a letter from NASDAQ advising us that for the 30 consecutive trading days preceding the date of the notice, the bid price of our common stock had closed below the $1.00 per share minimum bid price required for continued listing on The NASDAQ Capital Market, pursuant to NASDAQ Listing Rule 5550(a)(2)(a) (the “Bid Price Rule”). The letter stated that we would be provided 180 calendar days, or until April 18th, 2012, to regain compliance with the Bid Price Rule, which deadline was subsequently extended on a one-time basis to October 15, 2012. To regain compliance, the closing bid price of our common stock would have needed to be at least $1.00 per share for a minimum of ten consecutive business days prior to that date. We carefully evaluated our options to maintain our listing on NASDAQ, including whether or not to implement a reverse split to satisfy the $1.00 per share minimum bid price requirement, and concluded that it was not in the best interest of our shareholders.

For the year ended September 30, 2012, we had a net loss of approximately $2.6 million, although cash provided by operating activities for that period was approximately $1.1 million. For the six months ended March 31, 2013, we had a net loss of approximately $2.9 million, although cash used in operating activities for that period was approximately $1,000. Although we had cash of approximately $315,000 at March 31, 2013, our working capital was a deficit of approximately $3.3 million at that date.

During the second quarter of fiscal 2012, we terminated a consulting contract, which termination we expect will reduce our professional fee expense by approximately $143,000 for the remainder of fiscal 2013, as compared to the corresponding period of fiscal 2012. During the third quarter of fiscal 2012, we renegotiated certain supplier contracts which we expect will reduce our cost of sales by approximately $42,000 for the remainder of fiscal 2013, as compared to the corresponding period of fiscal 2012.

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”) – see note 2. The acquired Intella2 operations have achieved positive operating cash flow through March 31, 2013, although we also incurred debt and other liabilities during the six months ended March 31, 2013 that was associated specifically or generally with this acquisition – see notes 2 and 4.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Liquidity (continued)

On December 21, 2012, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”), agreeing to provide us, within twenty (20) days after our notice given on or before December 31, 2013, aggregate cash funding of up to $550,000, which may be requested in multiple tranches. Mr. Charles Johnston, who was one of our directors at the time of the transaction, is the president of J&C. This Funding Letter was obtained solely to demonstrate our ability to obtain short-term funds in the event other funding sources are not available, but does not represent any obligation to accept such funding on these terms and is not expected by us to be exercised. Cash provided under the Funding Letter would be in exchange for our issuance of (a) a note or notes with interest payable monthly at 15% per annum and principal payable on the earlier of a date twelve months from funding or July 1, 2014 and (b) our issuance of 2.3 million unregistered common shares, which shares would be prorated in the case of partial funding. The note or notes would be unsecured and subordinated to all of our other debts, except to the extent such the terms of such debts would allow pari passu status. Furthermore, the note or notes would not be subject to any provisions, other than with respect to priority of payments or collateral, of our other debts. Upon receipt by us of an equivalent amount in dollars of investment from any other source after the date of this Funding Letter, other than funding received in connection with the LPC Purchase Agreement (see note 6), to refinance existing debt and up to $500,000 funding for general working capital or other business uses, this Funding Letter will be terminated. From the date of the Funding Letter through May 10, 2013, we have received funding of approximately $1.5 million, of which approximately $1.0 million was refinancing of existing debt and approximately $500,000 was new funding for general working capital or other business uses. The $1.5 million excludes advances made under the Line after the date of the Funding Letter, which are considered to be refinancing of existing debt since the outstanding balance under the Line as of May 10, 2013 is less than the outstanding balance under the Line as of the date of the Funding Letter - see note 4. Accordingly, the Funding Letter remains in effect as of May 10, 2013.

During the three months ended June 30, 2012 (our most favorable recent quarter), our revenues were sufficient to fund our operating cash expenditures plus all capital expenditures and debt service expenditures (monthly principal and interest payments on the Rockridge Note and interest payable in cash on the Line and other debts). This was not the case for the three months ended September 30, 2012, primarily due to a seasonal decline in our revenues for that quarter, as compared to revenues for the three months ended June 30, 2012. However our revenues for each of the two quarters since then (the quarters ending December 31, 2012 and March 31, 2013) have represented a revenue increase from the immediately preceding quarter and we expect that this revenue increase will continue with respect to the three months ending June 30, 2013, although such increase may not be sufficient to attain revenues equal to or in excess of our revenues for the three months ended June 30, 2012. However, in the event we are unable to achieve sufficiently increased revenues, we believe that a combination of the already implemented cost savings discussed above, additional identified decreases in our current level of expenditures that we have already planned to implement or could implement and the raising of additional capital in the form of debt and/or equity that we believe we could obtain from identified sources would be sufficient to fund our operations through March 31, 2014. We will closely monitor our revenue and other business activity to determine if and when further cost reductions, the raising of additional capital, or other activity is considered necessary.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Liquidity (continued)

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

Basis of Consolidation

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

Cash and cash equivalents

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

Concentration of Credit Risk

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

Bad Debt Reserves

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

Inventories

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Fair Value Measurements

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

We have determined that the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued liabilities, amounts due to directors and officers and deferred revenue approximate fair value due to the short maturity of the instruments. We have also determined that the carrying amounts of certain notes and other debt approximate fair value due to the short maturity of the instruments, as well as the market value interest rates they carry – these include the Line and Equipment Notes and Leases. The accrued liability for the contingent portion of the Intella2 purchase price, a portion of which is classified as non-current as of March 31, 2013, was determined based on its fair value as of the November 30, 2012 Intella2 acquisition – see note 2 - and the fair value of that liability will be re-evaluated at the end of each subsequent accounting period and adjusted accordingly.

We have determined that the Rockridge Note, the CCJ Note, the Equipment Notes, the Subordinated Notes, the Intella2 Investor Notes, the Investor Notes, the Fuse Note, the Sigma Note and the USAC Note (the “Instruments”), discussed in note 4, meet the definition of a financial instrument as contained in the Financial Instruments topic of the Accounting Standards Codification (“ASC”), as this definition includes a contract that imposes a contractual obligation on us to deliver cash to the other party to the contract and/or exchange other financial instruments with the other party to the contract on potentially unfavorable terms. Accordingly, these items are (or were) financial liabilities subject to the accounting and disclosure requirements of the Fair Values Measurements and Disclosures topic of the ASC, whereby such liabilities are presented at fair value, which is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs.

The accounting standards describe a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value:

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

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Fair Value Measurements (continued)

We have determined that there are no Level 1 inputs for determining the fair value of the Instruments. However, we have determined that the fair value of the Instruments may be determined using Level 2 inputs, as follows: the fair market value interest rate paid by us under our line of credit arrangement (the “Line”), as discussed in note 4. We have also determined that the fair value of the Instruments may be determined using Level 3 inputs, as follows: third party studies arriving at recommended discount factors for valuing payments made in unregistered restricted stock instead of cash, interest rates and other related expenses such as finders and origination fees observed in our ongoing and active negotiations with various financing sources, including the terms of transactions engaged in by us that are not eligible to be Level 2 inputs because of the non-comparable duration of the transaction as compared to the transaction being valued. Level 3 inputs used by us in our fair value calculations with respect to the Instruments include finders and origination fees ranging between 6% and 14% per annum and periodic interest rate premiums arising from less favorable collateral and/or payment priority, as compared to the Line, ranging between 3% and 5% per annum.

Based on the use of the inputs described above, we have determined that there was no material difference between the carrying value and the fair value of the Instruments as of March 31, 2013, December 31, 2012, September 30, 2012, March 31, 2012, December 31, 2011 or September 30, 2011 and therefore no adjustment with respect to fair value was made to our consolidated financial statements as of those dates or for the six or three months ended March 31, 2013 and 2012.

Goodwill and other intangible assets

In accordance with the Intangibles – Goodwill and Other topic of the ASC, goodwill is reviewed annually (or more frequently if impairment indicators arise) for impairment. We follow a two step process for impairment testing of goodwill. The first step of this test, used to identify potential impairment and described above, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment, including a comparison and reconciliation of the carrying value of all of our reporting units to our market capitalization, after appropriate adjustments for control premium and other considerations.

During our fourth fiscal quarter ended September 30, 2011, we elected early adoption of the provisions of a recent ASC update to the above accounting standards that allow us to forego the two step impairment process based on certain qualitative evaluation – see discussion in Effects of Recent Accounting Pronouncements below. Also see note 2 – Goodwill and other Acquisition-Related Intangible Assets.

Other intangible assets, such as customer lists, are amortized to expense over their estimated useful lives, although they are still subject to review and adjustment for impairment.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Property and Equipment

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

Software

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

Revenue Recognition

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

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

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

Based on our review of the above data, we have determined that the material portion of our revenues for on-demand webcasting services are recognized during the period in which those services are provided, which complies with the provisions of the Revenue Recognition topic of the ASC. Furthermore, we have determined that the maximum potentially deferrable revenue from on-demand webcasting services charged for but not provided as of March 31, 2013 and September 30, 2012 was immaterial in relation to our recorded liabilities at those dates.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Revenue Recognition (continued)

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

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

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

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

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Revenue Recognition (continued)

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

Income Taxes

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

We have approximately $85.6 million in Federal net operating loss carryforwards as of March 31, 2013, which expire in fiscal years 2018 through 2033. Our utilization of approximately $20 million of the net operating loss carryforwards, acquired from the 2001 acquisition of EDNet and the 2002 acquisition of MOD and included in this $85.6 million total, against future taxable income may be limited as a result of ownership changes and other limitations.

Significant judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities and any valuation allowance recorded against those deferred tax assets. We had a deferred tax asset of approximately $32.2 million and $31.6 million as of March 31, 2013 and September 30, 2012, respectively, primarily resulting from net operating loss carryforwards. A full valuation allowance has been recorded related to the deferred tax asset due to the uncertainty of realizing the benefits of certain net operating loss carryforwards before they expire. Our management will continue to assess the likelihood that the deferred tax asset will be realizable and the valuation allowance will be adjusted accordingly.

Accordingly, no income tax benefit was recorded in our consolidated statement of operations as a result of the net tax losses for the six and three months ended March 31, 2013 and 2012. The primary differences between the net loss for book and the net loss for tax purposes are the following items expensed for book purposes but not deductible for tax purposes – amortization of certain loan discounts, amortization and/or impairment adjustments of certain acquired intangible assets, expenses for stock options issued in payment for consultant and employee services but not exercised by the recipients and expenses related to shares issued or committed to be issued in payment for consultant and employee services, until such shares are issued and eligible for resale by the recipient.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Income Taxes (continued)

The Income Taxes topic of the ASC prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. However, as of March 31, 2013 and September 30, 2012 we have not taken, nor recognized the financial statement impact of, any material tax positions, as defined above. Our policy is to recognize, as non-operating expense, interest or penalties related to income tax matters at the time such payments become probable, although we had not recognized any such material items in our statement of operations for the six and three months ended March 31, 2013 and 2012. The tax years ending September 30, 2009 and thereafter remain subject to examination by Federal and various state tax jurisdictions.

Valuation of Derivatives

In accordance with ASC Topic 415, Derivatives and Hedging, we follow a two-step approach to evaluate an instrument’s contingent exercise provisions, if any, and to evaluate the instrument’s settlement provisions when determining whether an equity-linked financial instrument (or embedded feature) is indexed to our own stock, which would in turn determine whether the instrument was treated as a liability to be recorded on our balance sheet at fair value and then adjusted to market in subsequent accounting periods. We have determined that this treatment was applicable to a warrant issued by us in September 2010 – see note 8.

Net Loss per Share

For the six months ended March 31, 2013 and 2012, net loss per share is based on the net loss divided by the weighted average number of shares of common stock outstanding, including the impact of 3,950,000 shares of common stock committed to be issued to certain Executives, but not yet issued, as of March 31, 2013 – see note 5. Since the effect of common stock equivalents was anti-dilutive, all such equivalents were excluded from the calculation of weighted average shares outstanding. The total outstanding options and warrants, which have been excluded from the calculation of weighted average shares outstanding, were 1,451,675 and 3,530,072 at March 31, 2013 and 2012, respectively.

In addition, the potential dilutive effects of the following convertible securities outstanding at March 31, 2013 have been excluded from the calculation of weighted average shares outstanding: (i) the $677,402 outstanding balance of the Rockridge Note, which could have potentially converted into up to 282,251 shares of our common stock (ii) the right of Rockridge to receive 591,667 restricted shares of our common stock for an origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us, (iii) the $200,000 outstanding balance of the Fuse Note, which could potentially converted into up to 400,000 shares of our common stock, (iv) the $200,000 portion of the outstanding balance of the Intella2 Investor Notes issued to Fuse Capital LLC which could potentially convert into up to 400,000 shares of our common stock and (v) the $50,000 portion of the outstanding balance of the Sigma Note which could potentially convert into up to 50,000 shares of our common stock.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Net Loss per Share (continued)

In addition, the potential dilutive effects of the following convertible securities outstanding at March 31, 2012 have been excluded from the calculation of weighted average shares outstanding: (i) 17,500 shares of Series A-13 Convertible Preferred Stock (“Series A-13”) which could have potentially converted into 101,744 shares of ONSM common stock (and which were converted into 437,500 shares based on a reduction in the conversion price agreed to by us in December 2012 – see note 6), (ii) 420,000 shares of Series A-14 Convertible Preferred Stock (“Series A-14”) which were converted into 260,000 shares of ONSM common stock on September 30, 2012 and 160,000 shares of ONSM common stock during the six months ended March 31, 2013, (iii) the $1,066,749 outstanding balance of the Rockridge Note, which could have potentially converted into up to 444,479 shares of our common stock (iv) the right of Rockridge to receive 366,667 restricted shares of our common stock for an origination fee in connection with the Rockridge Note, issuable upon not less than sixty-one (61) days written notice to us, (v) $350,000 of convertible notes which in aggregate could have potentially converted into up to 500,000 shares of our common stock, excluding interest (but which became convertible into up to 583,333 shares based on a May 12, 2012 modification – see note 4) and (vi) the $100,000 CCJ Note, which could have potentially converted into up to 50,000 shares of our common stock.

Compensation and related expenses

Compensation costs for employees considered to be direct labor are included as part of webcasting and smart encoding costs of revenue. Certain compensation costs for employees involved in development of software for internal use, as discussed under Software above, are capitalized. Accrued liabilities and amounts due to directors and officers includes, in aggregate, approximately $780,000 and $966,000 as of March 31, 2013 and September 30, 2012, respectively, related to salaries, commissions, taxes, vacation and other benefits earned but not paid as of those dates.

Equity Compensation to Employees and Consultants

We have a stock based compensation plan (the “Plan”) for our employees, directors and consultants. In accordance with the Compensation – Stock Compensation topic of the ASC, we measure compensation cost for all share-based payments, including employee stock options, at fair value, using the modified-prospective-transition method. Under this method, compensation cost recognized for the six and three months ended March 31, 2013 and 2012 includes compensation cost for all share-based payments granted subsequent to September 30, 2006, calculated using the Black-Scholes model, based on the estimated grant-date fair value and allocated over the applicable vesting and/or service period. There were no Plan options granted during the six months ended March 31, 2013. For Plan options that were granted and thus valued under the Black-Scholes model during the six months ended March 31, 2012, the expected volatility rates were approximately 97%, the risk-free interest rates were approximately 0.4% to 1.1% and the expected terms were 3 to 5 years.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Equity Compensation to Employees and Consultants (continued)

We have granted Non-Plan Options to consultants and other third parties. These options have been accounted for under the Equity topic (Equity-Based Payments to Non-Employees subtopic) of the ASC, under which the fair value of the options at the time of their issuance, calculated using the Black-Scholes model, is reflected as a prepaid expense in our consolidated balance sheet at that time and expensed as professional fees during the time the services contemplated by the options are provided to us. There were no Non-Plan options granted during the six months ended March 31, 2013 or March 31, 2012.

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

Advertising and marketing

Advertising and marketing costs, which are charged to operations as incurred and classified in our financial statements under Professional Fees or under Other General and Administrative Operating Expenses, were approximately $340,000 and $354,000 for the six months ended March 31, 2013 and 2012, respectively and were approximately $177,000 and $178,000 for the three months ended March 31, 2013 and 2012, respectively. These amounts include third party marketing consultant fees and third party sales commissions, but do not include commissions or other compensation to our employee sales staff.

Comprehensive Income or Loss

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

Accounting Estimates

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

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation, including segregation of the cash and non-cash components of compensation expense on the statement of operations.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Interim Financial Data

In the opinion of our management, the accompanying unaudited interim financial statements have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission. These interim financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements and should be read in conjunction with our annual financial statements as of September 30, 2012. These interim financial statements have not been audited. However, our management believes the accompanying unaudited interim financial statements contain all adjustments, consisting of only normal recurring adjustments, necessary to present fairly our consolidated financial position as of March 31, 2013, the results of our operations for the six and three months ended March 31, 2013 and 2012 and our cash flows for the six months ended March 31, 2013 and 2012. The results of operations and cash flows for the interim periods are not necessarily indicative of the results of operations or cash flows that can be expected for the year ending September 30, 2013.

Effects of Recent Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued updated accounting guidance related to fair value measurements and disclosures, which includes amendments that clarify the intent about the application of existing fair value measurements and disclosures, while other amendments change a principle or requirement for fair value measurements or disclosures. This guidance, which we first adopted on a prospective basis during our fiscal year ending September 30, 2013, had no material impact on our consolidated financial statements.

In June 2011, the FASB issued authoritative guidance related to the presentation of comprehensive income. The guidance requires that all non-owner changes in stockholders’ equity be presented in a single continuous statement of comprehensive income or in two separate but consecutive statements. The guidance does not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. In December 2011, the FASB issued guidance that indefinitely deferred one of the new provisions in the June 2011 guidance, which was a requirement for entities to present reclassification adjustments out of accumulated other comprehensive income by component in both the statement in which net income is presented and the statement in which other comprehensive income is presented (for both interim and annual financial statements). The remainder of the June 2011 guidance was effective for our fiscal year ending September 30, 2013, applied retrospectively. The adoption of this guidance had no material impact on our consolidated financial statements.

In September 2011, the FASB issued ASC Update ("ASU") No. 2011-08 - Intangibles - Goodwill and Other (Topic 350): Testing Goodwill for Impairment (“Update 2011-08”), which provides guidance setting forth the circumstances under which an entity may assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount and to use such qualitative assessment as a basis of determining whether it would be necessary to perform the two-step goodwill impairment test described in Topic 350. Although the terms of Update 2011-08 did not require implementation before our fiscal year ending September 30, 2012, early adoption was permitted, which we elected in order to first apply this guidance to our fiscal year ended September 30, 2011 and the related annual impairment tests – see note 2. The adoption of this guidance had no material impact on our consolidated financial statements.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Effects of Recent Accounting Pronouncements (continued)

In July 2012, the FASB issued ASU 2012-02 Intangibles - Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment, which is intended to reduce the complexity and cost of performing a quantitative test for impairment of indefinite-lived intangible assets by permitting an entity the option to perform a qualitative evaluation about the likelihood that an indefinite-lived intangible asset is impaired in order to determine whether it should calculate the fair value of the asset. The update also improves previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount. We adopted this guidance for our fiscal year ended September 30, 2012, which had no material impact on our consolidated financial statements.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 2: GOODWILL AND OTHER ACQUISITION-RELATED INTANGIBLE ASSETS

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


	March 31, 2013						September 30, 2012
	Gross Carrying Amount						Gross Carrying Amount
			Accumulated Amortization		Net Book Value				Accumulated Amortization		Net Book Value
			Accumulated Amortization		Net Book Value				Accumulated Amortization		Net Book Value
Goodwill:
Infinite Conferencing	$	8,600,887	$	-	$	8,600,887	$	8,600,887	$	-	$	8,600,887
EDNet		1,271,444		-		1,271,444		1,271,444		-		1,271,444
Intella2		411,656		-		411,656		-		-		-
Acquired Onstream		271,401		-		271,401		271,401		-		271,401
Auction Video		3,216		-		3,216		3,216		-		3,216
Total goodwill		10,558,604		-		10,558,604		10,146,948		-		10,146,948

Acquisition-related intangible assets (items listed are those remaining on our books as of March 31, 2013):
Infinite Conferencing -
customer lists, trademarks
and URLs		3,181,197		(3,148,391)		32,806		3,181,197		(2,922,977)		258,220
Intella2 - customer lists,
tradenames, URLs and
non-compete		759,848		(35,638)		724,210		-		-		-
Auction Video - patent
pending		351,675		(351,564)		111		350,888		(331,529)		19,359
Total intangible assets		4,292,720		(3,535,593)		757,127		3,532,085		(3,254,506)		277,579

Total goodwill and other acquisition-related intangible assets	$	14,851,324	$	(3,535,593)	$	11,315,731	$	13,679,033	$	(3,254,506)	$	10,424,527

Intella2 – November 30, 2012

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”). The acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail. The Intella2 assets and operations were purchased by Onstream Conferencing Corporation, our wholly owned subsidiary, and are being managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The unaudited revenues from the acquired operations for the twelve months ended August 31, 2012 were approximately $1.4 million, including free conferencing business revenues of approximately $300,000.

We have determined that the above transaction does not meet the requirements established by the Securities and Exchange Commission for a “significant acquisition”, and therefore no pro-forma or other financial information related to the periods prior to the acquisition is being presented.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Intella2 – November 30, 2012 (continued)

The total preliminary purchase price of the Intella2 assets and operations has been determined to be approximately $1.4 million, of which we have paid approximately $713,000 in cash to Intella2 through March 31, 2013. The remaining portion of the total preliminary purchase price, approximately $704,000, was the present value of management’s estimate of total additional payments considered probable with respect to the following remaining obligations incurred in connection with the Intella2 purchase:

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

(ii) Additional payment equal to fifty percent (50%) of the excess of eligible revenues for the twelve months ending November 30, 2013 over $1,098,000, provided that such additional payment would be no more than $300,000.

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

Eligible revenues for purposes of items (i) and (ii) above exclude free conferencing business revenues and non-recurring revenues and are further defined in the Asset Purchase Agreement dated November 30, 2012. The additional purchase price payments per items (i) and (ii) above are due in quarterly installments commencing August 31, 2013 and ending May 31, 2014. The additional purchase price payments per item (iii) above are due in monthly installments commencing January 31, 2013, subject to certain holdbacks and reserves. The unpaid portion of the total preliminary purchase price is reflected on our March 31, 2013 balance sheet as an accrued liability of $741,530, with a current portion of $447,908 and a non-current portion of $293,622. These amounts represent the remaining portion of the total preliminary purchase price determined as of the time of the initial purchase plus accretion of approximately $38,000, which has been reflected as interest expense on our statement of operations for the six and three months ended March 31, 2013.

The total purchase price and the liability for the unpaid portion of that purchase price recorded by us as of March 31, 2013 depends significantly on projections and estimates. Authoritative accounting guidance allows one year from the acquisition date for us to make adjustments to these amounts, in the event that such adjustments are based on facts and circumstances that existed as of the acquisition date that, if known, would have resulted in such adjusted assets and liabilities as of that date. Regardless of this, a contingent consideration liability shall be remeasured to fair value at each reporting date until the contingency is resolved. Changes resulting from facts and circumstances arising after the acquisition date, such as meeting a revenue target, shall be recognized in our results of operations. Changes resulting from a change in the discount rates applied to estimates of future cash flows shall also be recognized in our results of operations.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Intella2 – November 30, 2012 (continued)

Based on our continuing evaluation, we made adjustments to the following items as of March 31, 2013, as compared to the amounts recorded by us as of December 31, 2012: purchase price increase of approximately $58,000, customer list increase of approximately $123,000, goodwill decrease of approximately $52,000 and other intangible assets decrease of approximately $13,000. Since these changes were based on facts that existed as of the acquisition date, they were recorded with no impact to our results of operations. We have determined that as of March 31, 2013, no adjustments to these amounts are necessary resulting from facts and circumstances arising after the acquisition date.

The fair value of certain intangible assets (customer lists, tradenames, URLs (internet domain names) and employment and non-compete agreements) acquired as part of the Intella2 acquisition was determined by our management to be approximately $760,000 at the time of the acquisition. This fair value was primarily based on the discounted projected cash flows related to these assets for the three to seven years immediately following the acquisition on a stand-alone basis without regard to the Intella2 acquisition, as projected by our management and Intella2’s former management. The discount rate utilized considered equity risk factors (including small stock risk) as well as risks associated with profitability and working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining. The fair value of certain tangible assets (primarily equipment) acquired as part of the Intella2 acquisition was determined by our management to be approximately $246,000 at the time of the acquisition. This fair value was primarily based on management’s inspection of and evaluation of the condition and utility of the equipment, as well as comparable market values of similar used equipment when available. We are depreciating and amortizing these tangible and intangible assets over useful lives ranging from three to seven years. The approximately $1.4 million purchase price exceeded the fair values we assigned to Intella2’s tangible and intangible assets (net of liabilities at fair value) by approximately $412,000, which we recorded as goodwill.

Infinite Conferencing – April 27, 2007

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Infinite Conferencing – April 27, 2007 (continued)

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

The approximately $18.2 million purchase price exceeded the fair values we assigned to Infinite’s tangible and intangible assets (net of liabilities at fair value) by approximately $12.0 million, which we recorded as goodwill as of the purchase date. As of December 31, 2008, this initially recorded goodwill was determined to be impaired and a $900,000 adjustment was made to reduce its carrying value to approximately $11.1 million. A similar adjustment of $200,000 was made as of that date to reduce the carrying value of certain intangible assets acquired as part of the Infinite Merger. As of December 31, 2009, the Infinite goodwill was determined to be further impaired and a $2.5 million adjustment was made to reduce the carrying value of that goodwill to approximately $8.6 million. A similar adjustment of $600,000 was made as of that date to reduce the carrying value of certain intangible assets acquired as part of the Infinite Merger.

Auction Video – March 27, 2007

On March 27, 2007 we completed the acquisition of the assets, technology and patents pending of privately owned Auction Video, Inc., a Utah corporation, and Auction Video Japan, Inc., a Tokyo-Japan corporation (collectively, “Auction Video”). The acquisitions were made with a combination of restricted shares of our common stock valued at approximately $1.5 million issued to the stockholders of Auction Video Japan, Inc. and $500,000 cash paid to certain stockholders and creditors of Auction Video, Inc., for an aggregate purchase price of approximately $2.0 million, including transaction costs. On December 5, 2008 we entered into an agreement whereby one of the former owners of Auction Video Japan, Inc. agreed to shut down the Japan office of Auction Video as well as assume all of our outstanding assets and liabilities connected with that operation, in exchange for non-exclusive rights to sell our products in Japan and be compensated on a commission-only basis. It is the opinion of our management that any further developments with respect to this shut down or the above agreement will not have a material adverse effect on our financial position or results of operations.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Auction Video – March 27, 2007 (continued)

We allocated the Auction Video purchase price to the identifiable tangible and intangible assets acquired, based on a determination of their reasonable fair value as of the date of the acquisition. The technology and patent pending related to the video ingestion and flash transcoder, the Auction Video customer lists, future cost savings for Auction Video services and the consulting and non-compete agreements entered into with the former executives and owners of Auction Video were valued in aggregate at $1.4 million and have been and are being amortized over various lives between two to five years commencing April 2007 - as of September 30, 2010 the assets with a useful life of two or three years (customer lists, future cost savings and the consulting and non-compete agreements) had been fully amortized and removed from our balance sheet. $600,000 was assigned as the value of the video ingestion and flash transcoder and added to the DMSP’s carrying cost for financial statement purposes – see note 3.

Subsequent to the Auction Video acquisition, we began pursuing the final approval of the patent pending application and in March 2008 retained the law firm of Hunton & Williams to assist in expediting the patent approval process and to help protect rights related to proprietary Onstream technology. In April 2008, we revised the original patent application primarily for the purpose of splitting it into two separate applications, which, while related, were being evaluated separately by the U.S. Patent and Trademark Office (“USPTO”).

With respect to the claims pending in the first of the two applications, the USPTO issued non-final rejections in August 2008, February 2009 and May 2009, as well as final rejections in January 2010 and June 2010. Our responses to certain of these rejections included modifications to certain claims made in the original patent application. In response to the latest rejection we filed a Notice of Appeal with the USPTO on November 22, 2010 and we filed an appeal brief with the USPTO on February 9, 2011. The USPTO filed an Examiner's Answer to the Appeal Brief on May 10, 2011, which repeated many of the previous reasons for rejection, and we filed a response to this filing on July 8, 2011. A decision will be made as to our appeal by a three member panel based on these filings, plus oral argument at a hearing which has been requested by us but a time not yet set. The expected timing of this decision is uncertain at this time, but generally would be expected to occur by mid to late 2013. Regardless of the ultimate outcome of this matter, our management has determined that an adverse decision with respect to this patent application would not have a material adverse effect on our financial position or results of operations.

With respect to the claims pending in the second of the two applications, the USPTO issued a non-final rejection in June 2011 (which was reissued in January 2012) and a final rejection in June 2012. With respect to the June 2012 rejection, we filed a pre-appeal brief conference request on September 7, 2012 and the USPTO responded on September 27, 2012 with a decision to proceed to appeal. We filed a Request for Continuing Examination with the USPTO on April 5, 2013, which the USPTO may take several months to respond to. In the event that USPTO response is unfavorable, we will still have the option to proceed with further appeal filings. Regardless of the ultimate outcome of this matter, our management has determined that an adverse decision with respect to this patent application would not have a material adverse effect on our financial position or results of operations.

Certain of the former owners of Auction Video, Inc. have an interest in proceeds that we may receive under certain circumstances in connection with these patents.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Acquired Onstream – December 23, 2004

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

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

The primary asset acquired in the Onstream Merger was the partially completed DMSP, recorded at fair value as of the December 23, 2004 closing, in accordance with the Business Combinations topic of the ASC. The fair value was primarily based on the discounted projected cash flows related to this asset for the five years immediately following the acquisition on a stand-alone basis without regard to the Onstream Merger, as projected at the time of the acquisition by our management and Acquired Onstream’s management. The discount rate utilized considered equity risk factors (including small stock risk and bridge/IPO stage risk) plus risks associated with profitability/working capital, competition, and intellectual property. The projections were adjusted for charges related to fixed assets, working capital and workforce retraining. See note 3.

The approximately $10.0 million purchase price we paid for 100% of Acquired Onstream exceeded the fair values we assigned to Acquired Onstream’s tangible and intangible assets (net of liabilities at fair value) by approximately $8.4 million, which we recorded as goodwill as of the purchase date. As of December 31, 2008, this initially recorded goodwill was determined to be impaired and a $4.3 million adjustment was made to reduce the carrying value of that goodwill to approximately $4.1 million. As of September 30, 2010, the Acquired Onstream goodwill was determined to be further impaired and a $1.6 million adjustment was made to reduce the carrying value of that goodwill to approximately $2.5 million. As of September 30, 2011, the Acquired Onstream goodwill was determined to be further impaired and a $1.7 million adjustment was made to reduce the carrying value of that goodwill to approximately $821,000. As of September 30, 2012, the Acquired Onstream goodwill was determined to be further impaired and a $550,000 adjustment was made to reduce the carrying value of that goodwill to approximately $271,000.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

EDNet – July 25, 2001

Prior to 2001, we recorded goodwill of approximately $750,000, resulting from the acquisition of 51% of EDNet, which we were initially amortizing on a straight-line basis over 15 years. As of July 1, 2001, we adopted SFAS 142, Goodwill and Other Intangible Assets, which addressed the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition. This standard required that goodwill no longer be amortized, and instead be tested for impairment on a periodic basis. When we acquired the remaining 49% of EDNet on July 25, 2001 the transaction generated $2,293,000 in goodwill which when combined with the unamortized portion of the initial goodwill resulted in total EDNet goodwill of $2,799,000. Based on our goodwill impairment tests as of September 30, 2002 we determined that the EDNet goodwill was impaired by approximately $728,000 and therefore the goodwill was written down to approximately $2,071,000. Based on our goodwill impairment tests as of September 30, 2004 we determined that the EDNet goodwill was impaired by approximately $470,000 and therefore the goodwill was written down to approximately $1,601,000. Based on our goodwill impairment tests as of September 30, 2005 we determined that the EDNet goodwill was impaired by approximately $330,000 and therefore the goodwill was written down to approximately $1,271,000. We have continued to evaluate the carrying value of the EDNet goodwill on an annual basis, with no further writedowns required to date.

Testing for Impairment

The Intangibles – Goodwill and Other topic of the ASC, which addresses the financial accounting and reporting standards for goodwill and other intangible assets subsequent to their acquisition, requires that goodwill be tested for impairment on a periodic basis. Although other intangible assets are being amortized to expense over their estimated useful lives, the unamortized balances are still subject to review and adjustment for impairment. There is a two-step process for impairment testing of goodwill and other intangible assets. The first step of this test, used to identify potential impairment, compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment. With respect to our annual impairment review of our goodwill and other acquisition-related intangible assets conducted as of September 30, 2012, we applied the provisions of ASU 2011-08, which allows us to forego the two-step impairment process based on certain qualitative evaluation, and which pronouncement we first adopted for our annual impairment review conducted as of September 30, 2011 (see note 1 - Effects of Recent Accounting Pronouncements).

We perform our own independent analysis to determine whether goodwill is potentially impaired. Our management performs a discounted cash flow analysis and uses market-multiple-based analyses to estimate the enterprise fair value of ONSM and its segments and test the related goodwill for potential impairment. Our management independently determines the rates and assumptions, including the probability of future revenues and costs, used by it to perform this goodwill impairment analysis and to assess and evaluate the recoverability of goodwill.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Testing for Impairment (continued)

This qualitative evaluation included our assessment of relevant events and circumstances as listed in ASU 2011-08, some of which relate to the Onstream Media corporate entity (“ONSM”) as a whole, which includes reporting units with acquired goodwill and other intangible assets as well as other operations engaged in by ONSM, and some of which pertain to the individual reporting units. These relevant events and circumstances included certain macroeconomic conditions, including access to capital, which we believe to be affected by an entity-level condition - the recent decrease in the ONSM share price. Although this might result in decreased access to capital, we concluded that this would not affect the valuation of our individual reporting units, since (a) the decline in share price is related to factors which do not stem from the reporting units and (b) all of our significant reporting units would be able to obtain sufficient capital for their operations on an independent basis, based on their particular operating results.

In order to address whether any further consideration of ONSM’s share price was needed with respect to impairment testing, we performed an analysis to compare our book value (after the impairment adjustment for Acquired Onstream/DMSP discussed below) to our market capitalization as of September 30, 2012, including adjustments for (i) paid-for but not issued common shares, such as those from non-redeemable preferred stock and (ii) an appropriate control premium. We also took into account market data for unrelated business entities and transactions comparable to our reporting units and relevant to the valuation thereof. Recent market multiples for comparable webcasting, telecommunications and digital media businesses for trailing twelve month revenue ranged from a low of 0.9 to a high of 1.7. Based on this analysis, we concluded that there were no conditions which would make us ineligible to employ qualitative evaluation with respect to our reporting units.

In reviewing goodwill for potential impairment, our management considered macroeconomic and other conditions such as:

· Onstream’s credit rating and access to capital

· A decline in market-dependent multiples in absolute terms

· Telecommunications industry growth projections

· Internet industry growth projections

· Entertainment industry growth projections (re EDNet customer base)

· Onstream’s current sales compared to last year

· Onstream’s technological accomplishments compared to its peer group

In addition to evaluating the above factors with respect to the Infinite and EDNet reporting units, we compared the results for the year ended September 30, 2012 to the projections on which the September 30, 2010 goodwill impairment analysis was primarily based (since our impairment review as of September 30, 2011 determined that no adjustment was necessary to these projections). Based on this comparison and the related analysis, as well as our understanding of generally favorable expectations for business activity in the audio and web conferencing industry in general as well as our business activity in specific, we concluded that the Infinite and EDNet reporting unit projections for 2012-2015, on which the September 30, 2010 goodwill impairment analysis was based, continued to be reasonably achievable and indicative of our minimum expectations.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

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

Testing for Impairment (continued)

Based on this qualitative evaluation, we determined that it was more likely than not, as well as clear, that the fair values of the Infinite and EDNet reporting units were more than their respective carrying amounts and accordingly it would not be necessary to perform the two-step goodwill impairment test with respect to those reporting units as of September 30, 2012. However, we were unable to arrive at the same conclusion as a result of our qualitative evaluation of the Acquired Onstream business unit. Accordingly, we performed impairment tests on Acquired Onstream as of September 30, 2012, using the two-step process described above and we determined that Acquired Onstream’s goodwill was impaired as of that date. Based on that condition, a $550,000 adjustment was made to reduce the carrying value of goodwill as of that date.

An annual impairment review of our goodwill and other acquisition-related intangible assets will be performed as part of preparing our September 30, 2013 financial statements. Until that time, we will review certain factors to determine whether a triggering event has occurred that would require an interim impairment review Those factors include, but are not limited to, our management’s estimates of future sales and operating income, which in turn take into account specific company, product and customer factors, as well as general economic conditions and the market price of our common stock. Based on that review, including an increase in the closing price of our common shares from $0.48 per share at September 30, 2012 to $0.49 per share as of May 10, 2013, we have concluded that no triggering event has occurred through May 10, 2013. Although we note that there was very low trading volume of ONSM common shares on May 10, 2013, and the volume weighted average price for the week then ended was $0.41 per share, we do not consider this a sufficiently significant difference to change our conclusion in this regard.

NOTE 3: PROPERTY AND EQUIPMENT

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

	March 31, 2013						September 30, 2012
	Historical Cost		Accumulated Depreciation and Amortization		Net Book Value		Historical Cost		Accumulated Depreciation and Amortization		Net Book Value		Useful Lives(Yrs)

Equipment and
software	$	10,922,939	$	(10,265,848)	$	657,091	$	10,533,026	$	(10,133,186)	$	399,840	1-5
DMSP		5,954,131		(5,409,265)		544,866		5,882,160		(5,328,649)		553,511	5
Other capitalized
internal use software		3,310,521		(1,446,638)		1,863,883		3,078,552		(1,248,519)		1,830,033	3-5
Travel video
library		1,368,112		(1,368,112)		-		1,368,112		(1,368,112)		-	N/A
Furniture, fixture
and leasehold improvements		608,543		(527,663)		80,880		573,196		(515,465)		57,731	2--7
Totals	$	22,164,246	$	(19,017,526)	$	3,146,720	$	21,435,046	$	(18,593,931)	$	2,841,115

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 3: PROPERTY AND EQUIPMENT (Continued)

Depreciation and amortization expense for property and equipment was approximately $424,000 and $455,000 for the six months ended March 31, 2013 and 2012, respectively and approximately $225,000 and $228,000 for the three months ended March 31, 2013 and 2012, respectively.

As part of the Onstream Merger (see note 2), we became obligated under a contract with SAIC, under which SAIC would build a platform that eventually, albeit after further extensive design and re-engineering by us, led to the DMSP. A partially completed version of this platform was the primary asset included in our purchase of Acquired Onstream, and was recorded at an initial amount of approximately $2.7 million. Subsequent to the Onstream Merger, we continued to develop the DMSP, making payments under the SAIC contract and to other vendors, as well as to our own development staff as discussed below, which were recorded as an increase in the DMSP’s carrying cost.

A limited version of the DMSP was first placed in service in November 2005. “Store and Stream” was the first version of the DMSP sold to the general public, starting in October 2006. The SAIC contract terminated by mutual agreement of the parties on June 30, 2008. Although cancellation of the contract released SAIC to offer what was identified as the “Onstream Media Solution” directly or indirectly to third parties, we do not expect this right to result in a material adverse impact on future DMSP sales.

As of March 31, 2013 we have capitalized as part of the DMSP approximately $1.1 million of employee compensation, payments to contract programmers and related costs development of “Streaming Publisher”, a second version of the DMSP with additional functionality. As of March 31, 2013, approximately $816,000 of these costs had been placed in service and are being depreciated over five years, including approximately $410,000 for the initial release in September/October 2009 and approximately $231,000 for a subsequent release in May 2010. The remainder of the costs not in service relate primarily to a new release of the DMSP under development. Streaming Publisher is a stand-alone product based on a different architecture than Store and Stream and is a primary building block of the MP365 platform, discussed below.

Other capitalized internal use software as of March 31, 2013 includes:

(i) approximately $1.4 million of employee compensation and payments to contract programmers for development of the MP365 platform, which enables the creation of on-line virtual marketplaces and trade shows utilizing many of our other technologies such as DMSP, webcasting, UGC and conferencing. Approximately $297,000 of these costs, for phase one of MP365, were placed in service on August 1, 2010 and another approximately $675,000 of these costs, for phase two of MP365, were placed in service on July 1, 2011. All costs placed in service are being depreciated over five years. The remaining costs, not placed in service, relate primarily to the next phases of MP365 under development. MP365 development costs exclude costs for development of Streaming Publisher, discussed separately above; and

(ii) approximately $1.3 million of employee compensation and other costs for the development of webcasting applications, including. Approximately $1,144,000 of these costs had been placed in service, including approximately $444,000 placed in service in December 2009 for the initial release of iEncode software, which runs on a self-administered, webcasting appliance used to produce a live video webcast, and approximately $324,000 placed in service in January 2013 for a new release of our basic webcasting platform, and are being depreciated over five years. The remainder of the costs have not been placed in service and relate primarily to new features of the webcasting platform under development.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 3: PROPERTY AND EQUIPMENT (Continued)

The capitalized software development costs discussed above are summarized as follows:

Period	DMSP	MP365	Webcasting	Totals

Six months ended March 31, 2013	$ 72,000	$ 78,000	$ 154,000	$ 304,000
Year ended September 30, 2012	131,000	289,000	306,000	726,000
Year ended September 30, 2011	99,000	489,000	150,000	738,000
Year ended September 30, 2010	314,000	435,000	180,000	929,000
Year ended September 30, 2009	274,000	148,000	288,000	710,000
Year ended September 30, 2008	186,000	-	213,000	399,000

Totals through March 31, 2013	$ 1,076,000	$ 1,439,000	$ 1,291,000	$ 3,806,000

NOTE 4: DEBT

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

Convertible Debentures

Convertible debentures consist of the following:

	March 31, 2013	September 30, 2012
Rockridge Note	$ 677,402	$ 878,115
Fuse Note	200,000	-
Intella2 Investor Notes (excluding portion in notes payable at March 31, 2013)	200,000	-
Sigma Note (excluding portion in notes payable at March 31, 2013)	50,000	-
Equipment Notes	-	350,000
CCJ Note (included in notes payable at March 31, 2013)	-	100,000
Total convertible debentures	1,127,402	1,328,115
Less: discount on convertible debentures	(159,743)	(118,887)
Convertible debentures, net of discount	967,659	1,209,228
Less: current portion, net of discount	( 387,531)	( 407,384)
Convertible debentures, net of current portion and discount	$ 580,128	$ 801,844

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Rockridge Note

In April and June 2009 we borrowed an aggregate $1.0 million from Rockridge Capital Holdings, LLC (“Rockridge”), an entity controlled by one of our largest shareholders, in accordance with the terms of a Note and Stock Purchase Agreement (the “Rockridge Agreement”) between Rockridge and us. On September 14, 2009, we entered into Amendment Number 1 to the Agreement, as well as an Allonge to the Note, under which we borrowed an additional aggregate $1.0 million, resulting in cumulative borrowings by us under the Rockridge Agreement, as amended, of $2.0 million. In connection with this transaction, we issued a note (the “Rockridge Note”), which is collateralized by a first priority lien on all of our assets, such lien subordinated only to the extent higher priority liens on assets, primarily accounts receivable and certain designated software and equipment, are held by certain of our other lenders. We also entered into a Security Agreement with Rockridge that contains certain covenants and other restrictions with respect to the collateral.

The Rockridge Note bears interest at 12% per annum. In accordance with a second Allonge to the Note dated December 12, 2012, the remaining principal balance outstanding under the Rockridge Note, as well as the related interest at 12% per annum, is payable in twenty-two (22) equal monthly installments of $41,322, commencing on December 14, 2012 and ending on September 14, 2014 (the “Maturity Date”). Prior to the second Allonge to the Note, the remaining balance was payable in monthly principal and interest installments of $41,409 through August 14, 2013 plus a balloon payment of $505,648 on September 14, 2013. As consideration for the second Allonge to the Note, the loan origination fee was increased as discussed in more detail below. The balance due under the Rockridge Note is classified between current and non-current on our September 30, 2012 balance sheet based on the modified payment terms.

Since we concluded that there was less than a 10% difference between the present value of the cash flows of the Rockridge Note after the December 12, 2012 modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), the modified terms are not considered substantially different and therefore accounting for this modification as an extinguishment of debt is not required.

Upon notice from Rockridge at any time and from time to time prior to the Maturity Date the outstanding principal balance may be converted into a number of restricted shares of our common stock. These conversions are subject to a minimum of one month between conversion notices (unless such conversion amount exceeds $25,000) and will use a conversion price of eighty percent (80%) of the fair market value of the average closing bid price for our common stock for the twenty (20) days of trading on The NASDAQ Capital Market (or such other exchange or market on which our common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share. We will not effect any conversion of the Rockridge Note, to the extent Rockridge and Frederick Deluca, after giving effect to such conversion, would beneficially own in excess of 9.9% of our outstanding common stock (the “Beneficial Ownership Limitation”). The Beneficial Ownership Limitation may be waived by Rockridge upon not less than sixty-one (61) days prior written notice to us unless such waiver would result in a violation of the NASDAQ shareholder approval rules.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Rockridge Note (continued)

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

The Rockridge Agreement, as amended, provided that Rockridge may receive an origination fee upon not less than sixty-one (61) days written notice to us, payable by our issuance of 591,667 restricted shares of our common stock (the “Shares”). This origination fee was 366,667 shares prior to the second Allonge to the Note discussed above. The Rockridge Agreement, as amended, provides that on the Maturity Date we shall pay Rockridge up to a maximum of $75,000 (the “Shortfall Payment”), based on the sum of (i) the cash difference between the per share value of $1.20 (the “Minimum Per Share Value”) and the average sale price for all previously sold Shares (whether such number is positive or negative) multiplied by the number of sold Shares and (ii) for the Shares which were not previously sold by Rockridge, the cash difference between the Minimum Per Share Value and the market value of the Shares at the Maturity Date (whether such number is positive or negative) multiplied by the number of unsold Shares, up to a maximum shortfall amount of $75,000 in the aggregate for items (i) and (ii). We have recorded no accrual for this matter on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, the required payment would be approximately $75,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

The fair market value of the first 366,667 Shares, determined to be approximately $626,000 at the date of the Rockridge Agreement or Amendment Number 1, as applicable, plus legal fees of $55,337 we paid in connection with the Rockridge Agreement, were reflected as the initial $681,337 discount against the Rockridge Note and amortized as interest expense over the term of the Rockridge Note through the date of the December 2012 Allonge. The fair market value of the additional 225,000 origination fee Shares arising from the December 2012 Allonge was recorded as additional discount of approximately $79,000 and, along with the unamortized portion of the initial discount, is being amortized as interest expense over the remaining term of the Rockridge Note, commencing in January 2013. The unamortized portion of the discount was $107,342 and $78,771 as of March 31, 2013 and September 30, 2012, respectively. Corresponding increases in additional paid-in capital were also recorded for the value of the Shares.

The effective interest rate of the Rockridge Note was approximately 44.3% per annum, until the September 2009 amendment, when reduced it to approximately 28.0% per annum, and the December 2012 amendment, which increased it to approximately 29.1% per annum. These rates do not give effect to any difference between the sum of the value of the Shares at the time of issuance plus any Shortfall Payment, as compared to the assigned value of the Shares on our books, nor do they give effect to the discount from market prices that might be applicable if any portion of the principal is satisfied in common shares instead of cash.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Fuse Note

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

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

In connection with the Fuse Note, we issued Fuse 80,000 restricted common shares (the “Fuse Common Stock”), which we agreed to buy back under the following terms: If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 40,000 shares of the originally issued Fuse Common Stock from Fuse at $0.40 per share. If the fair market value of the Fuse Common Stock is not equal to at least $0.40 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 80,000 shares of the originally issued Fuse Common Stock, less the amount of any shares already bought back at the one year point, from Fuse at $0.40 per share. The above only applies to the extent the Fuse Common Stock is still held by Fuse at the applicable dates. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, no stock repurchase payment would be required. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

In connection with the Fuse Note, we also issued 40,000 restricted common shares to an unrelated third party for finder and other fees. The value of the Fuse Common Stock plus the value of the common stock issued for related financing fees was approximately $52,000, which was reflected as an increase in additional paid-in capital, with one half included in the debt extinguishment loss recognized for the six and three months ended March 31, 2013, as discussed above, and the other half recorded as a discount against the Fuse Note. The discount portion of approximately $26,000 is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 19% per annum. The aggregate unamortized portion of the debt discount recorded against the Fuse Note was $25,458 as of March 31, 2013.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes

In June and July 2008 we received an aggregate of $1.0 million from seven accredited individuals and other entities (the “Investors”), under a software and equipment financing arrangement. We issued notes to those Investors (the “Equipment Notes”) with an original maturity date of June 3, 2011. The Equipment Notes were collateralized by specifically designated software and equipment owned by us with a cost basis of approximately $1.2 million, plus a subordinated lien on certain other of our assets to the extent that the designated software and equipment, or other software and equipment added to the collateral at a later date, was not considered sufficient security for the loan.

After various modifications, as well as principal repayments via cash and conversions to common shares, the principal balance outstanding under the Equipment Notes was reduced to $350,000 and in July 2011, these remaining Equipment Notes were amended to provide for a September 3, 2011 maturity date and a $0.90 per common share conversion rate (at the Investors’ option). Effective October 1, 2011 these Equipment Notes were further amended to provide for an October 15, 2012 maturity date and a $0.70 per common share conversion rate (at the Investors’ option). In addition, the payment terms were amended so that 50% of the principal would be paid in eleven equal monthly installments commencing November 15, 2011 and 50% of the principal would be payable on the maturity date. These Equipment Notes were assigned by the applicable Investors to three accredited entities (the “Noteholders”) in October 2011 and that time it was agreed that the first six monthly payments would be deferred and added to the final balloon payment.

Effective May 14, 2012 the Equipment Notes were modified, primarily to extend the principal repayment terms to a single balloon payment on July 15, 2013. In consideration of this modification, we agreed (i) to modify the conversion rate to $0.60 per share and (ii) to issue an aggregate of 70,000 unregistered ONSM common shares to the Noteholders. Although the present value of the cash flows of the Equipment Notes after this modification was not substantially different from the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 if the conversion rate modification changes the fair value of the conversion option by 10% or more of the carrying value of the Equipment Notes immediately before the change, it would be considered substantially different terms and therefore an extinguishment of debt, in which case a new debt instrument would be recorded at fair value and that amount used to determine a non-cash debt extinguishment gain or loss recognized in our statement of operations. We determined that the fair value of the conversion option of the Equipment Notes as modified to $0.60 per share was zero, which represents no change in the value of the conversion option before such modification, and as a result this transaction was not treated as a debt extinguishment.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes (continued)

Although the closing market price on the effective date of the modification was $0.66 per share, since it is our policy that Board approval is required before stock may be issued, and consistent with that policy we did not issue the 70,000 common shares to the Noteholders that were part of this modification transaction until such approval was obtained, the June 12, 2012 Board approval date, when the closing market price was $0.56, should be used for purposes of valuing the modified conversion option. Accordingly, we assigned the modified conversion option a valuation of zero.

On December 31, 2012 we issued an aggregate of 140,000 restricted common shares to the Noteholders in consideration of a December 12, 2012 modification of the scheduled principal payment date from July 15, 2013 to payments of $100,000 on November 15, 2013, $150,000 on December 15, 2013 and $100,000 on December 31, 2013 (collectively, the “Maturity Dates”). The balance due under the Equipment Notes was classified as non-current on our September 30, 2012 balance sheet based on those modified payment terms. As part of this modification, we also agreed to issue the Noteholders an aggregate of 583,334 restricted common shares (split into two tranches in January and June 2013), to be credited upon issuance as a reduction of the outstanding Equipment Notes balance, using a price of $0.30 per share and (after both tranches are issued) which would have resulted in a Credited Value of $175,000 and a remaining outstanding Equipment Notes balance of $175,000.

In accordance with the December 12, 2012 modification, 291,668 shares were issued to the Noteholders on January 18, 2013. However, the terms of the Sigma Note, which closed on March 21, 2013, required us to immediately repay from those proceeds the remaining balance due on the Equipment Notes. Such repayment was made by us with $175,000 cash and issuance of the remaining 291,666 shares to the Noteholders. As provided for in the December 12, 2012 modification, once the 583,334 shares were issued, the Equipment Notes were no longer convertible into any additional common shares. Furthermore, in connection with our early repayment in March 2013, the Noteholders relinquished all claims to the collateral previously associated with this obligation. However, the terms of the Equipment Notes still provide that on the Maturity Dates (as established in the December 12, 2012 modification), the Recognized Value shall be calculated as the sum of the following two items – (i) the gross proceeds to the Investors from the sales of the 583,334 shares issued per the December 12, 2012 modification plus (ii) the value of those shares issued and still held by the Noteholders and not sold, using the average ONSM closing bid price per share for the ten (10) trading days prior to the Maturity Dates. If the Recognized Value exceeds the Credited Value, then we shall receive 50% (fifty percent) of such excess, although the amount received by us shall not exceed $175,000. If the Credited Value exceeds the Recognized Value, then we shall be obligated to pay such excess to the Noteholders. We have recorded no accrual for this matter on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, the Noteholders would owe us approximately $32,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Convertible Debentures (continued)

Equipment Notes (continued)

Since we concluded that there was more than a 10% difference between the present value of the cash flows of the Equipment Notes after the December 12, 2012 modification and the present value of the cash flows under the payment terms in place one year earlier, under the provisions of ASC 470-50-40, the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the six months ended March 31, 2013. This $68,600 debt extinguishment loss was calculated as the excess of the $399,000 acquisition cost of the new debt ($350,000 face value of the notes plus the $49,000 fair value of the 140,000 common shares issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $330,400. The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification.

In lieu of cash payment of $80,148 for interest due on these Equipment Notes for the period from November 1, 2010 through September 30, 2011, we elected to issue 85,574 unregistered common shares to the Investors, which were recorded based on the $91,853 fair value of those shares on the issuance dates. Interest at 12% per annum was paid in cash on April 15, 2012 and October 15, 2012, plus a final interest payment in March 2013.

From October 1, 2011 to May 12, 2012, the effective interest rate of the Equipment Notes was 12% per annum, excluding the impact of our payment of certain interest amounts in discounted common shares instead of cash. The $49,000 fair value of the 70,000 shares issued as part of the May 2012 modification was recorded as a discount (as well as a corresponding increase in additional paid-in capital) and was partially amortized as interest expense over the remaining term of the Equipment Notes through December 31, 2012, resulting in an effective interest rate of approximately 26% per annum through that date. The unamortized portion of this discount was $30,625 as of September 30, 2012 and was $19,600 as of December 31, 2012, prior to its write-off as part of the debt extinguishment loss recognized for the six months ended March 31, 2013, as discussed above. The $49,000 fair value of the 140,000 shares issued as part of the December 2012 modification was also included in the debt extinguishment loss (and reflected as an increase in additional paid-in capital). As a result, the effective interest rate of the Equipment Notes after December 31, 2012 was 12% per annum.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable

Notes and leases payable consist of the following:

	March 31, 2013	September 30, 2012
Line of Credit Arrangement	$ 1,760,707	$ 1,526,648
Sigma Note (excluding portion in convertible debentures at March 31, 2013)	550,000	-
USAC Note	357,538	-
Subordinated Notes	333,333	300,000
Intella2 Investor Notes (excluding portion in convertible debentures at March 31, 2013)	250,000	-
Investor Notes	200,000	-
CCJ Note (included in convertible debentures at September 30, 2012)	129,344	-
Equipment Notes and Leases	69,088	65,590
Total notes and leases payable	3,650,010	1,892,238
Less: discount on notes payable	(517,733)	(51,396)
Notes and leases payable, net of discount	3,132,277	1,840,842
Less: current portion, net of discount	( 2,349,839)	( 1,650,985)
Notes and leases payable, net of current portion and discount	$ 782,438	$ 189,857

Line of Credit Arrangement

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

The outstanding principal balance due under the Line may be repaid by us at any time, and the term may be extended by us past the current December 27, 2013 expiration date for an extra year, subject to compliance with all loan terms, including no material adverse change, as well as concurrence of the Lender. The outstanding principal is due on demand in the event a payment default is uncured one (1) day after written notice.

The Line is also subject to us maintaining an adequate level of receivables, based on certain formulas, as well as our compliance with a quarterly debt service coverage covenant (the “Covenant”). The Covenant, as defined in the applicable loan documents for quarterly periods after December 31, 2011, requires that the sum of (i) our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense and (ii) contributions to capital (less cash distributions and/or cash dividends paid during such period) and proceeds from subordinated unsecured debt, be equal to or greater than the sum of cash payments for interest and debt principal payments. We have complied with this Covenant for all quarters through March 31, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Line of Credit Arrangement (continued)

Effective February 2012, the terms of the Line require that all funds remitted by our customers in payment of receivables be deposited directly to a bank account owned by the Lender. Once those deposited funds become available, the Lender is then required to immediately remit them to our bank account, provided that we are not in default under the Line and to the extent those funds exceed any past due principal, interest or other payments due under the Line, which the Lender may offset before remitting the balance.

Commitment fees and other fees and expenses paid to the Lender are recorded by us as debt discount and amortized as interest expense over the remaining term of the Line. The unamortized portion of the debt discount was $30,782 and $23,446 as of March 31, 2013 and September 30, 2012, respectively. A commitment fee of $40,000, calculated as one percent (1%) per year of the maximum allowable borrowing amount, was incurred for the two-year renewal of the Line effective December 28, 2011, and such fee is payable in two installments - the first was paid in February 2012 and the second was paid in December 2012.

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

Sigma Note

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

Interest, computed at 17% per annum on the outstanding principal balance, is payable in monthly installments commencing April 30, 2013. The principal balance is payable as follows:

June 30, 2013	$7,000
July 31 – September 30, 2013	$12,000 per month
October 31, 2013 – March 31, 2014	$22,000 per month
April 30 – June 30, 2014	$35,000 per month
July 31 – September 30, 2014	$40,000 per month
October 31 – November 30, 2014	$50,000 per month
December 18, 2014	$50,000
December 18, 2014 – Balloon payment	$50,000 plus funded portion of Contingent Financing

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Sigma Note (continued)

The balloon payment is convertible into restricted common shares, at Sigma’s option, using a conversion rate of $1.00 per share.

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

Aggregate Capital Raise	Early Repayment Amount
$500,000 to $1,000,000	Lesser of outstanding principal plus interest or 25% of Capital Raise
$1,000,001 to $2,000,000	Lesser of outstanding principal plus interest or 50% of Capital Raise (reduced by any amounts previously repaid as a result of a Capital Raise transaction)
$2,000,001 or Higher	All outstanding principal plus Interest must be paid

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

In connection with this financing, we issued 300,000 restricted common shares to Sigma and agreed to reimburse up to $30,000 of Sigma’s legal and other expenses related to this financing, $27,500 of which was paid by us at the Sigma Closing. We also issued 60,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and agreed to pay them a $75,000 advisory fee, in connection with an Advisory Services Agreement we entered into with Sigma Capital effective March 18, 2013. $55,000 of the cash fee was paid by us at the Sigma Closing and the remaining $20,000 is being paid over the next four months. We also paid finders and other fees to unrelated third parties in connection with this transaction, which totaled 60,000 restricted common shares and $12,000 cash. The value of the common stock issued plus the amount of cash paid for related financing fees and expenses, was reflected as a $331,188 discount against the Sigma Note (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the note, resulting in an effective interest rate of approximately 60% per annum. This effective interest rate would decrease if the Contingent Financing is received, since there would be no further fees or costs, other than the stated interest rate, in connection with receipt of those funds. This effective rate would increase in the event an Early Repayment Amount was required, as discussed above. The aggregate unamortized portion of the debt discount recorded against the Sigma Note was $323,303 (including $26,942 related to the portion of this debt classified as a convertible debenture) as of March 31, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Sigma Note (continued)

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

USAC Note

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

Subordinated Notes

Since March 9, 2012, we have received funding from various unrelated lenders, of which $300,000 and $333,333 was outstanding as of September 30, 2012 and March 31, 2013, respectively, in exchange for our issuance of unsecured subordinated promissory notes (“Subordinated Notes”), which are fully subordinated to the Line and the Rockridge Note or any assignees or successors thereto. Details of each note making up these totals are as follows:

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Subordinated Notes (continued)

On March 9, 2012 we received $100,000 for an unsecured subordinated note bearing interest at 15% per annum. Finders and origination fees were paid by the issuance of an aggregate of 20,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $12,800. This amount was reflected as a discount and was amortized as interest expense over the one year term through November 30, 2012, at which time the unamortized balance was written off as additional interest expense. Including this discount, the effective interest rate of this note was approximately 30% per annum. Interest payments were made on this note through November 30, 2012, at which time we satisfied the outstanding $100,000 balance by using it as partial funding for a $200,000 Intella2 Investor Note issued on that date and which is discussed in more detail below. The balance due under this March 9, 2012 note is classified as non-current on our September 30, 2012 balance sheet based on the terms of payment of that Intella2 Investor Note.

Since we concluded that there was less than a 10% difference between the present value of the cash flows of this note after its modification (by virtue of its inclusion in the Intella2 Investor Note dated November 30, 2012) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, the modified terms are not considered substantially different and therefore accounting for this modification as an extinguishment of debt is not required.

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Subordinated Notes (continued)

On June 1, 2012 we received $100,000 for an unsecured subordinated note bearing interest at 12% per annum. The principal is payable in equal monthly installments of $8,333 starting January 1, 2013 plus a final payment of $58,333 on June 1, 2013. Interest for the first six months was paid on December 1, 2012 and is payable thereafter on a monthly basis. The outstanding balance of this note was $75,000 as of March 31, 2013 and $100,000 as of September 30, 2012. Finders and origination fees were paid by the issuance of an aggregate of 40,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $23,600. This amount was reflected as a discount and is being amortized as interest expense over the one year term. Including this discount, the effective interest rate of this note is approximately 39% per annum.

On October 12, 2012 we received $50,000 for an unsecured subordinated note. The principal is payable in six equal monthly installments of $8,333 starting November 12, 2012, with each installment containing the applicable portion of the total interest of $5,000. The outstanding balance of this note was $8,333 as of March 31, 2013. An origination fee was paid to the lender by the issuance of 15,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $5,700. This amount was reflected as a discount and is being amortized as interest expense over the six month term.

During January 2013 we received an aggregate of $150,000 pursuant to our issuance of two unsecured subordinated notes, bearing interest at 20% per annum. The principal plus accrued interest is payable in a single balloon payment in July 2013. An origination fee was paid to the lenders by the issuance of an aggregate of 120,000 restricted ONSM common shares, which had a fair market value at issuance of approximately $38,000. This amount was reflected as a discount and is being amortized as interest expense over the six month term. Including this discount, the effective interest rate of these notes is approximately 71% per annum.

The aggregate unamortized portion of the debt discount recorded against the Subordinated Notes was $40,347 and $27,950 as of March 31, 2013 and September 30, 2012, respectively.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Intella2 Investor Notes

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

Although there was no difference between the present value of the cash flows of the November 30, 2012 Intella2 Investor Note held by Fuse after its modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40 ("Derecognition"), if a conversion feature added to an instrument is considered to be substantive, the modified terms are considered substantially different and extinguishment accounting is required. Since the ONSM closing price was greater than the $0.50 per share conversion price at times during the ninety days prior to granting such conversion feature (although the ONSM closing price was below $0.50 at the time the conversion feature was granted), we determined that it was at least reasonably possible that the conversion feature would be exercised and thus the conversion feature was determined to be substantive. Accordingly, we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the six and three months ended March 31, 2013. This $43,481 debt extinguishment loss was calculated as the excess of the $200,000 acquisition cost of the new debt over the net carrying amount of the extinguished debt immediately before the modification, which was $156,519.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Intella2 Investor Notes (continued)

In connection with the above financing, we issued to the holders of the Intella2 Investor Notes an aggregate of 180,000 restricted common shares (the “Intella2 Common Stock”), which we have agreed to buy back, under certain terms. The buy-back terms are as follows: If the fair market value of the Intella2 Common Stock is not equal to at least $0.40 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 90,000 shares of the originally issued Intella2 Common Stock from the investor at $0.40 per share. If the fair market value of the Intella2 Common Stock is not equal to at least $0.40 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 180,000 shares of the originally issued Intella2 Common Stock, less the amount of any shares already bought back at the one year point, from the investor at $0.40 per share. The above only applies to the extent the Intella2 Common Stock is still held by the investor(s) at the applicable dates. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, no stock repurchase payment would be required. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

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

The unamortized portion of this discount related to the Intella2 Investor Note held by Fuse was $43,481 as of March 31, 2013, prior to its write-off as the debt extinguishment loss recognized for the six and three months ended March 31, 2013, as discussed above. As a result, the effective interest rate of the Intella2 Investor Note held by Fuse after March 31, 2013 will be 12% per annum, with the effective interest rate for the other Intella2 Investor Notes remaining at approximately 26% per annum. After the write-off of a portion of the discount as debt extinguishment loss, the aggregate unamortized portion of the debt discount recorded against the Intella2 Investor Notes was $54,352 (none of which related to the portion of this debt classified as a convertible debenture) as of March 31, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

Investor Notes

On or about November 30, 2012 we received $175,000 pursuant to unsecured promissory notes issued to four investors and on January 2, 2013 we received $25,000 pursuant to an unsecured promissory note issued to CCJ (in aggregate, the “Investor Notes”), bearing interest at 12% per annum and which are fully subordinated to the Line and the Rockridge Note or any assignees or successors thereto. Note payments are interest only during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the twenty-fifth month.

In connection with the above financing, we issued to the holders of the Investor Notes an aggregate of 240,000 restricted common shares (the “Investor Common Stock”), of which we have agreed to buy back up to 40,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the Investor Common Stock is not equal to at least $0.80 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 20,000 shares of the originally issued Investor Common Stock from the investor at $0.80 per share. If the fair market value of the Investor Common Stock is not equal to at least $0.80 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 40,000 shares of the originally issued Investor Common Stock, less the amount of any shares already bought back at the one year point, from the investor at $0.80 per share. The above only applies to the extent the Investor Common Stock is still held by the investor(s) at the applicable dates. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, the required stock repurchase payment would be approximately $32,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

We paid a third-party agent financing fees of $14,000 plus 35,000 unrestricted common shares related to this financing.

The value of the Investor Common Stock, plus the value of common stock issued and cash paid for related financing fees, was reflected as a $113,700 discount against the Investor Notes (as well as a corresponding increase in additional paid-in capital for the shares) and that amount is being amortized as interest expense over the term of the notes, resulting in an effective interest rate of approximately 43% per annum. The aggregate unamortized portion of the debt discount recorded against the Investor Notes was $95,892 as of March 31, 2013.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 4: DEBT (Continued)

Notes and Leases Payable (continued)

CCJ Note

As of September 30, 2012 we were obligated for $100,000 under the CCJ Note and as of December 31, 2012 we would have owed the $100,000 principal plus the final quarterly interest payment of $2,500. However, we agreed with CCJ to combine that $102,500 obligation with another unpaid obligation of $43,279 related to reimbursement of the shortfall upon the resale of common shares issued upon conversion of Series A-13 – see note 6. The combined obligation of $145,779 was the principal amount of a replacement subordinated note issued to CCJ dated December 31, 2012 and payable in 24 monthly principal and interest installments of $6,862 starting January 31, 2013 and which payment amount includes interest at 12% per annum. The balance due under the CCJ Note was classified between current and non-current on our September 30, 2012 balance sheet based on these modified terms of payment. Prior to the issuance of the December 31, 2012 replacement note, the CCJ Note was convertible by CCJ into our common shares at the greater of (i) the previous 30 day market value or (ii) $2.00 per share. The December 31, 2012 replacement note has no conversion rights.

In consideration of a December 29, 2009 predecessor transaction to the CCJ Note, the 35,000 shares of Series A-12 held by CCJ at that date were exchanged for 35,000 shares of Series A-13 plus four-year warrants for the purchase of 29,167 ONSM common shares at $3.00 per share - see note 6. As a result, the effective interest rate of the CCJ Note was approximately 47.4% per annum, including the Black-Scholes value of the warrants of $32,518 plus the $108,500 value of the increased number of common shares underlying the Series A-13 shares versus the Series A-12 shares, which total of $141,018 we recorded as a debt discount. The effective rate of 47.4% per annum also included 11.2% per annum related to dividends that would have accrued to CCJ as a result of the later mandatory conversion date of the Series A-13 shares versus the mandatory conversion date of the Series A-12 shares. In conjunction with and in consideration of a January 2011 predecessor transaction to the CCJ Note, certain terms of the 35,000 shares of Series A-13 held by CCJ at that date were modified - see note 6. As a result, the effective interest rate of the CCJ Note increased to approximately 78.5% per annum, reflecting the $46,084 value of the increased number of common shares underlying the Series A-13 shares as a result of the modified terms, which we recorded as a debt discount, the increase in the periodic cash interest rate from 8% to 10% per annum and 9.3% per annum related to dividends that could accrue to CCJ as a result of the later mandatory conversion date of the Series A-13 shares as a result of the modified terms. As of January 1, 2013, the effective interest rate of the CCJ Note was 12% per annum. The unamortized portion of the debt discount was zero and $9,491 as of March 31, 2013 and September 30, 2012, respectively.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 2013

NOTE 4: DEBT (Continued)

The minimum cash payments required for the convertible debentures, notes payable and capitalized lease obligations listed above are as follows:


Year Ending March 31:
	2014	$ 2,971,980
	2015	1,805,432
	2016 and thereafter	-
	Total minimum debt payments	$ 4,777,412

The Line is included above as a $1,760,707 payment during the year ending March 2014, based on its balance sheet classification and the fact that it expires in December 2013, although we have renewed the Line on a regular basis since its 2009 inception and expect to renew it or a similar financing arrangement on or before the December 2013 expiration. The amounts shown above are before deducting unamortized discount and do not include interest.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES

Employment contracts and severance

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

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

Under the terms of the employment agreements, upon a termination subsequent to a change of control, termination without cause or constructive termination, each as defined in the agreements, we would be obligated to pay each of the Executives an amount equal to three (3) times the Executive’s base salary plus full benefits for a period of the lesser of (i) three (3) years from the date of termination or (ii) the date of termination until a date one (1) year after the end of the initial employment contract term. We may defer the payment of all or part of this obligation for up to six (6) months, to the extent required by Internal Revenue Code Section 409A.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued)

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

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

2. Effective September 16, 2012, the base salary amounts being paid to the Executives were reinstated by an amount representing approximately 7.8% of the contractual base salary. A second reinstatement to the Executives representing approximately 4.5% of the contractual base salary was approved for January 2013, although as of May 10, 2013, and in recognition of our cash requirements, the second reinstatement has not been implemented. Once the second reinstatement is implemented, the base salary payments to the Executives would still be 10% less than the contractual base salaries, equal to the initial reduction level that was established in October 2009.

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued)

As of May 10, 2013, the Executive Shares have not been issued, due to certain administrative and documentation requirements, nor has the $100,000 in cash been paid. However, since the Executive Shares were committed to be issued by the January 22, 2013 action of the Board, that issuance has been reflected in our financial statements as of and for the periods ended March 31, 2013. The number of Executive Shares was based on the average of the closing bid prices for the three trading days prior to the approval by our Board of Directors in their January 22, 2013 meeting, which was approximately $0.29 per share. However, the Executive Shares have been recorded on our financial statements based on their fair value at the time of the January 22, 2013 agreement, which was $578,000 ($0.34 per share), with the approximately $86,000 excess of that fair value over the amount of the previously recorded liability being satisfied by such issuance reflected as non-cash compensation expense.

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

To the extent there is any shortfall from the gross proceeds upon resale by the Executives of the Executive Shares as compared to twenty-nine cents ($0.29) per share, the shortfall will be reimbursed to the Executives by us in cash, or at our option, by the issuance of additional fully vested ONSM common shares (the “Additional Executive Shares”), with the Additional Executive Shares subject to reimbursement by us to the Executives of any shortfall from the gross proceeds upon resale as compared to the fair value used to determine the number of such Additional Executive Shares. All shortfall reimbursements shall be payable by us within ten (10) business days after presentation by reasonable supporting documentation of the shortfall to us by the Executives.We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, no additional payment, or share issuance, would be required with respect to the Executive Shares. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued)

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

· Record revenues in each of fiscal years 2011 through 2015.

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

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

The objectives related to fiscal 2011 and fiscal 2012 were based on discussions between the Board and the Executives that had been going on for some time as part of the process of agreeing on the Executive Incentive Plan. In addition, as disclosed in our previous public filings, the Compensation Committee had already indicated their intent as of January 14, 2011 to issue options to purchase at least 90,000 underlying common shares to each Executive, for which the issuance and vesting would have required no performance and which would have been convertible into paid-up shares (including tax effect) under certain circumstances. Accordingly, the Board determined that the objectives for fiscal 2011 and fiscal 2012 were a reasonable basis for the issuance of an aggregate of 190,000 Executive Incentive Shares to each Executive for the accomplishment of those goals for that two-year period.

Accomplishment of the objectives for fiscal 2013 through fiscal 2015 would result in 125,000 Executive Incentive Shares issued to each Executive for each of those three years. A lesser amount of Executive Incentive Shares would be issuable for achievement for only one or two of the three objectives set for each year. In addition, we agreed to issue an aggregate of 1.3 million Executive Incentive Shares to the Executives as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled.

The Executive Incentive Shares are subject to a complete restriction on the Executive’s ability to access or transact in any way such shares until the restriction is lifted. Upon a change of control, termination of the Executive’s employment or the imminently proposed and/or anticipated sale of the Company at a price of $1.00 per common share or more, all restrictions on the Executive Incentive Shares and any other common shares held by the Executives will be lifted. In the case of a sale, all restrictions will be lifted in time for those previously restricted shares to participate in all voting with respect to the proposed sale and will be eligible, at the Executive’s option, for inclusion as part of the shares sold in that transaction.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Employment contracts and severance (continued)

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

The Executive Incentive Shares will be issued in accordance with the terms of the 2007 Equity Incentive Plan (the “Plan”) which our Board of Directors and a majority of our shareholders adopted on September 18, 2007 and they amended on March 25, 2010 and on June 13, 2011, and to the extent these and other issuances under the Plan do not exceed the number of authorized Plan shares, which is currently 4,500,000.

As of May 10, 2013, the Executive Incentive Shares have not been issued, due to certain administrative and documentation requirements. However, since the Executive Incentive Shares were committed to be issued by the February 20, 2013 action of the Board, that issuance of the 2,250,000 Executive Incentive Shares that have been earned to date has been reflected in our financial statements as of and for the periods ended March 31, 2013. The Executive Incentive Shares have been recorded on our financial statements based on their fair value at the time of the February 20, 2013 agreement, which was $1,237,500 ($0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation. The net amount of approximately $1,137,000 was reflected as non-cash compensation expense. Due to the restrictions on the Executive Incentive Shares, we have determined that the issuance thereof will not result in taxable compensation income to the Executives (or tax deductible compensation expense to the Company) until such restrictions have been lifted.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Other compensation

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

Lease commitments

As of March 31, 2013, we were obligated under operating leases for five office locations (one each in Pompano Beach, Florida, San Francisco, California and Colorado Springs, Colorado and two in the New York City area), which call for monthly payments totaling approximately $54,000. The leases have expiration dates ranging from 2013 to 2017 (after considering our rights of termination) and in most cases provide for renewal options. We also became obligated on a short-term lease for a San Diego, California office facility in connection with the November 2012 Intella2 acquisition discussed in note 2 – this lease is considered immaterial for further disclosures.

The three-year operating lease for our principal executive offices in Pompano Beach, Florida expires September 15, 2013. The monthly base rental is currently approximately $20,100 (including our share of property taxes, insurance and other operating expenses incurred under the lease but excluding operating expenses such as electricity paid by us directly). The lease provided for two percent (2%) annual increases, as well as one two-year renewal option, with a three percent (3%) rent increase in year one. We have notified the landlord of our exercise of the renewal option. Although the landlord has not yet confirmed that we have met the conditions for such renewal, we have included the lease payments for such renewal period in the table of future minimum lease payments as presented below.

The five-year operating lease for our office space in San Francisco expires July 31, 2015. The monthly base rental (including month-to-month parking) is approximately $9,700 with annual increases up to 5.1%. The lease provides one five-year renewal option at 95% of fair market value and also provides for early cancellation at any time after August 1, 2011, at our option, with six month notice and a cancellation payment of no more than approximately $14,000.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Lease commitments (continued)

The one-year operating lease for our Infinite Conferencing location in New Jersey expires October 31, 2013. The monthly base rental is approximately $15,700. The lease provided for one one-year renewal option, with no rent increase, but we did not exercise that option, electing instead to open negotiations with the landlord for different space in the same building, although we currently expect that it the monthly rental will be approximately $2,000 higher and the lease term could be as long as five years. Pending a final lease agreement, we have not included the lease payments for this new space in the table of future minimum lease payments as presented below.

The five-year operating lease for our office space in New York City expires January 24, 2018. The monthly base rental is approximately $7,900 with annual increases up to 2.8%. The lease provides one two-year renewal option at the greater of the fifth year rental or fair market value and also provides for early cancellation at any time after forty-two months, at our option, with notice of no more than nine months and no less than six months plus a cancellation payment of approximately $22,000.

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

		Operating
Year Ending March 31:		Leases
	2014	$ 541,581
	2015	345,971
	2016	225,418
	2017	108,999
	Total minimum lease payments	$ 1,221,969

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

In addition to the commitments listed above, we have commitments not included in the above table for leasing equipment space at co-location or other equipment housing facilities in South Florida; Atlanta, Georgia; New Jersey, Colorado, Texas, Iowa, Minnesota and California. An aggregate approximately $6,000 per month related to these facilities is classified by us as rental expense with an approximately $24,000 per month remaining balance of our payments to these facilities classified as cost of revenues – see discussion of bandwidth and co-location facilities purchase commitment discussion below. Total rental expense (including executory costs) for all operating leases was approximately $457,000 and $373,000 for the six months ended March 31, 2013 and 2012, respectively and approximately $244,000 and $202,000 for the three months ended March 31, 2012 and 2011, respectively.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Purchase commitments

We have entered into various agreements for our purchase of Internet and other connectivity as well as use of the co-location facilities discussed above, for an aggregate remaining minimum purchase commitment of approximately $900,000, such agreements expiring at various times through August 2017.

Legal and regulatory proceedings

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

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 5: COMMITMENTS AND CONTINGENCIES (Continued)

Future cash payments or share issuances contingent on future market price of ONSM common share

We have entered into certain agreements that result in our contingent obligation to pay cash or issue additional shares, subject to the market or sales price of an ONSM common share at various times in the future. These contingent obligations are summarized below and discussed in more detail in notes 4, 5 and 6.

Rockridge Note	Origination Fee Shares	Reimburse shortfall versus $1.20 per share price on 591,667 common shares, up to maximum of $75,000 – no accrual on financial statements
Fuse Note	Origination Fee Shares	Repurchase 80,000 common shares if the market value is less than $0.40 per share – no accrual on financial statements
Equipment Notes	Principal Repayment Shares	Reimburse shortfall versus $0.30 per share price on 583,334 common shares – no accrual on financial statements
Intella2 Investor Notes	Origination Fee Shares	Repurchase 180,000 common shares if the market value is less than $0.40 per share – no accrual on financial statements
Investor Notes	Origination Fee Shares	Repurchase 40,000 common shares if the market value is less than $0.80 per share – no accrual on financial statements
Executive Shares	Compensation Shares	Reimburse shortfall (in cash or shares) versus $0.29 per share price on 1,700,000 common shares – no accrual on financial statements
Series A-13 Convertible Preferred	Conversion Shares	Reimburse shortfall (in cash or shares) versus $175,000 minimum sales proceeds on 437,500 common shares – $43,750 accrual on financial statements

NOTE 6: CAPITAL STOCK

Common Stock

During the six months ended March 31, 2013 we issued 538,943 unregistered common shares for financial consulting and advisory services valued at approximately $178,000, which are being recognized as professional fees expense over various service periods of up to twelve months. None of these shares were issued to our directors or officers, except for 82,000 of these shares, valued at approximately $27,000 and issued to J&C Resources, Inc. (“J&C”). Mr. Charles Johnston, who was one of our directors at the time of the transaction, is the president of J&C.

Professional fee expenses arising from these and prior issuances of shares and options for financial consulting and advisory services were approximately $139,000 and $419,000 for the six months ended March 31, 2013 and 2012, respectively. As a result of previously issued shares and options for financial consulting and advisory services, we have recorded approximately $95,000 in deferred equity compensation expense at March 31, 2013, to be amortized over the remaining periods of service of up to eleven months. The deferred equity compensation expense is included in the balance sheet caption prepaid expenses.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 6: CAPITAL STOCK (Continued)

Common Stock (continued)

During the six months ended March 31, 2013, we issued 1,470,000 common shares for interest and financing fees, which were valued at approximately $593,000 and are being recognized as interest expense over various financing periods of up to twenty-four months. See summary below and note 4 for details.

	Number of Shares	Approximate Value

Sigma Note – origination and finders fees	420,000	$ 209,000
Fuse Note – origination and finders fees	120,000	52,000
Equipment Notes - renegotiation and extension	140,000	49,000
Subordinated Notes - renegotiation and extension	35,000	13,000
Subordinated Notes – origination fees	170,000	58,000
Intella2 Investor Notes – origination and finders fees	280,000	101,000
Investor Notes – origination and finders fees	275,000	100,000
Other short-term financing fees	30,000	11,000
	1,470,000	$ 593,000

During the six months ended March 31, 2013 we issued 583,334 common shares valued at $175,000 as partial payment of the Equipment Notes – see note 4.

During the six months ended March 31, 2013 we issued 8,750 unregistered common shares for Series A-13 dividends for calendar 2012, as discussed in more detail below. During December 2012 we issued 437,500 common shares as a result of the conversion of Series A-13, as discussed in more detail below. During November and December 2012 we issued an aggregate of 160,000 common shares as a result of the conversion of Series A-14, as discussed in more detail below.

We (as authorized by our Board of Directors) agreed, effective January 22, 2013, to issue the Executives an aggregate of 1,700,000 fully vested ONSM common shares (the “Executive Shares”), in connection with the satisfaction of unpaid salary due to the Executives under their employment agreements as well as other liabilities to certain of the Executives. We (as authorized by our Board of Directors) agreed, effective February 20, 2013, to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares (the “Executive Incentive Shares”), in connection with meeting certain financial objectives related to fiscal 2011 and fiscal 2012 as well as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled. As of May 10, 2013, the Executive Shares and the Executive Incentive Shares have not been issued, due to certain administrative and documentation requirements. However, since these shares were committed to be issued by the January 22, 2013 and February 20, 2013 actions of the Board, both issuances have been reflected in our financial statements as of and for the periods ended March 31, 2013. See note 5.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 6: CAPITAL STOCK (Continued)

Common Stock (continued)

On September 17, 2010, we entered into a Purchase Agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to an initial purchase of 300,000 shares of our common stock and 420,000 shares of our Series A-14 Preferred Stock (“Series A-14”), together with a warrant (“LPC Warrant 1”). In accordance with the Purchase Agreement, LPC also received 50,000 shares of our common stock as a one-time commitment fee and a cash payment of $26,250 as a one-time structuring fee. On September 24, 2010, we received $824,045 net proceeds (after deducting fees and legal, accounting and other out-of-pocket costs incurred by us) related to our issuance under that Purchase Agreement of the equivalent of 770,000 common shares (including those issuable upon conversion of the preferred shares). See notes 6 and 8 for further details with respect to the Series A-14 and LPC Warrant 1.

During the year ended September 30, 2011, we sold LPC an additional 1,530,000 shares of our common stock under that Purchase Agreement for net proceeds of approximately $1.4 million. LPC remains committed to purchase, at our sole discretion, up to an additional 1.8 million (which quantity is after giving effect to the terms of an April 28, 2011 amendment to the Purchase Agreement) shares of our common stock in installments over the remaining term of the Purchase Agreement, generally at prevailing market prices, but subject to the specific restrictions and conditions in the Purchase Agreement. There is no upper limit to the price LPC may pay to purchase these additional shares. The purchase of our shares by LPC will occur on dates determined solely by us and the purchase price of the shares will be fixed on the purchase date and will be equal to the lesser of (i) the lowest sale price of our common stock on the purchase date or (ii) the average of the three (3) lowest closing sale prices of our common stock during the twelve (12) consecutive business days prior to the date of a purchase by LPC. LPC shall not have the right or the obligation to purchase any shares of our common stock from us at a price below $0.75 per share. Our most recent sale of shares to LPC under the Purchase Agreement was on August 30, 2011. The closing ONSM share price has been less than $0.75 per share for most of the trading days since that date and the closing market price was $0.49 per share on May 10, 2013. Also, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share. Accordingly, we are not currently able to sell additional common shares to LPC under that Purchase Agreement.

The Purchase Agreement has a term of 36 months and expires accordingly on September 17, 2013, but it may be terminated by us at any time at our discretion without any cost to us and may be terminated by us at any time in the event LPC does not purchase shares as directed by us in accordance with the terms of the Purchase Agreement. LPC may terminate the Purchase Agreement upon certain events of default set forth therein, including but not limited to the occurrence of a material adverse effect, delisting of our common stock and the lack of immediate relisting on one of the specified alternate markets and the lapse of the effectiveness of the applicable registration statement for more than the specified number of days. As a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, as discussed in note 1, and the resulting loss of our S-3 eligibility, the applicable registration statement is no longer effective. However, on November 20, 2012 LPC provided us with a letter stating that the lapse of the effectiveness of the applicable registration statement would not be considered an event of default under the Purchase Agreement, although LPC would not be required to purchase shares under the Purchase Agreement until the effectiveness of the applicable registration statement is restored or a replacement registration statement is filed. The Purchase Agreement restricts our use of variable priced financings for the greater of one year or the term of the Purchase Agreement and, in the event of future financings by us, allows LPC the right to participate under conditions specified in the Purchase Agreement.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 6: CAPITAL STOCK (Continued)

Preferred Stock

The following issuances were outstanding on September 30, 2012 but not on March 31, 2013.

Series A-13 Convertible Preferred Stock

Effective December 17, 2009, our Board of Directors authorized the sale and issuance of up to 170,000 shares of Series A-13 Convertible Preferred Stock (“Series A-13”). On December 23, 2009, we filed a Certificate of Designation, Preferences and Rights for the Series A-13 (the “A-13 Designation”) with the Florida Secretary of State, setting forth a coupon of 8% per annum, an assigned value of $10.00 per preferred share and a con version rate of $3.00 per common share (based on the assigned value). After a March 2, 2011 modification, the conversion rate was reduced to $2.00. After a January 20, 2012 modification, the conversion rate was reduced to $1.72. After a December 21, 2012 modification, the conversion rate was reduced to $0.40.

As of September 30, 2011, the only holder of Series A-13 was CCJ, which owned 35,000 shares it obtained in December 2009 for a stated value of $350,000. In January 2012, as part of a transaction under which J&C Resources issued us a funding commitment letter, we agreed to reimburse CCJ in cash the shortfall, as compared to minimum guaranteed net proceeds of $139,000, from their resale of 101,744 common shares CCJ was to receive upon their conversion of 17,500 shares of Series A-13 and after effecting our agreement as part of the same transaction to reduce the conversion rate on the remaining 17,500 Series A-13 shares owned by CCJ from $2.00 per common share to $1.72 per common share. During March 2012, CCJ effected such conversion and we recorded the shortfall liability of $85,279 as a prepaid expense, which we amortized to interest expense as a cost of the funding commitment letter over its one-year term ending December 31, 2012. We paid $42,000 against the shortfall liability and the remaining balance of $43,279 was included in the CCJ Note dated December 31, 2012 – see note 4. Based on the shortfall plus (i) the increased value of the underlying common stock related to this tranche as well as the second tranche of 17,500 shares of Series A-13 owned by CCJ and (ii) the Black-Scholes value of adjustments to warrants held by LPC arising from anti-dilution provisions, the total economic cost of this funding commitment letter was approximately $130,000.

As provided in the A-13 Designation, any shares of Series A-13 still outstanding as of December 31, 2012 would automatically convert into our common shares. In December 2012, as part of a transaction under which J&C Resources issued us a Funding Letter (see note 1), we agreed to reimburse CCJ in cash the shortfall, payable on December 31, 2014, as compared to minimum guaranteed net proceeds of $175,000, from their resale of 437,500 common shares CCJ received on December 31, 2012 upon their conversion of 17,500 shares of Series A-13 and after effecting our agreement as part of the same transaction to reduce the conversion rate on all Series A-13 shares from $1.72 per common share to $0.40 per common share. We recorded an estimated shortfall liability of $43,750 as a prepaid expense, which we are amortizing to interest expense as a cost of the Funding Letter over its one-year term ending December 31, 2013. Based on an ONSM price of $0.41 per share on May 10, 2013, the gross proceeds would be approximately $ 179,000 and therefore no adjustment to the estimated shortfall liability is necessary at this time. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share. Based on the estimated shortfall calculated based on the closing ONSM share price on the date of the agreement with J&C Resources, plus the increased value of the underlying common stock related to this tranche of Series A-13 shares owned by CCJ, the total economic cost of this Funding Letter was approximately $151,000.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 6: CAPITAL STOCK (Continued)

Preferred Stock (continued)

Series A-13 Convertible Preferred Stock (continued)

In lieu of cash payments for Series A-13 dividends, we elected to issue the following unregistered common shares to the holder, using the minimum conversion rate of $2.00 per share, which shares were recorded based on the fair value of those shares on the issuance date.

Share issuance date	Number of unregistered common shares	Dividend period	Dividends if paid in cash	Fair value of shares at issuance
March 3, 2011	14,000	Jan - December 2010	$28,000	$15,820
May 24, 2011	3,500	Jan 2011 – March 2011	$ 7,000	$ 4,129
August 24, 2011	3,500	April 2011 – June 2011	$ 7,000	$ 2,868
November 21, 2011	3,500	July 2011 – Sept 2011	$ 7,000	$ 1,644
February 13, 2012	3,500	Oct 2011–December 2011	$ 7,000	$ 2,381
December 31, 2012	8,750	Jan – December 2012	$ 17,500	$ 2,712

Series A-14 Convertible Preferred Stock

Effective September 17, 2010, our Board of Directors authorized the sale and issuance of up to 420,000 shares of Series A-14 Preferred Stock (“Series A-14”). On September 22, 2010, we filed a Certificate of Designation, Preferences and Rights for the Series A-14 (the “Series A-14 Designation”) with the Florida Secretary of State and we issued 420,000 shares of Series A-14 to LPC on September 24, 2010. Series A-14 had a onetime 5% dividend payable in cash, which was satisfied by our $26,250 cash payment on September 20, 2011.

Series A-14 had a stated value of $1.25 per preferred share and a fixed conversion rate of $1.25 per common share. Although per the Series A-14 Designation any Series A-14 shares still outstanding on September 24, 2012 would automatically convert to common shares, the Series A-14 Designation also provided that the number of shares of ONSM common stock that could be issued upon the conversion of Series A-14 was limited to the extent necessary to ensure that following the conversion the total number of shares of ONSM common stock beneficially owned by the holder would not exceed 4.999% of our issued and outstanding common stock. Due to this restriction, LPC was only able to convert 260,000 shares of Series A-14 to 260,000 common shares as of September 30, 2012. LPC converted the remaining 160,000 shares of Series A-14 to 160,000 common shares during the six months ended March 31, 2013.

The fair value of the warrant issued in connection with the Purchase Agreement (“LPC Warrant 1”) was calculated to be approximately $386,000 using the Black-Scholes model (with the assumptions including expected volatility of 105% and a risk free interest rate of 1.08%). The common shares issued as a one-time commitment fee in connection with the Purchase Agreement were valued at approximately $55,000, based on the quoted market value on the date of issuance. The aggregate of these two items, plus the cash out-of-pocket costs incurred by us in connection with the Purchase Agreement, was allocated on a pro-rata basis between the number of common shares sold and the common shares underlying the Series A-14. The amount allocated to the Series A-14, $298,639, was recorded on our balance sheet as a discount and was amortized as a dividend over the term of the Series A-14. The unamortized portion of the discount was zero at March 31, 2013 and September 30, 2012, respectively.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 7: SEGMENT INFORMATION

Our operations are comprised within two groups, Digital Media Services and Audio and Web Conferencing Services. The primary operating activities of the Webcasting and MP365 divisions of the Digital Media Services Group, as well as our corporate headquarters, are in Pompano Beach, Florida. The Webcasting division has a sales and support facility in New York City. The primary operating activities of the Smart Encoding division of the Digital Media Services Group and the EDNet division of the Audio and Web Conferencing Services Group are in San Francisco, California. The primary operating activities of the DMSP and UGC divisions of the Digital Media Services Group are in Colorado Springs, Colorado. The primary operating activities of the Infinite division of the Audio and Web Conferencing Services Group are in the New York City area and the primary operating activities of the OCC division of the Audio and Web Conferencing Services Group are in San Diego, California. All material sales, as well as property and equipment, are within the United States. Detailed below are the results of operations by segment for the six and three months ended March 31, 2013 and 2012, respectively, and total assets by segment as of March 31, 2013 and September 30, 2012.

	For the six months ended March 31,		For the three months ended March 31,
	2013	2012	2013	2012
Segment revenue:
Digital Media Services Group	$ 3,123,136	$ 3,924,257	$ 1,450,743	$ 1,913,343
Audio and Web Conferencing Services Group	5,551,903	5,246,197	2,944,579	2,742,994
Total consolidated revenue	$ 8,675,039	$ 9,170,454	$ 4,395,322	$ 4,656,337

Segment operating income:
Digital Media Services Group	$ 598,187	$ 861,754	$ 179,732	$ 336,370
Audio and Web Conferencing Services Group	1,696,183	1,571,849	867,402	847,661
Total segment operating income	2,294,370	2,433,603	1,047,134	1,184,031
Depreciation and amortization	( 704,681)	( 714,622)	( 375,456)	( 358,114)
Corporate and unallocated shared expenses	( 3,692,273)	( 2,751,720)	( 2,437,776)	( 1,345,331)
Other expense, net	( 782,005)	( 340,693)	( 403,123)	( 201,180)
Net loss	$ ( 2,884,589)	$ ( 1,373,432)	$ ( 2,169,221)	$ ( 720,594)

	March 31, 2013	September 30, 2012
Assets:
Digital Media Services Group	$ 3,822,384	$ 3,931,714
Audio and Web Conferencing Services Group	13,083,087	12,018,033
Corporate and unallocated	660,900	619,084
Total assets	$ 17,566,371	$ 16,568,831

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS

As of March 31, 2013, we had issued options and warrants still outstanding to purchase up to 1,451,675 ONSM common shares, including 585,166 shares under Plan Options to employees and directors; 12,342 shares under Non-Plan Options to employees; 525,000 shares under Plan and Non-Plan Options to financial and other consultants; and 329,167 shares under warrants issued in connection with various financings and other transactions.

On September 18, 2007, our Board of Directors and a majority of our shareholders adopted the 2007 Equity Incentive Plan (the “Plan”), which authorized the issuance of up to 1,000,000 shares of ONSM common stock pursuant to stock options, stock purchase rights, stock appreciation rights and/or stock awards for employees, directors and consultants. On March 25, 2010, our Board of Directors and a majority of our shareholders approved a 1,000,000 increase in the number of shares authorized for issuance under the Plan, for total authorization of 2,000,000 shares and on June 13, 2011 they authorized a further increase in authorized Plan shares by 2,500,000 to 4,500,000. Based on the issuance of 377,763 common shares under the Plan, the 2,750,000 Executive Incentive Shares committed for issue under the Plan (see Notes 5 and 6), 585,166 outstanding employee and director Plan Options as of March 31, 2013 and 91,667 outstanding consultant Plan Options as of March 31, 2013, there are 695,404 shares available for issuance under the Plan.

Detail of employee and director Plan Option activity under the Plan for the six months ended March 31, 2013 is as follows:

	Number of Shares	Weighted Average Exercise Price

Balance, beginning of period	1,887,332	$ 4.41
Granted during the period	-	$ -
Expired or forfeited during the period	(1,302,166)	$ 5.48
Balance, end of the period	585,166	$ 2.03

Exercisable at end of the period	560,166	$ 2.08

Non-cash compensation expense was approximately $1,418,000 and $322,000 for the six months ended March 31, 2013 and 2012, respectively. These amounts included approximately $84,000 and $179,000, respectively, related to Plan Options granted to employees and vesting during those periods. The balance of non-cash compensation expense is related to our issuance of common shares or other equity.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)

The outstanding Plan Options for the purchase of 585,166 common shares all have exercise prices equal to or greater than the fair market value at the date of grant, the exercisable portion has a weighted-average remaining life of approximately 2.4 years and are further described below.

Grant date	Description	Total number of underlying common shares	Vested portion of underlying common shares	Exercise price per share	Expiration date

May 2008	Consultant	16,667	16,667	$6.00	Jan 2015
May 2009	Consultant	33,333	33,333	$3.00	Jan 2015
Aug 2009	Director	6,676	6,676	$9.42	Apr 2013
Aug 2009	Employee (non-Executive)	10,014	10,014	$9.42	Aug 2014
Dec 2009	Director	9,990	9,990	$9.42	Apr 2013
Dec 2009	Employee (non-Executive)	14,986	14,986	$9.42	Dec 2014
Jan 2011	Director	25,000	25,000	$1.23	Apr 2013
Jan 2011	Directors	50,000	50,000	$1.23	Jan 2015
Jan 2011	Employees (non-Executive)	343,500	343,500	$1.23	Jan 2015
Jan 2011	Consultant	25,000	25,000	$1.23	Jan 2015
Jun 2011	Director	25,000	25,000	$1.00	Jun 2015
July 2012	Employee (non-Executive)	25,000	-	$1.00	July 2016

	Total common shares underlying Plan Options as of March 31, 2013	585,166	560,166

On January 14, 2011 our Compensation Committee awarded 983,700 four-year options under the provisions of the 2007 Plan. These options were issued to our directors, employees and consultants, vesting over two years and having an exercise price of $1.23 per share, fair market value on the date of the grant. In January 2011, our Compensation Committee approved (subject to our shareholders’ approval in the annual shareholder meeting on June 13, 2011 of sufficient additional authorized Plan shares, which approval was received) augmenting the above grant by an equal number of options issued to the same recipients, using the same strike price as the above grant, to the extent permitted by applicable law and subject to shareholder and/or any other required regulatory approvals. 140,200 of the pending option issuances relate to terminated directors, employees and consultants and in January 2013, the Compensation Committee and the Executives agreed on an Executive Incentive Plan which included provisions that were in lieu of issuing 450,000 of the pending options – see note 5. The Compensation Committee is in the process of finalizing the grant of the remaining 393,500 options.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)

As of March 31, 2013, there were outstanding Non-Plan Options issued to employees for the purchase of 12,342 common shares, which were issued during fiscal 2005 in conjunction with the Onstream Merger (see note 2). These options are immediately exercisable at $20.26 per share and expire in May 2013.

As of March 31, 2013, there were outstanding and fully vested Plan and Non-Plan Options issued to financial and other consultants for the purchase of 525,000 common shares, as follows:

Issuance period	Number of common shares	Exercise price per share	Type	Expiration Date

November 2011	30,000	$0.92	Plan	Nov 2016
March 2012	25,000	$0.65	Plan	March 2015
July 2012	20,000	$6.00	Plan	July 2016
Year ended September 30, 2012	75,000

March 2011	300,000	$1.50	Non-Plan	March 2015
Year ended September 30, 2011	300,000

October 2009	75,000	$3.00	Non-Plan	Oct 2013
July 2010	50,000	$6.00	Non-Plan	July 2014
Year ended September 30, 2010	125,000

August 2009	16,667	$3.00	Plan	Aug 2013
September 2009	8,333	$3.00	Non-Plan	Sept 2013
Year ended September 30, 2009	25,000

Total common shares underlying consultant options as of March 31, 2013	525,000

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)

As of March 31, 2013, there were outstanding vested warrants, issued in connection with various financings, to purchase an aggregate of 329,167 shares of common stock, as follows:

Description of transaction	Number of common shares	Exercise price per share	Expiration Date

LPC stock purchase – February 2012 (“New LPC Warrant 2”)	50,000	$0.38	February 2017
LPC Purchase Agreement – September 2010 – see note 6 (“New LPC Warrant 1”)	250,000	$0.38	March 2016
CCJ Note – December 2009 – see note 4	29,167	$3.00	December 2013
Total common shares underlying warrants as of March 31, 2013	329,167

With respect to the September 2010 warrant issued in connection with the LPC Purchase Agreement (“LPC Warrant 1”), both the exercise price and the number of underlying shares were subject to adjustment in accordance with certain anti-dilution provisions. As a result of the effective conversion price of our common shares issued to retire certain debt through December 31, 2011, including a portion of the Equipment Notes (see note 4), the exercise price of LPC Warrant 1 was adjusted from the original exercise price of $2.00 to approximately $1.91, and the number of underlying shares was increased from the original of 540,000 shares to approximately 565,090 shares. In January 2012, we modified the rate for converting Series A-13 Preferred shares to common shares from $2.00 to $1.72 per share and as a result of the March 2012 conversion of 17,500 Series A-13 shares to common using this modified conversion price, the exercise price of LPC Warrant 1 was again adjusted from approximately $1.91 to $1.72 per share and the number of underlying shares was increased from approximately 565,090 to 627,907. Although the anti-dilution provisions of LPC Warrant 1 provided that the exercise price could not be adjusted below $1.72 per share, those provisions did allow that in the event of an equity issuance by us below $1.72 per share, the number of shares underlying LPC Warrant 1 would be increased by 12,000 shares for every $0.01 below $1.72, such additional shares not to exceed 564,000.

Due to the price-based anti-dilution protection provisions of LPC Warrant 1 (also known as “down round” provisions) and in accordance with ASC Topic 815, “Contracts in Entity’s Own Equity”, we have been required to recognize LPC Warrant 1 as a liability at its fair value on each previous reporting date. LPC Warrant 1 was reflected as a non-current liability of $173,260, $165,160 and $188,211 on our consolidated balance sheets as of March 31, 2012, December 31, 2011 and September 30, 2011, respectively. The $14,951 decrease in the fair value of this liability from September 30, 2011 to March 31, 2012 was reflected as other income in our consolidated statement of operations for the six months ended March 31, 2012. The $8,100 increase in the fair value of this liability from December 31, 2011 to March 31, 2012 was reflected as other expense in our consolidated statement of operations for the three months ended March 31, 2012.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)

Effective October 25, 2012, LPC Warrant 1 was cancelled and replaced with New LPC Warrant 1, which was issued with 250,000 underlying common shares exercisable at $0.38 per share, with such amounts only adjustable in accordance with standard anti-dilution provisions – the price-based anti-dilution provisions discussed above are not contained within New LPC Warrant 1. Accordingly, we performed a valuation of LPC Warrant 1 as of October 25, 2012 in order to make the appropriate adjustment reflected in our statement of operations. Based on this valuation of $53,894, as compared to the $81,374 carrying value of LPC Warrant 1 on our consolidated balance sheet as of September 30, 2012, the $27,480 decrease in the fair value of this liability from September 30, 2012 to October 25, 2012 was reflected as other income in our consolidated statement of operations for the six and three months ended March 31, 2013. Since accounting for LPC Warrant 1 or New LPC Warrant 1 under ASC Topic 815 is no longer applicable, we reclassified the remaining $53,894 from non-current liability to additional paid-in capital as of October 25, 2012.

Since LPC Warrant 1 was issued in connection with issuance of common stock plus preferred stock in September 2011, we have concluded that the accounting for New LPC Warrant 1 should follow that accounting. Since no entry was made to reflect the issuance of LPC Warrant 1 for the portion related to common stock (42%), no entry would be made to reflect 42% of the value of New LPC Warrant 1. The remaining 58% of the $53,894 valuation of New LPC Warrant 1 at the time of its October 25, 2012 issuance would be $31,259. This portion of LPC Warrant 1 was accounted for as a Series A-14 preferred dividend. However since 62% of the Series A-14 had been converted to common prior to October 25, 2012 and the remainder was converted to common by December 31, 2012, we have concluded that $31,258 is immaterial for any further entry.

The initial expiration date of New LPC Warrant 1 was the same September 24, 2015 expiration date as LPC Warrant 1, which, consistent with the terms of LPC Warrant 1, was extended to March 24, 2016 effective April 22, 2013, the date as of which the applicable registration statement had not been effective for a six month period– see note 6.

On February 15, 2012, in exchange for $140,000 cash proceeds, we issued LPC 200,000 unregistered common shares and a five-year warrant to purchase 100,000 unregistered common shares at an exercise price of $1.00 per share (“LPC Warrant 2”). This transaction was unrelated to the Purchase Agreement. Effective October 25, 2012, LPC Warrant 2 was cancelled and replaced with New LPC Warrant 2, which was issued with 50,000 underlying common shares exercisable at $0.38 per share, with such amounts only adjustable in accordance with standard anti-dilution provisions. The expiration date of New LPC Warrant 2 is the same February 15, 2017 expiration date as LPC Warrant 2. Since LPC Warrant 2 was issued in connection with an issuance of common stock in February 2012, we have concluded that the accounting for New LPC Warrant 2 should follow that accounting. Since no entry was made to reflect the issuance of LPC Warrant 2, no entry will be made to reflect the issuance of New LPC Warrant 2.

The exercise prices of New LPC Warrant 1 and New LPC Warrant 2 were considered to be at market value, based on the closing market price of our common stock of $0.38 per share on October 24, 2012. New LPC Warrant 1 and New LPC Warrant 2 contain certain cashless exercise rights, as did the predecessor warrants. The number of shares of ONSM common stock that can be issued upon the exercise of New LPC Warrant 1 or New LPC Warrant 2 is limited to the extent necessary to ensure that following the exercise the total number of shares of ONSM common stock beneficially owned by the holder does not exceed 4.99% of our issued and outstanding common stock, although this percentage may be changed at the holder’s option upon not less than 61 days advance notice to us and provided the changed limitation does not exceed 9.99%.

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2013

NOTE 8: STOCK OPTIONS AND WARRANTS (Continued)

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

NOTE 9: SUBSEQUENT EVENTS

Notes 2 (filing with USPTO in April 2013; impact of change in ONSM common share price through May 10, 2013), 4 (impact of change in ONSM common share price through May 10, 2013), 5 (status of Executive Shares, Executive Incentive Shares and certain cash payments of Executive compensation through May 10, 2013; lease renewal negotiations in New Jersey and Florida after March 31, 2013), 6 (status of Executive Shares, Executive Incentive Shares through May 10, 2013; impact of change in ONSM common share price through May 10, 2013) and 8 (April 2013 extension of New LPC Warrant 1 expiration date) contain disclosure with respect to transactions occurring after March 31, 2013.

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

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

Overview

We are a leading online service provider of live and on-demand corporate audio and web communications, virtual event technology and social media marketing, provided primarily to corporate (including large as well as small to medium sized businesses), education and government customers. We had approximately 106 full time employees as of May 10, 2013, with operations organized in two main operating groups:

· Digital Media Services Group

· Audio and Web Conferencing Services Group

Our Digital Media Services Group consists primarily of our Webcasting division, our DMSP (“Digital Media Services Platform”) division and our MarketPlace365 (“MP365”) division. The DMSP division includes the related UGC (“User Generated Content”) and Smart Encoding divisions.

Our Webcasting division, which operates primarily from Pompano Beach, Florida and has a sales and support facility in New York City, provides an array of corporate-oriented, web-based media services to the corporate market including live audio and video webcasting and on-demand audio and video streaming for any business, government or educational entity. Our DMSP division, which operates primarily from Colorado Springs, Colorado, provides an online, subscription based service that includes access to enabling technologies and features for our clients to acquire, store, index, secure, manage, distribute and transform these digital assets into saleable commodities. Our UGC division, which also operates as Auction Video and operates primarily from Colorado Springs, Colorado, provides a video ingestion and flash encoder that can be used by our clients on a stand-alone basis or in conjunction with the DMSP. Our Smart Encoding division, which operates primarily from San Francisco, California, provides both automated and manual encoding and editorial services for processing digital media. This division also provides hosting, storage and streaming services for digital media, which are provided via the DMSP.

Our MP365 division, which operates primarily from Pompano Beach, Florida with additional operations in San Francisco, California, enables publishers, associations, tradeshow promoters and entrepreneurs to self-deploy their own online virtual marketplaces using the MarketPlace365® platform.

Our Audio and Web Conferencing Services Group consists of our Infinite Conferencing (“Infinite”) division, our Onstream Conferencing Corporation (“OCC”) division and our EDNet division. Our Infinite division, which operates primarily from the New York City area, and our OCC division, which operates primarily from San Diego, California, provide “reservationless” and operator-assisted audio and web conferencing services. Our EDNet division, which operates primarily from San Francisco, California, provides connectivity (in the form of high quality audio, compressed video and multimedia data communications) within the entertainment and advertising industries through its managed network, which encompasses production and post-production companies, advertisers, producers, directors, and talent.

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

Recent Developments

Effective October 22, 2012, our Board of Directors voluntarily decided to move the listing of our common stock from The NASDAQ Capital Market ("NASDAQ") to OTC Markets' OTCQB marketplace ("OTCQB"). The Board of Directors’ voluntary decision to move the Company’s listing from NASDAQ to OTCQB was made following the detailed review of numerous factors including NASDAQ filing fees (versus OTCQB); the significant compliance obligations and restrictions that result from the maintenance of the NASDAQ listing, including the associated out-of-pocket costs (versus OTCQB); the effects of the Company's last reverse stock split; and the Board's determination that the Company would not be able to regain compliance with the NASDAQ minimum bid price rule before the October 15, 2012 deadline. Based on the foregoing factors, the Board of Directors does not believe there is continuing shareholder value in maintaining our listing on NASDAQ at this time. However, the move to the OTCQB does not change our reporting obligations with the Securities and Exchange Commission under applicable federal securities laws. Accordingly, we will continue to file our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

The total preliminary purchase price for the Intella2 assets and operations has been determined to be approximately $1.4 million, of which we have paid approximately $713,000 in cash to Intella2 through March 31, 2013. The remaining portion of the total preliminary purchase price, approximately $704,000, is the present value of management’s estimate of total additional payments considered probable with respect to the remaining obligations incurred in connection with the Intella2 purchase. These payment obligations are based on eligible revenues (which exclude free conferencing business revenues and non-recurring revenues) for the twelve months ending November 30, 2013 as well as a percentage (between 50 and 70%) of the free conferencing business revenues, net of applicable expenses, from December 1, 2012 through November 30, 2017.

The acquired Intella2 operations have achieved positive operating cash flow through March 31, 2013, which we expect to continue for the foreseeable future, although we also incurred new term debt of approximately $1.1 million (net of term debt repayments and excluding advances under the Line and the USAC Note) during the six months ended March 31, 2013, of which approximately $800,000 was associated specifically or generally with this acquisition. In addition to this new financing, during the six months ended March 31, 2013, we negotiated modifications of certain debts outstanding as of September 30, 2012, which resulted in balance sheet reclassifications from short-term (i.e., current) to long-term (i.e., non-current). These new financing transactions plus renegotiation of terms of already existing financing resulted in our issuance of 1,470,000 common shares for financing related fees during the six months ended March 31, 2013, as well as our agreement to issue 225,000 additional common shares as an origination fee upon notice from the noteholder. In addition to cash repayments of term debts, during the six months ended March 31, 2013 we also repaid $175,000 of Equipment Notes by the issuance of 583,334 common shares, also agreeing to reimburse any shortfall arising from the noteholders’ resale of those shares. We also issued an aggregate of 597,500 common shares during the six months ended March 31, 2013 related to the conversion of all remaining outstanding Series A-13 and Series A-14 preferred shares. See Liquidity and Capital Resources.

This Funding Letter was obtained solely to demonstrate our ability to obtain short-term funds in the event other funding sources are not available, but does not represent any obligation to accept such funding on these terms and is not expected by us to be exercised. Cash provided under the Funding Letter would be in exchange for our issuance of (a) a note or notes with interest payable monthly at 15% per annum and principal payable on the earlier of a date twelve months from funding or July 1, 2014 and (b) our issuance of 2.3 million unregistered common shares, which shares would be prorated in the case of partial funding. The note or notes would be unsecured and subordinated to all of our other debts, except to the extent such the terms of such debts would allow pari passu status. Furthermore, the note or notes would not be subject to any provisions, other than with respect to priority of payments or collateral, of our other debts. Upon receipt by us of an equivalent amount in dollars of investment from any other source after the date of this Funding Letter, other than funding received in connection with the LPC Purchase Agreement, to refinance existing debt and up to $500,000 funding for general working capital or other business uses, this Funding Letter will be terminated. We have determined that the funding received by us from the date of the Funding Letter through May 10, 2013 is less that these thresholds and accordingly, the Funding Letter remains in effect as of May 10, 2013.

During January 2013, we agreed to issue 1.7 million fully vested common shares plus a cash payment of $100,000 in the connection with the satisfaction of unpaid salary due to our five senior executives (the “Executives” as well as other liabilities to certain of the Executives. During February 2013, we agreed to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares in connection with meeting certain financial objectives related to fiscal 2011 and fiscal 2012 as well as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled. See Liquidity and Capital Resources.

Revenue Recognition

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

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

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

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

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

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

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

Results of Operations

Our consolidated net loss for the six months ended March 31, 2013 was approximately $2.9 million ($0.19 loss per share) as compared to a net loss of approximately $1.4 million ($0.12 loss per share) for the corresponding period of the prior fiscal year, an increase in our net loss of approximately $1.5 million (110.0%). The increased net loss was primarily due to an approximately $1.1 million, or 340.5%, increase in compensation paid with common shares and other equity, as compared to the corresponding period of the prior fiscal year. During February 2013, we agreed to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares in connection with meeting certain financial objectives related to fiscal 2011 and fiscal 2012 as well as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled. These shares are being issued in accordance with the terms of the 2007 Equity Incentive Plan approved by our Board and a majority of our shareholders on September 18, 2007 and as subsequently amended. These shares have been recorded on our financial statements based on their fair value at the time of the February 2013 agreement, which was $1,237,500 ($0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation. The net amount of approximately $1,137,000 was reflected as non-cash compensation expense. Although we expect to continue compensating the Executives, as well as our employees, directors and consultants, with equity from time to time, we do not expect future issuances to result in this level of expense in a single quarter.

Our consolidated net loss for the three months ended March 31, 2013 was approximately $2.2 million ($0.12 loss per share) as compared to a net loss of approximately $721,000 ($0.06 loss per share) for the corresponding period of the prior fiscal year, an increase in our net loss of approximately $1.4 million (201.0%). The increased net loss was primarily due to an approximately $1.2 million, or 1,243.9%, increase in compensation paid with common shares and other equity, as compared to the corresponding period of the prior fiscal year. This was a result of our February 2013 agreement to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares, as discussed above. Although we expect to continue compensating the Executives, as well as our employees, directors and consultants, with equity from time to time, we do not expect future issuances to result in this level of expense in a single quarter.

Six months ended March 31, 2013 compared to the six months ended March 31, 2012 - The following table shows, for the periods indicated, the percentage of revenue represented by items on our consolidated statements of operations.

	Six months ended March 31,
	2013		2012
Revenue:

Audio and web conferencing	51.7	%	46.5	%
Webcasting	29.9		32.0
DMSP and hosting	5.5		10.0
Network usage	11.6		10.3
Other	1.3		1.2
Total revenue	100.0	%	100.0	%

Costs of revenue:

Audio and web conferencing	14.5	%	14.4	%
Webcasting	8.7		9.5
DMSP and hosting	0.8		5.1
Network usage	6.0		5.1
Other	0.4		0.3
Total costs of revenue	30.4	%	34.4	%

Gross margin	69.6	%	65.6	%

Operating expenses:
Compensation (excluding equity)	45.6	%	41.3	%
Compensation (paid with equity)	16.3		3.5
Professional fees	9.2		12.5
Other general and administrative	14.6		11.8
Depreciation and amortization	8.1		7.8
Total operating expenses	93.8	%	76.9	%

Loss from operations	(24.2)	%	(11.3)	%

Other expense, net:
Interest expense	(7.3)	%	(4.2)	%
Debt extinguishment loss	(1.7)		-
Gain from adjustment of derivative liability to fair value	0.3		0.2
Other (expense) income	(0.4)		0.3
Total other expense, net	(9.1)		(3.7)	%

Net loss	(33.3)	%	(15.0)	%

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 six months ended
	March 31,				Increase (Decrease)
	2013		2012		Amount		Percent

Total revenue	$	8,675,039	$	9,170,454	$	(495,415)	(5.4)	%
Total costs of revenue		2,635,715		3,153,343		(517,628)	(16.4)
Gross margin		6,039,324		6,017,111		22,213	0.4	%

General and administrative expenses		7,437,227		6,335,228		1,101,999	17.4	%
Depreciation and amortization		704,681		714,622		(9,941)	(1.4)
Total operating expenses		8,141,908		7,049,850		1,092,058	15.5	%

Loss from operations		(2,102,584)		(1,032,739)		1,069,845	103.6	%

Other expense, net		(782,005)		(340,693)		441,312	129.5

Net loss	$	(2,884,589)	$	(1,373,432)	$	1,511,157	110.0	%

Revenues and Gross Margin

Consolidated operating revenue was approximately $8.7 million for the six months ended March 31, 2013, a decrease of approximately $495,000 (5.4%) from the corresponding period of prior fiscal year, due to decreased revenues of the Digital Media Services Group.

Digital Media Services Group revenues were approximately $3.1 million for the six months ended March 31, 2013, a decrease of approximately $801,000 (20.4%) from the corresponding period of the prior fiscal year, primarily due to a decrease in DMSP and hosting division revenues as well as a decrease in webcasting revenues.

DMSP and hosting division revenues decreased by approximately $445,000 (48.3%) for the six months ended March 31, 2013 as compared to the corresponding period of the prior fiscal year. This decline was primarily related to the July 2012 loss of a single customer that we were providing streaming services to at very little margin, as part of a larger business relationship that is still in place. Therefore, the loss of this customer and the related revenues did not have a material impact on our net operating results.

Revenues of the webcasting division, which is part of the Digital Media Services Group, also decreased by approximately $343,000 (11.7%) for the six months ended March 31, 2013 as compared to the corresponding period of the prior fiscal year. Although the approximately 2,500 webcasts we produced during the six months ended March 31, 2013 represented an increase of approximately 100 webcasts, as compared to the corresponding period of the prior fiscal year, since this increase was entirely related to lower priced audio-only events instead of higher priced video events, the average revenue per webcast event of $1,091 for the six months ended March 31, 2013 represented a decrease of $185, or 14.5%, from the corresponding period of the prior fiscal year. The number of webcasts reported, as well as the resulting calculation of the average revenue per webcast event, does not include any webcast events attributed with $100 or less revenue, based on our determination that excluding such low-priced or even no-charge events increases the usefulness of this statistic. The average revenue per webcast also includes revenue billed by the webcasting division to its customers but purchased by the webcasting division from another Onstream division and thus included in that other division’s reported revenues.

We believe that our webcasting division revenues will be favorably impacted during the remainder of fiscal 2013 by a comprehensive update to our webcasting platform (V4), which we released in January 2013. The updated webcasting platform includes the following features that were not in the previous version: a “wizard” for creating new webcasting events, comprehensive social media integration, template-driven web pages and features, viewer-controlled webcast player layout, pre-created “themes” for professional-looking web pages with one click and an ad-hoc report generator for custom analytics. We also expect to eventually see increased webcasting sales as a result of additional sales personnel and a recently introduced MP365 pricing model that includes a fixed monthly fee to us as well as establishes MP365 as a value-added platform to assist the customer in using our webcasting services and more particularly, our webinar services. This new MP365 pricing model enables the show organizer to sell inexpensively or give away the exhibitor booths and instead charge for the webinars as a lead generation tool.

Audio and Web Conferencing Services Group revenues were approximately $5.6 million for the six months ended March 31, 2013, an increase of approximately $306,000 (5.8%) from the corresponding period of the prior fiscal year. This increase was a result of the first four months of revenues from the operations of our OCC division, after it acquired Intella2 Inc., a San Diego-based communications company (“Intella2”) on November 30, 2012. Our OCC division is being managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The Intella2 acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail. We recognized total revenues of approximately $428,000, including approximately $94,000 of free conferencing business revenues, from the first four months of those operations included in our results for the six months ended March 31, 2013.

The Infinite division revenues of approximately $4.1 million for the six months ended March 31, 2013 represent a decrease of approximately $211,000 (4.9%) as compared to the corresponding period of the prior fiscal year. This was due to a decrease in average revenue per minute, which was approximately 6.6 cents for the six months ended March 31, 2013, as compared to approximately 7.1 cents for the corresponding period of the prior fiscal year. This decrease in average revenue per minute was partially offset by a 4.7% increase in the number of minutes billed which was approximately 63.6 million for the six months ended March 31, 2013, as compared to approximately 60.8 million minutes for the corresponding period of the prior fiscal year. The average revenue per minute statistic includes auxiliary services and fees that are not billed to the customer on a per minute basis. The average revenue per minute also includes revenue billed by Infinite to its customers but purchased by Infinite from another Onstream division and thus included in that other division’s reported revenues.

As a result of a major storm system affecting the northeastern United States on October 29, 2012, our Infinite division’s primary operating office location in New Jersey was closed due to inaccessibility during the week ended November 2, 2012 and even after the office was re-opened, operating activities based in that office were restricted for several weeks thereafter. Although it is difficult to quantify the financial impact of this event, particularly with respect to lost revenue opportunities, we are now finalizing a business interruption insurance claim for submission, which we expect will be approximately $70,000, although any reimbursement of that amount will be subject to final adjudication by our insurance carrier, based on the terms of our coverage.

Although the decrease in average revenue per minute reflects our reactions to competitive pressures on the pricing side, we are also continuing our efforts to reduce costs accordingly. During the third quarter of fiscal 2012, we renegotiated certain supplier contracts which reduced our Infinite division cost of sales by approximately $114,000 for the six months ended March 31, 2013 and that we expect will reduce our Infinite division cost of sales by another approximately $36,000 for the remainder of fiscal 2013, as compared to the corresponding period of fiscal 2012.

We also believe that Infinite’s ongoing alliance with BT Conferencing to provide a jointly developed conferencing platform to Infinite’s reservationless client base, along with Infinite’s other sales initiatives, will favorably impact Infinite division revenues during the remainder of fiscal 2013.

Consolidated gross margin was approximately $6.0 million for the six months ended March 31, 2013, an increase of approximately $22,000 (0.4%) from the corresponding period of the prior fiscal year. Our consolidated gross margin percentage was 69.6% for the six months ended March 31, 2013, versus 65.6% for the corresponding period of the prior fiscal year. This was due to reductions in Infinite cost of sales and the impact of the acquired Intella2 operations, as well as the discontinuance of a single low margin DMSP and hosting customer, all as discussed above.

Consistent with our expectations that our consolidated fiscal 2013 revenues will exceed the respective corresponding fiscal 2012 amounts for the year as a whole, provided such comparison is made before considering the impact of the lost revenues from a single DMSP and hosting customer that as discussed above had very little impact on gross margin, we expect consolidated gross margin (in dollars) for fiscal year 2013 to exceed the corresponding fiscal 2012 amount, although this cannot be assured.

Operating Expenses

Consolidated operating expenses were approximately $8.1 million for the six months ended March 31, 2013, an increase of approximately $1.1 million (15.5%) from the corresponding period of the prior fiscal year, primarily due to an approximately $1.1 million, or 340.5%, increase in compensation paid with common shares and other equity, as compared to the corresponding period of the prior fiscal year. During February 2013, we agreed to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares in connection with meeting certain financial objectives related to fiscal 2011 and fiscal 2012 as well as earned compensation for past service and in recognition that all options previously held by, or promised to, the Executives have been cancelled. These shares are being issued in accordance with the terms of the 2007 Equity Incentive Plan approved by our Board and a majority of our shareholders on September 18, 2007 and as subsequently amended. These shares have been recorded on our financial statements based on their fair value at the time of the February 2013 agreement, which was $1,237,500 ($0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation. The net amount of approximately $1,137,000 was reflected as non-cash compensation expense. Although we expect to continue compensating the Executives, as well as our employees, directors and consultants, with equity from time to time, we do not expect future issuances to result in this level of expense in a single quarter.

Excluding the impact of non-cash compensation expense as well as the impact, if any, arising from any fiscal 2013 goodwill impairment charges as compared to those costs in fiscal 2012, as well as increased general and administrative expenses related to any increased revenues, we expect our consolidated operating expenses for fiscal year 2013 to be less than the corresponding fiscal 2012 amounts for the year as a whole, although this cannot be assured.

Other Expense

Other expense of approximately $782,000 for the six months ended March 31, 2013 represented an approximately $441,000 (129.5%) increase as compared to the corresponding period of the prior fiscal year. This increase was in turn due to (i) an approximately $250,000, or 65.0%, increase in interest expense as compared to the corresponding period of the prior fiscal year and (ii) a debt extinguishment loss of approximately $143,000, for which there was no corresponding expense during the six months ended March 31, 2012.

The approximately $250,000 increase in interest expense was primarily attributable to:

(i) approximately $143,000 for the aggregate of cash and non-cash interest expense for certain financing directly or indirectly related to the Intella2 acquisition and recognized during the six months ended March 31, 2013 and for which there was no corresponding expense during the six months ended March 31, 2012, and

(ii) approximately $38,000 for accretion of the Intella2 preliminary purchase price, which was originally recorded at the present value of management’s estimate of total additional payments considered probable with respect to the remaining obligations incurred in connection with the Intella2 purchase. This accretion was reflected as interest expense on our statement of operations for the six months ended March 31, 2013 and there was no corresponding expense during the six months ended March 31, 2012, and

(iii) the approximately $44,000 excess of the $65,000 representing a portion of the cost of the funding commitment letter provided us in January 2012 by J&C Resources, which we recognized as interest expense for the six months ended March 31, 2013, over the $21,000 portion of the cost for this item which we recognized as interest expense for the six months ended March 31, 2012. As part of the consideration for that funding commitment letter we agreed to reimburse CCJ in cash for the shortfall, as compared to minimum guaranteed net proceeds of $139,000, from their resale of 101,744 common shares CCJ received upon their conversion of 17,500 shares of Series A-13. The ultimate shortfall liability was $85,279 and based on that amount plus (i) the increased value of the underlying common stock related to this tranche as well as a second tranche of 17,500 shares of Series A-13 owned by CCJ and (ii) the Black-Scholes value of adjustments to warrants held by Lincoln Park Capital arising from certain anti-dilution provisions, the total economic cost of this funding commitment letter was approximately $130,000, and

(iv) approximately $11,000 which represented a portion of the cost of the Funding Letter provided us in December 2012 by J&C Resources, which we recognized as interest expense for the six months ended March 31, 2013 and for which there was no corresponding expense during the six months ended March 31, 2012. As part of the consideration for that funding commitment letter we agreed to reimburse CCJ in cash for the shortfall, as compared to minimum guaranteed net proceeds of $175,000, from their resale of 437,500 common shares CCJ received upon their conversion of 17,500 shares of Series A-13. We recorded an estimated shortfall liability of $43,750 as a prepaid expense, which we are amortizing to interest expense as a cost of the Funding Letter over its one-year term ending December 31, 2013. Based on that amount plus the increased value of the underlying common stock related to this tranche of Series A-13 shares owned by CCJ, the total economic cost of this Funding Letter was approximately $151,000.

The approximately $143,000 debt extinguishment loss arose from:

(i) a December 2012 modification of the $350,000 Equipment Notes modifying the scheduled principal payment date from July 15, 2013 to payments of $100,000 on November 15, 2013, $150,000 on December 15, 2013 and $100,000 on December 31, 2013. Since we concluded that there was more than a 10% difference between the present value of the cash flows of the Equipment Notes after the December 12, 2012 modification and the present value of the cash flows under the payment terms in place one year earlier, under the provisions of ASC 470-50-40, the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the six months ended March 31, 2013. A $68,600 debt extinguishment loss was calculated as the excess of the $399,000 acquisition cost of the new debt ($350,000 face value of the notes plus the $49,000 fair value of the 140,000 common shares issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $330,400. The comparison of the present value of cash flows under the modified terms is normally done using the present value of cash flows under the terms existing immediately before the modification. However, under the provisions of ASC 470-50-40, if a modification was done less than a year ago that was not considered substantially different, then the comparison of current terms should be to the terms existing one year prior to the current modification, and

(ii) a March 2013 modification of a $100,000 note dated November 15, 2012, which principal balance was due on May 15, 2013, by its inclusion in the Fuse Note dated March 19, 2013. The Fuse Note, is payable as follows: interest only (at 12% per annum) during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year. Since we concluded that there was more than a 10% difference between the present value of the cash flows of the November 15, 2012 note after its modification (by virtue of its inclusion in the Fuse Note dated March 19, 2013) versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, the modified terms were considered substantially different and we were required to recognize a non-cash debt extinguishment loss in our statement of operations for the six and three months ended March 31, 2013. A $31,170 debt extinguishment loss was calculated as the excess of the $126,000 acquisition cost of the new debt ($100,000 face value of the portion of the March 19, 2013 note replacing the November 15, 2012 note plus the $26,000 fair value of the corresponding pro-rata portion of the common shares issued in consideration of the modification) over the net carrying amount of the extinguished debt immediately before the modification, which was $94,830, and

(iii) a March 2013 modification of one of the Intella2 Investor Notes, held by Fuse and having a $200,000 outstanding principal balance, to allow conversion of the principal balance into restricted common shares at Fuse’s option using a rate of $0.50 per share. Although there was no difference between the present value of the cash flows of the November 30, 2012 Intella2 Investor Note held by Fuse after its modification versus the present value of the cash flows before the modification, under the provisions of ASC 470-50-40, if a conversion feature added to an instrument is considered to be substantive, the modified terms are considered substantially different and extinguishment accounting is required. Since the ONSM closing price was greater than the $0.50 per share conversion price at times during the ninety days prior to granting such conversion feature (although the ONSM closing price was below $0.50 at the time the conversion feature was granted), we determined that it was at least reasonably possible that the conversion feature would be exercised and thus the conversion feature was determined to be substantive. Accordingly, we were required to recognize a $43,481 non-cash debt extinguishment loss in our statement of operations for the six and three months ended March 31, 2013, which was calculated as the excess of the $200,000 acquisition cost of the new debt over the net carrying amount of the extinguished debt immediately before the modification, which was $156,519.

Three months ended March 31, 2013 compared to the three months ended March 31, 2012 - The following table shows, for the periods indicated, the percentage of revenue represented by items on our consolidated statements of operations.

	Three months ended March 31,
	2013		2012
Revenue:

Audio and web conferencing	55.5	%	48.3	%
Webcasting	27.7		30.9
DMSP and hosting	5.3		9.6
Network usage	10.9		10.1
Other	0.6		1.1
Total revenue	100.0	%	100.0	%

Costs of revenue:

Audio and web conferencing	15.5	%	14.6	%
Webcasting	8.3		9.4
DMSP and hosting	0.8		4.7
Network usage	6.1		5.3
Other	0.4		0.5
Total costs of revenue	31.1	%	34.5	%

Gross margin	68.9	%	65.5	%

Operating expenses:
Compensation (excluding equity)	48.0	%	43.3	%
Compensation (paid with equity)	29.1		2.1
Professional fees	8.8		11.6
Other general and administrative	14.6		12.0
Depreciation and amortization	8.6		7.7
Total operating expenses	109.1	%	76.7	%

Loss from operations	(40.2)	%	(11.2)	%

Other expense, net:
Interest expense	(7.5)	%	(4.3)	%
Debt extinguishment loss	(1.7)		-
Loss from adjustment of derivative liability to fair value	-		(0.2)
Other income	-		0.2
Total other expense, net	(9.2)	%	(4.3)	%

Net loss	(49.4)	%	(15.5)	%

	For the three months ended
	March 31,				Increase (Decrease)
	2013		2012		Amount		Percent

Total revenue	$	4,395,322	$	4,656,337	$	(261,015)	(5.6)	%
Total costs of revenue		1,366,456		1,606,255		(239,799)	(14.9)
Gross margin		3,028,866		3,050,082		(21,216)	(0.7)	%

General and administrative expenses		4,419,508		3,211,382		1,208,126	37.6	%
Depreciation and amortization		375,456		358,114		17,342	4.8
Total operating expenses		4,794,964		3,569,496		1,225,468	34.3	%

Loss from operations		(1,766,098)		(519,414)		1,246,684	240.0	%

Other expense, net		(403,123)		(201,180)		201,943	100.4

Net loss	$	(2,169,221)	$	(720,594)	$	1,448,627	201.0	%

Revenues and Gross Margin

Consolidated operating revenue was approximately $4.4 million for the three months ended March 31, 2013, a decrease of approximately $261,000 (5.6%) from the corresponding period of prior fiscal year, due to decreased revenues of the Digital Media Services Group.

Digital Media Services Group revenues were approximately $1.5 million for the three months ended March 31, 2013, a decrease of approximately $463,000 (24.2%) from the corresponding period of the prior fiscal year, primarily due to a decrease in DMSP and hosting division revenues as well as a decrease in webcasting revenues.

DMSP and hosting division revenues decreased by approximately $214,000 (47.7%) for the three months ended March 31, 2013 as compared to the corresponding period of the prior fiscal year. This decline was primarily related to the July 2012 loss of a single customer that we were providing streaming services to at very little margin, as part of a larger business relationship that is still in place. Therefore, the loss of this customer and the related revenues did not have a material impact on our net operating results.

Revenues of the webcasting division, which is part of the Digital Media Services Group, also decreased by approximately $222,000 (15.4%) for the three months ended March 31, 2013 as compared to the corresponding period of the prior fiscal year. Although the approximately 1,100 webcasts we produced during the three months ended March 31, 2013 was approximately equal to the corresponding period of the prior fiscal year, the webcasts for the three months ended March 31, 2013 had a higher proportion of lower priced audio-only events, versus higher priced video events, and therefore the average revenue per webcast event of $1,132 for the three months ended March 31, 2013 represented a decrease of $213, or 15.9%, from the corresponding period of the prior fiscal year. The number of webcasts reported, as well as the resulting calculation of the average revenue per webcast event, does not include any webcast events attributed with $100 or less revenue, based on our determination that excluding such low-priced or even no-charge events increases the usefulness of this statistic. The average revenue per webcast also includes revenue billed by the webcasting division to its customers but purchased by the webcasting division from another Onstream division and thus included in that other division’s reported revenues.

Audio and Web Conferencing Services Group revenues were approximately $2.9 million for the three months ended March 31, 2013, an increase of approximately $202,000 (7.3%) from the corresponding period of the prior fiscal year. This increase was a result of revenues from the operations of our OCC division, which acquired Intella2 Inc., a San Diego-based communications company (“Intella2”) on November 30, 2012. Our OCC division is being managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The Intella2 acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail. We recognized total revenues of approximately $317,000, including approximately $67,000 of free conferencing business revenues, from those operations included in our results for the three months ended March 31, 2013.

The Infinite division revenues of approximately $2.1 million for the three months ended March 31, 2013 represent a decrease of approximately $130,000 (5.8%) as compared to the corresponding period of the prior fiscal year. This was due to a decrease in average revenue per minute, which was approximately 6.4 cents for the three months ended March 31, 2013, as compared to approximately 6.9 cents for the corresponding period of the prior fiscal year. This decrease in average revenue per minute was partially offset by a 3.7% increase in the number of minutes billed which was approximately 34.0 million for the three months ended March 31, 2013, as compared to approximately 32.7 million minutes for the corresponding period of the prior fiscal year. The average revenue per minute statistic includes auxiliary services and fees that are not billed to the customer on a per minute basis. The average revenue per minute also includes revenue billed by Infinite to its customers but purchased by Infinite from another Onstream division and thus included in that other division’s reported revenues.

As discussed above, during the third quarter of fiscal 2012, we renegotiated certain supplier contracts which reduced our Infinite division cost of sales by approximately $59,000 for the three months ended March 31, 2013, as compared to the corresponding period of fiscal 2012.

Consolidated gross margin was approximately $3.0 million for the three months ended March 31, 2013, a decrease of approximately $21,000 (0.7%) from the corresponding period of the prior fiscal year. Our consolidated gross margin percentage was 68.9% for the three months ended March 31, 2013, versus 65.5% for the corresponding period of the prior fiscal year. This was due to reductions in Infinite cost of sales and the impact of the acquired Intella2 operations, as well as the discontinuance of a single low margin DMSP and hosting customer, all as discussed above.

Operating Expenses

Consolidated operating expenses were approximately $4.8 million for the three months ended March 31, 2013, an increase of approximately $1.2 million (34.3%) from the corresponding period of the prior fiscal year, primarily due to an approximately $1.2 million, or 1,243.9%, increase in compensation paid with common shares and other equity, as compared to the corresponding period of the prior fiscal year. As discussed above, during February 2013, we agreed to issue the Executives an aggregate of 2,250,000 fully restricted ONSM common shares, which resulted in the net amount of approximately $1,137,000 being reflected as non-cash compensation expense. Although we expect to continue compensating the Executives, as well as our employees, directors and consultants, with equity from time to time, we do not expect future issuances to result in this level of expense in a single quarter.

Other Expense

Other expense of approximately $403,000 for the three months ended March 31, 2013 represented an approximately $202,000 (100.4%) increase as compared to the corresponding period of the prior fiscal year. This increase was due in turn to (i) an approximately $127,000, or 62.9%, increase in interest expense as compared to the corresponding period of the prior fiscal year and (ii) a debt extinguishment loss of approximately $75,000, for which there was no corresponding expense during the three months ended March 31, 2012.

The approximately $127,000 increase in interest expense was primarily attributable to:

(i) approximately $85,000 for the aggregate of cash and non-cash interest expense for certain financing directly or indirectly related to the Intella2 acquisition and recognized during the three months ended March 31, 2013 and for which there was no corresponding expense during the three months ended March 31, 2012, and

(ii) approximately $38,000 for accretion of the Intella2 preliminary purchase price, which was originally recorded at the present value of management’s estimate of total additional payments considered probable with respect to the remaining obligations incurred in connection with the Intella2 purchase. This accretion was reflected as interest expense on our statement of operations for the three months ended March 31, 2013 and there was no corresponding expense during the three months ended March 31, 2012.

The approximately $75,000 debt extinguishment loss arose from March 2013 modifications of (i) a $100,000 note dated November 15, 2012 and (ii) one of the Intella2 Investor Notes, held by Fuse and having a $200,000 outstanding principal balance, both as discussed above.

Liquidity and Capital Resources

For the six months ended March 31, 2013, we had a net loss of approximately $2.9 million, although cash used in operating activities for that period was approximately $1,000. Although we had cash of approximately $315,000 at March 31, 2013, our working capital was a deficit of approximately $3.3 million at that date.

We incurred new term debt of approximately $1.1 million (net of term debt repayments and excluding advances under the Line and the USAC Note) during the six months ended March 31, 2013, of which approximately $800,000 was associated specifically or generally with the Intella2 acquisition. In addition to this new financing, during the six months ended March 31, 2013, we negotiated modifications of certain debts outstanding as of September 30, 2012, which resulted in balance sheet reclassifications from short-term (i.e., current) to long-term (i.e., non-current). These new financing transactions plus renegotiation of terms of already existing financing resulted in our issuance of 1,470,000 common shares for financing related fees during the six months ended March 31, 2013, as well as our agreement to issue 225,000 additional common shares as an origination fee upon notice from the noteholder. In addition to cash repayments of term debts, during the six months ended March 31, 2013 we also repaid $175,000 of Equipment Notes by the issuance of 583,334 common shares, also agreeing to reimburse any shortfall arising from the noteholders’ resale of those shares. We also issued an aggregate of 597,500 common shares during the six months ended March 31, 2013 related to the conversion of all remaining outstanding Series A-13 and Series A-14 preferred shares.

We are obligated under a Note (the “Rockridge Note”) issued to Rockridge Capital Holdings, LLC (“Rockridge”), an entity controlled by one of our largest shareholders, which had an outstanding principal balance of approximately $677,000 at March 31, 2013. The Rockridge Note is secured by a first priority lien on all of our assets, such lien subordinated only to the extent higher priority liens on assets, primarily accounts receivable and certain designated software and equipment, are held by certain of our other lenders. We also entered into a Security Agreement with Rockridge that contains certain covenants and other restrictions with respect to the collateral.

The remaining principal balance outstanding under the Rockridge Note, as well as the related interest at 12% per annum, is payable in equal monthly installments of $41,322 ending on September 14, 2014 (the “Maturity Date”). Upon notice from Rockridge at any time and from time to time prior to the Maturity Date, all or part of the outstanding principal amount of the Rockridge Note may be converted into a number of restricted shares of ONSM common stock. These conversions are subject to a minimum of one month between conversion notices (unless such conversion amount exceeds $25,000) and will use a conversion price of eighty percent (80%) of the fair market value of the average closing bid price for ONSM common stock for the twenty (20) days of trading on the OTCQB (or such other exchange or market on which ONSM common shares are trading) prior to such Rockridge notice, but such conversion price will not be less than $2.40 per share.

The Note and Stock Purchase Agreement with Rockridge calls for our issuance of an origination fee, upon not less than sixty-one (61) days written notice to us, of 591,667 restricted shares of our common stock (the “Shares”). The value of those Shares is subject to a limited guaranty of no more than an additional payment by us of $75,000 which will be effective in the event the Shares are sold for an average share price less than the minimum of $1.20 per share (the “Shortfall Payment”) We have recorded no accrual for this matter on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share on was used as a basis of calculation, the required Shortfall Payment would be approximately $75,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

Including the fair market value of the Shares at the time they were recorded on our books, plus legal fees paid by us, the effective interest rate of the Rockridge Note was approximately 44.3% per annum, until a September 2009 amendment, when it was reduced to approximately 28.0% per annum and a December 2012 amendment, when it was increased to approximately 29.1% per annum. These rates do not give effect to any difference between the sum of the value of the Shares at the time of issuance plus any Shortfall Payment, as compared to the assigned value of the Shares on our books, nor do they give effect to the discount from market prices that might be applicable if any portion of the principal is satisfied in common shares instead of cash.

In December 2007, we entered into a line of credit arrangement (the “Line”) with a financial institution (the “Lender”) under which we may presently borrow up to an aggregate of $2.0 million for working capital, collateralized by our accounts receivable and certain other related assets. Borrowings under the Line are subject to certain formulas with respect to the amount and aging of the underlying receivables. The outstanding balance (approximately $1.7 million as of May 10, 2013) bears interest at 12.0% per annum, adjustable based on changes in prime, plus a weekly monitoring fee of one twentieth of a percent (0.05%) of the borrowing limit. The outstanding principal under the Line may be repaid at any time, and the term may be extended by us past the current December 27, 2013 expiration date for an extra year, subject to compliance with all loan terms, including no material adverse change, as well as concurrence of the Lender. The outstanding principal is due on demand in the event a payment default is uncured one (1) day after written notice.

The Line is also subject to our compliance with a quarterly debt service coverage covenant (the “Covenant”). The Covenant, as defined in the applicable loan documents for quarterly periods after December 31, 2011, requires that the sum of (i) our net income or loss, adjusted to remove all non-cash expenses as well as cash interest expense and (ii) contributions to capital (less cash distributions and/or cash dividends paid during such period) and proceeds from subordinated unsecured debt, be equal to or greater than the sum of cash payments for interest and debt principal payments. We have complied with this Covenant for all quarters through March 31, 2013.

Effective February 2012, the modified terms of the Line require that all funds remitted by our customers in payment of our receivables be deposited directly to a bank account owned by the Lender. Once those deposited funds become available, the Lender is then required to immediately remit them to our bank account, provided that we are not in default under the Line and to the extent those funds exceed any past due principal, interest or other payments due under the Line, which the Lender may offset before remitting the balance.

Interest, computed at 17% per annum on the outstanding principal balance, is payable in monthly installments commencing April 30, 2013. The principal balance is payable as follows:

June 30, 2013	$7,000
July 31 – September 30, 2013	$12,000 per month
October 31, 2013 – March 31, 2014	$22,000 per month
April 30 – June 30, 2014	$35,000 per month
July 31 – September 30, 2014	$40,000 per month
October 31 – November 30, 2014	$50,000 per month
December 18, 2014	$50,000
December 18, 2014 – Balloon payment	$50,000 plus funded portion of Contingent Financing

The balloon payment is convertible into restricted common shares, at Sigma’s option, using a conversion rate of $1.00 per share.

Aggregate Capital Raise	Early Repayment Amount
$500,000 to $1,000,000	Lesser of outstanding principal plus interest or 25% of Capital Raise
$1,000,001 to $2,000,000	Lesser of outstanding principal plus interest or 50% of Capital Raise (reduced by any amounts previously repaid as a result of a Capital Raise transaction)
$2,000,001 or Higher	All outstanding principal plus Interest must be paid

In connection with this financing, we issued 300,000 restricted common shares to Sigma and agreed to reimburse up to $30,000 of Sigma’s legal and other expenses related to this financing, $27,500 of which was paid by us at the Sigma Closing. We also issued 60,000 restricted common shares to Sigma Capital Advisors, LLC (“Sigma Capital”) and agreed to pay them a $75,000 advisory fee, in connection with an Advisory Services Agreement we entered into with Sigma Capital effective March 18, 2013. $55,000 of the cash fee was paid by us at the Sigma Closing and the remaining $20,000 is being paid over the next four months. We also paid finders and other fees to unrelated third parties in connection with this transaction, which totaled 60,000 restricted common shares and $12,000 cash. Including the value of the common stock issued plus the amount of cash paid for related financing fees and expenses results in an effective interest rate of approximately 60% per annum. This effective interest rate would decrease if the Contingent Financing is received, since there would be no further fees or costs, other than the stated interest rate, in connection with receipt of those funds. This effective rate would increase in the event an Early Repayment Amount was required, as discussed above.

As of March 31, 2013, we were obligated for $200,000 under an unsecured subordinated note issued on March 19, 2013 to Fuse Capital LLC (“Fuse”) (the “Fuse Note”). The Fuse Note, which is convertible into restricted common shares at Fuse’s option using a rate of $0.50 per share, is payable as follows: interest only (at 12% per annum) during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year.

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

As of March 31, 2013, we were obligated for $333,333 under unsecured subordinated notes issued to various unrelated lenders from April 2012 through January 2013, which are fully subordinated to the Line and the Rockridge Note. These notes bear cash interest at rates generally ranging from 12% to 20% per annum and the principal is due as follows: $16,666 in April 2013, $8,333 in May 2013, $58,334 in June 2013, $150,000 in July 2013 and $100,000 in October 2014. Including the value of common shares issued to the various unrelated lenders in connection with these notes results in effective interest rates ranging from approximately 21% to 66% per annum.

As of March 31, 2013, we were obligated for $650,000 outstanding principal on unsecured subordinated notes issued in November 2012 to various unrelated lenders, which are fully subordinated to the Line and the Rockridge Note. These notes bear cash interest at 12% per annum. Note payments are interest only during the first year, approximately 30% of the principal plus interest during the second year and the remaining principal balance at the end of the second year. One of these notes, held by Fuse and having a $200,000 outstanding principal balance, is convertible into restricted common shares at Fuse’s option using a rate of $0.50 per share. Including the value of common shares issued to the various unrelated lenders in connection with these notes results in effective interest rates ranging from approximately 26% to 43% per annum, except that the effective interest rate of the note held by Fuse is 12% per annum, after the write-off of a portion of the value of these common shares as a debt extinguishment loss, arising from the March 2013 modification of the note held by Fuse to add the conversion feature.

In connection with the above financing, we issued to the holders of the certain of the above notes having an initial outstanding balance of $450,000 an aggregate of 180,000 restricted common shares, which we have agreed to buy back, under certain terms. The buy-back terms are as follows: If the fair market value of the stock is not equal to at least $0.40 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 90,000 shares of the originally issued stock from the investor at $0.40 per share. If the fair market value of the stock is not equal to at least $0.40 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 180,000 shares of the originally issued stock, less the amount of any shares already bought back at the one year point, from the investor at $0.40 per share. The above only applies to the extent the stock is still held by the investor(s) at the applicable dates. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share used as a basis of calculation, no stock repurchase payment would be required. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

In connection with the above financing, we issued to the holders of the notes having an initial outstanding balance of $200,000 an aggregate of 240,000 restricted common shares, of which we have agreed to buy back up to 40,000 shares, under certain terms. The buy-back terms are as follows: If the fair market value of the stock is not equal to at least $0.80 per share on the date one (1) year after issuance, we will buy back, to the extent permitted by law, up to 20,000 shares of the originally issued stock from the investor at $0.80 per share. If the fair market value of the stock is not equal to at least $0.80 per share on the date two (2) years after issuance, we will buy back, to the extent permitted by law, up to 40,000 shares of the originally issued stock, less the amount of any shares already bought back at the one year point, from the investor at $0.80 per share. The above only applies to the extent the stock is still held by the investor(s) at the applicable dates. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, the required stock repurchase payment would be approximately $32,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

As of March 31, 2013, we were obligated for $129,344 under a subordinated note issued to CCJ dated December 31, 2012 and payable in monthly principal and interest installments of $6,862, which includes interest at 12% per annum.

On March 13, 2013 we were obligated for $357,538 under a letter agreement promissory note with the Universal Service Administrative Company (“USAC”), payable in monthly installments of $19,075 through December 15, 2014 (the “USAC Note”). These payments include interest at 12.75% per annum. This letter agreement promissory note is related to our liability for Universal Service Fund (USF) contribution payments previously reflected as an accrued liability on our balance sheet and therefore resulted in the reclassification of a portion of that accrued liability to notes payable. USAC is a not-for-profit corporation designated by the Federal Communications Commission (“FCC”) as the administrator of the USF program.

In December 2012, as part of a transaction under which J&C Resources issued us a Funding Letter, we agreed to reimburse CCJ in cash the shortfall, payable on December 31, 2014, as compared to minimum guaranteed net proceeds of $175,000, from their resale of 437,500 common shares CCJ received on December 31, 2012 upon their conversion of 17,500 shares of Series A-13 and after effecting our agreement as part of the same transaction to reduce the conversion rate on all Series A-13 shares from $1.72 per common share to $0.40 per common share. We recorded an estimated shortfall liability of $43,750 as a prepaid expense, which we are amortizing to interest expense as a cost of the Funding Letter over its one-year term ending December 31, 2013. Based on an ONSM price of $0.41 per share on May 10, 2013, the gross proceeds would be approximately $179,000 and therefore no adjustment to the estimated shortfall liability is necessary at this time. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

During the six months ended March 31, 2013 we repaid $175,000 of Equipment Notes by the issuance of 583,334 common shares. However, the terms of the Equipment Notes still provide that on the Maturity Dates (ranging from November 15, 2013 through December 31, 2013), the Recognized Value shall be calculated as the sum of the following two items – (i) the gross proceeds to the Investors from the sales of the 583,334 shares issued per the December 12, 2012 modification plus (ii) the value of those shares issued and still held by the Noteholders and not sold, using the average ONSM closing bid price per share for the ten (10) trading days prior to the Maturity Dates. If the Recognized Value exceeds the Credited Value, then we shall receive 50% (fifty percent) of such excess, although the amount received by us shall not exceed $175,000. If the Credited Value exceeds the Recognized Value, then we shall be obligated to pay such excess to the Noteholders. We have recorded no accrual for this matter on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, the Noteholders would owe us approximately $32,000. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”). The acquisition included a list of over 2,500 customers as well as software licenses, equipment and network infrastructure and a non-compete. The service capabilities acquired from Intella2 include audio conferencing, web conferencing, text messaging, and voicemail. The Intella2 assets and operations were purchased by Onstream Conferencing Corporation, our wholly owned subsidiary, and will be managed by our Infinite Conferencing division, which specializes in audio and web conferencing. The unaudited revenues from the acquired operations for the twelve months ended August 31, 2012 were approximately $1.4 million, including free conferencing business revenues of approximately $300,000. The acquired Intella2 operations have achieved positive operating cash flow through March 31, 2013, which we expect to continue for the foreseeable future.

The total preliminary purchase price of the Intella2 assets and operations has been determined to be approximately $1.4 million, of which we have paid approximately $713,000 in cash to Intella2 through March 31, 2013. The remaining portion of the total preliminary purchase price, approximately $704,000, is the present value of management’s estimate of total additional payments considered probable with respect to the following remaining obligations incurred in connection with the Intella2 purchase:

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

To the extent there is any shortfall from the gross proceeds upon resale by the Executives of the Executive Shares as compared to twenty-nine cents ($0.29) per share, the shortfall will be reimbursed to the Executives by us in cash, or at our option, by the issuance of additional fully vested ONSM common shares (the “Additional Executive Shares”), with the Additional Executive Shares subject to reimbursement by us to the Executives of any shortfall from the gross proceeds upon resale as compared to the fair value used to determine the number of such Additional Executive Shares. All shortfall reimbursements shall be payable by us within ten (10) business days after presentation by reasonable supporting documentation of the shortfall to us by the Executives. We have recorded no liability for this commitment on our financial statements through March 31, 2013, since we believe that the variables affecting any eventual liability cannot be reasonably estimated at this time. However, if an ONSM share price of $0.41 per share was used as a basis of calculation, no additional payment, or share issuance, would be required with respect to the Executive Shares. The closing ONSM share price was $0.49 per share on May 10, 2013. However, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share.

The Executive Shares have been recorded on our financial statements based on their fair value at the time of the January 22, 2013 agreement, which was $578,000 ($0.34 per share), with the approximately $86,000 excess of that fair value over the amount of the previously recorded liability being satisfied by such issuance reflected as non-cash compensation expense.

· Record revenues in each of fiscal years 2011 through 2015.

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

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

The 2,250,000 Executive Incentive Shares currently issuable have been recorded on our financial statements based on their fair value at the time of the February 20, 2013 agreement, which was $1,237,500 ($0.55 per share), less the approximately $100,000 Black-Scholes value of the cancelled stock options as calculated immediately before their cancellation.

Projected capital expenditures for the twelve months ending December 31, 2013 total approximately $950,000, which includes software and hardware upgrades to the DMSP, the webcasting platform (including iEncode) and the audio and web conferencing infrastructure, as well as costs of software development and hardware costs in connection with the MarketPlace365 platform. Some of these projected capital expenditures may be financed, deferred past the twelve month period or cancelled entirely, depending on our other cash flow considerations.

On September 17, 2010, we entered into a Purchase Agreement (the “Purchase Agreement”) with Lincoln Park Capital Fund, LLC (“LPC”), whereby LPC agreed to an initial purchase of 300,000 shares of our common stock and 420,000 shares of our Series A-14 Preferred Stock (“Series A-14”), together with a warrant to purchase 540,000 of our common shares. In accordance with the Purchase Agreement, LPC also received 50,000 shares of our common stock as a one-time commitment fee and a cash payment of $26,250 as a one-time structuring fee. On September 24, 2010, we received $824,045 net proceeds (after deducting fees and legal, accounting and other out-of-pocket costs incurred by us) related to our issuance under that Purchase Agreement of the equivalent of 770,000 common shares (including those issuable upon conversion of the preferred shares).

During the year ended September 30, 2011, we sold LPC an additional 1,530,000 shares of our common stock under that Purchase Agreement for net proceeds of $1,408,192. LPC remains committed to purchase, at our sole discretion, up to an additional 1.8 million (which quantity is after giving effect to the terms of an April 28, 2011 amendment to the Purchase Agreement) shares of our common stock in installments over the remaining term of the Purchase Agreement, generally at prevailing market prices, but subject to the specific restrictions and conditions in the Purchase Agreement. There is no upper limit to the price LPC may pay to purchase these additional shares. The purchase of our shares by LPC will occur on dates determined solely by us and the purchase price of the shares will be fixed on the purchase date and will be equal to the lesser of (i) the lowest sale price of our common stock on the purchase date or (ii) the average of the three (3) lowest closing sale prices of our common stock during the twelve (12) consecutive business days prior to the date of a purchase by LPC. LPC shall not have the right or the obligation to purchase any shares of our common stock from us at a price below $0.75 per share. Our most recent sale of shares to LPC under the Purchase Agreement was on August 30, 2011. The closing ONSM share price has been less than $0.75 per share for most of the trading days since that date and the closing market price was $0.49 per share on May 10, 2013. Also, there was very low trading volume of ONSM common shares on May 10, 2013 – the volume weighted average price for the week then ended was $0.41 per share. Accordingly, we are not currently able to sell additional common shares to LPC under that Purchase Agreement.

The Purchase Agreement has a term of 36 months and expires accordingly on September 17, 2013, but it may be terminated by us at any time at our discretion without any cost to us and may be terminated by us at any time in the event LPC does not purchase shares as directed by us in accordance with the terms of the Purchase Agreement. LPC may terminate the Purchase Agreement upon certain events of default set forth therein, including but not limited to the occurrence of a material adverse effect, delisting of our common stock and the lack of immediate relisting on one of the specified alternate markets and the lapse of the effectiveness of the applicable registration statement for more than the specified number of days. As a result of the October 22, 2012 transfer of the listing of our common shares from NASDAQ to OTCQB, and the resulting loss of our S-3 eligibility, the applicable registration statement is no longer effective. However, on November 20, 2012 LPC provided us with a letter stating that the lapse of the effectiveness of the applicable registration statement would not be considered an event of default under the Purchase Agreement, although LPC would not be required to purchase shares under the Purchase Agreement until the effectiveness of the applicable registration statement is restored or a replacement registration statement is filed. The Purchase Agreement restricts our use of variable priced financings for the greater of one year or the term of the Purchase Agreement and, in the event of future financings by us, allows LPC the right to participate under conditions specified in the Purchase Agreement.

On December 21, 2012, we received a funding commitment letter (the “Funding Letter”) from J&C Resources, Inc. (“J&C”), agreeing to provide us, within twenty (20) days after our notice given on or before December 31, 2013, aggregate cash funding of up to $550,000, which may be requested in multiple tranches. Mr. Charles Johnston, who was one of our directors at the time of the transaction, is the president of J&C. This Funding Letter was obtained solely to demonstrate our ability to obtain short-term funds in the event other funding sources are not available, but does not represent any obligation to accept such funding on these terms and is not expected by us to be exercised. Cash provided under the Funding Letter would be in exchange for our issuance of (a) a note or notes with interest payable monthly at 15% per annum and principal payable on the earlier of a date twelve months from funding or July 1, 2014 and (b) our issuance of 2.3 million unregistered common shares, which shares would be prorated in the case of partial funding. The note or notes would be unsecured and subordinated to all of our other debts, except to the extent such the terms of such debts would allow pari passu status. Furthermore, the note or notes would not be subject to any provisions, other than with respect to priority of payments or collateral, of our other debts. Upon receipt by us of an equivalent amount in dollars of investment from any other source after the date of this Funding Letter, other than funding received in connection with the LPC Purchase Agreement, to refinance existing debt and up to $500,000 funding for general working capital or other business uses, this Funding Letter will be terminated. From the date of the Funding Letter through May 10, 2013, we have received funding of approximately $1.5 million, of which approximately $1.0 million was refinancing of existing debt and approximately $500,000 was new funding for general working capital or other business uses. The $1.5 million excludes advances made under the Line after the date of the Funding Letter, which are considered to be refinancing of existing debt since the outstanding balance under the Line as of May 10, 2013 is less than the outstanding balance under the Line as of the date of the Funding Letter. Accordingly, the Funding Letter remains in effect as of May 10, 2013.

We have incurred losses since our inception, and have an accumulated deficit of approximately $134.4 million as of March 31, 2013. Our operations have been financed primarily through the issuance of equity and debt, including convertible debt and debt combined with the issuance of equity. Cash required to fund our continued operations will be affected by numerous known and unknown risks and uncertainties including, but not limited to, our ability to successfully market and sell the DMSP, iEncode and MarketPlace365 products and services as well as our other existing products and services, the degree to which competitive products and services are introduced to the market, our ability to control and/or reduce expenses, our need to invest in new equipment and/or technology, and our ability to service and/or refinance our existing debt and accounts payable. We cannot assure that our revenues will continue at their present levels, nor can we assure that they will not decrease.

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

Cash used in operating activities was approximately $1,000 for the six months ended March 31, 2013, as compared to approximately $392,000 provided by operations for the corresponding period of the prior fiscal year. The approximately $1,000 used in operating activities reflects our net loss of approximately $2.9 million, reduced by approximately $2.7 million of non-cash expenses included in that loss and by approximately $125,000 arising from a net decrease in non-cash working capital items during the period and increased by approximately $27,000 of non-cash income included in that loss. The $225,000 net decrease in non-cash working capital items for the six months ended March 31, 2013 is primarily due to an approximately $280,000 increase in accounts payable, accrued liabilities and amounts due to directors and officers and an approximately $125,000 decrease in accounts receivables, partially offset by an approximately $68,000 increase in prepaid expenses and an approximately $114,000 decrease in deferred revenue. The $225,000 decrease in non-cash working capital items compares to a net decrease in non-cash working capital items of approximately $211,000 for the corresponding period of the prior fiscal year. The primary non-cash expenses included in our loss for the six months ended March 31, 2013 were approximately $1.4 million of employee compensation expenses paid with common shares and other equity and approximately $705,000 of depreciation and amortization. The primary sources of cash inflows from operations are from receivables collected from sales to customers.

Cash used in investing activities was approximately $1.2 million for the six months ended March 31, 2013 as compared to approximately $425,000 for the corresponding period of the prior fiscal year. Current period investing activities related primarily to the Intella2 acquisition. Prior period investing activities related primarily to the acquisition of property and equipment, including capitalized software development costs and these investing activities were included in the current period as well.

Cash provided by financing activities was approximately $1.1 million for the six months ended March 31, 2013 as compared to approximately $78,000 provided in the corresponding period of the prior fiscal year. Current year period financing activities, as well as those in the comparable prior year period, primarily related to proceeds from notes payable, partially offset by repayments of notes and leases payable. Most of the cash provided by financing activities for the six months ended March 31, 2013 was associated specifically or generally with the Intella2 acquisition.

Critical Accounting Policies and Estimates

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

Goodwill and Other Intangible Assets:

Our prior acquisitions of several businesses, including Infinite Conferencing, Intella2, EDNet and Acquired Onstream, have resulted in significant increases in goodwill and other intangible assets. Goodwill and other unamortized intangible assets, which include acquired customer lists, were approximately $11.3 million at March 31, 2013, representing approximately 64% of our total assets and approximately 118% of the book value of shareholder equity. In addition, property and equipment as of March 31, 2013 includes approximately $2.4 million (net of depreciation) related to the capitalized development costs of the DMSP, MP365 and Webcasting/iEncode platforms, representing approximately 14% of our total assets and approximately 25% of the book value of shareholder equity.

In accordance with GAAP, we periodically test these assets for potential impairment. As part of our testing, we rely on both historical operating performance as well as anticipated future operating performance of the entities that have generated these intangibles. Factors that could indicate potential impairment include a significant change in projected operating results and cash flow, a new technology developed and other external market factors that may affect our customer base. We will continue to monitor our intangible assets and our overall business environment. If there is a material adverse and ongoing change in our business operations (or if an adverse change initially considered temporary is determined to be ongoing), the value of our intangible assets, including those of our DMSP, Infinite, webcasting or MP365 divisions, could decrease significantly. In the event that it is determined that we will be unable to successfully market or sell our DMSP, audio and web conferencing, iEncode or MP365 services, an impairment charge to our statement of operations could result. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition and results of operations.

In accordance with the Intangibles – Goodwill and Other topic of the ASC, goodwill is reviewed annually (or more frequently if impairment indicators arise) for impairment and is tested using a two-step process. However, with respect to our annual impairment review of our goodwill and other acquisition-related intangible assets conducted as of September 30, 2012, we applied the provisions of ASU 2011-08, which allows us to forego the two-step impairment process based on certain qualitative evaluation, and which pronouncement we first adopted for our annual impairment review conducted as of September 30, 2011. This qualitative evaluation included our assessment of relevant events and circumstances as listed in ASU 2011-08, some of which relate to the Onstream Media corporate entity (“ONSM”) as a whole, which includes reporting units with acquired goodwill and other intangible assets as well as other operations engaged in by ONSM, and some of which pertain to the individual reporting units.

In the event that after qualitative evaluation the two step process is still required, the first step compares the fair value of a reporting unit with its carrying amount, including goodwill. The second step, if necessary, measures the amount of the impairment, including a comparison and reconciliation of the carrying value of all of our reporting units to our market capitalization, after appropriate adjustments for control premium and other considerations. If our market capitalization, after appropriate adjustments for control premium and other considerations, is determined to be less than our net book value (i.e., stockholders’ equity as reflected in our financial statements), that condition might indicate an impairment requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition and results of operations.

Based on this qualitative evaluation, with respect to the Infinite and EDNet reporting units, we determined that it was more likely than not, as well as clear, that the fair values of the Infinite and EDNet reporting units were more than their respective carrying amounts and accordingly it would not be necessary to perform the two-step goodwill impairment test with respect to those reporting units as of September 30, 2012. However, we were unable to arrive at the same conclusion as a result of our qualitative evaluation of the Acquired Onstream business unit. Accordingly, we performed impairment tests on Acquired Onstream as of September 30, 2012, using the two-step process described above and we determined that Acquired Onstream’s goodwill was impaired as of that date. Based on that condition, a $550,000 adjustment was made to reduce the carrying value of goodwill as of that date.

Contingent Purchase Price:

On November 30, 2012 we acquired certain assets and operations of Intella2 Inc., a San Diego-based communications company (“Intella2”). The total preliminary purchase price of the Intella2 assets and operations has been determined to be approximately $1.4 million, of which we have paid approximately $713,000 in cash to Intella2 through March 31, 2013. The remaining portion of the total preliminary purchase price, approximately $704,000, plus approximately $38,000 accretion for a total liability of approximately $742,000, is the present value of management’s estimate of total additional payments considered probable with respect to the remaining obligations incurred in connection with the Intella2 purchase. These payment obligations are based on eligible revenues (which exclude free conferencing business revenues and non-recurring revenues) for the twelve months ending November 30, 2013 as well as a percentage (between 50 and 70%) of the free conferencing business revenues, net of applicable expenses, from December 1, 2012 through November 30, 2017. The total purchase price and the liability for the unpaid portion of that purchase price recorded by us as of March 31, 2013 depends significantly on projections and estimates. Authoritative accounting guidance allows one year from the acquisition date for us to make adjustments to these amounts, in the event that such adjustments are based on facts and circumstances that existed as of the acquisition date that, if known, would have resulted in such adjusted assets and liabilities as of that date. Regardless of this, a contingent consideration liability shall be remeasured to fair value at each reporting date until the contingency is resolved. Changes resulting from facts and circumstances arising after the acquisition date, such as meeting a revenue target, shall be recognized in our results of operations. Changes resulting from a change in the discount rates applied to estimates of future cash flows shall also be recognized in our results of operations.

ITEM 4. CONTROLS AND PROCEDURES

Limitations on the effectiveness of controls

We are responsible for establishing and maintaining adequate disclosure controls and procedures and internal control over financial reporting. Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of external financial statements in accordance with generally accepted accounting principles. However, all control systems, no matter how well designed, have inherent limitations. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Therefore, even those systems determined to be effective can provide only reasonable, not absolute, assurance with respect to financial statement preparation and presentation. Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements, omissions, errors or even fraud. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Management’s report on disclosure controls and procedures:

As required by Rules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934, as of the end of the period covered by the quarterly report, being March 31, 2013, we have carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer along with our Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that our disclosure controls and procedures are effective.

Changes in internal control over financial reporting:

As required by Rules 13a-15(d) and 15d-15(d) under the Securities Exchange Act of 1934, we have carried out an evaluation of changes in our internal control over financial reporting during the period covered by this Quarterly Report. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer along with our Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer along with our Chief Financial Officer concluded that there was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

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

On March 19, 2013 we issued 135,975 unregistered common shares for professional marketing consultant services as well as other operating expenses valued at approximately $46,000, which were recognized as earned at the time of issuance. None of these shares were issued to our directors or officers.

On April 8, 2013 we issued 100,000 unregistered common shares for professional sales and marketing services valued at approximately $46,000, which are being recognized as professional fees expense over a service period of twelve months. None of these shares were issued to our directors or officers.

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

Item 3. Defaults upon Senior Securities

None.

Item 4. Removed and Reserved

Item 5. Other Information

None.

100

Item 6. Exhibits

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

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

32.1 - Section 906 Certification of Chief Executive Officer

32.2 - Section 906 Certification of Chief Financial Officer

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

101.INS - XBRL Instance Document

101.SCH - XBRL Taxonomy Extension Schema Document

101.CAL - XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF - XBRL Taxonomy Extension Definition Linkbase Document

101.LAB - XBRL Taxonomy Extension Label Linkbase Document

101.PRE - XBRL Taxonomy Extension Presentation Linkbase Document

Note: The XBRL (Extensible Business Reporting Language) information in Exhibit 101 and its subparts, as listed above, is furnished and not filed, is not a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

SIGNATURES

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

		Onstream Media Corporation,
		a Florida corporation

Date: May 15, 2013

		/s/ Randy S. Selman
		Randy S. Selman,
		President and Chief Executive Officer

		/s/ Robert E. Tomlinson
		Robert E. Tomlinson
		Chief Financial Officer
		And Principal Accounting Officer

101

Onstream Media Corporation

TABLE OF CONTENTS

PART II – OTHER INFORMATION

CONSOLIDATED BALANCE SHEETS

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

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

ONSTREAM MEDIA CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

CONSOLIDATED STATEMENTS OF CASH FLOWS

Preferred Stock

Preferred Stock (continued)